Considering hiring, but can’t decide if you should bring on an employee or a self-employed contractor? Or maybe you have a job opportunity, but the company wants to hire you as a contractor rather than an employee and you aren’t sure if that’s right for you.
In this article we’ll discuss the differences between employees and self-employed individuals from the company’s perspective, as well as the worker’s perspective. There’s a lot at stake, so read carefully!
Features of an Employment Relationship
In an employment relationship, an employer is responsible for withholding certain deductions at source, such as federal and provincial income tax, Canada Pension Plan (CPP), and Employment Insurance (EI). Also, employees are entitled to certain rights, such as severance, statutory holiday pay, and vacation pay, under various provincial employment standards acts, such as the Alberta Employment Standards Code. An employment relationship is assumed to be ongoing unless otherwise stipulated in the employment contract. Pay can be hourly, salary, or commission based and can include bonuses. Employers typically administer certain benefits (such as sickness benefits) on behalf of their employees.
Features of a Self-Employed Contractor
A contractor is an individual or company hired to provide services to another, most commonly for a limited time or for a particular project. The payer has no obligation to withhold CPP, EI, or tax from the contractor’s pay, and the typical minimum standards inherent in an employment relationship do not apply. These are a few reasons why many companies prefer to use contractors as it drastically simplifies the legal and tax side of the relationship.
Contractors have to maintain their own medical and other benefits and pay into the CPP (either through source deductions for Personal Service Businesses or on their personal tax returns). However, the payer may prefer the stability of an employment relationship as contractors are typically allowed to take on other work and to subordinate their duties, subject to the terms of the sub-contract agreement.
4 Factors That the CRA Considers in Determining if a Worker is an Employee or Self-employed
As mentioned earlier, the payer and the worker cannot simply contract their way out of an employment relationship; even if it was clear that the parties intended to enter into a sub-contract agreement, the relationship may prove to be an employment relationship. All of the facts of the relationship, not just the agreement, matter when making this determination, so it is important to structure sub-contract relationships accordingly. Four factors* the CRA will consider are:
1. What is the payer’s degree of control over the work?
A high degree of payer control over the work is conducive to an employment relationship. Does the payer control and manage the worker’s day-to-day activities, methods, and results? Does the worker need permission to work for other payers? Did the worker receive training to perform the work? This may be difficult to determine in situations where the worker has a high degree of autonomy but it is a factor the CRA will consider.
2. Who provides the tools to perform the work?
When the worker is provided with an office, company car, cell phone, laptop and software, physical tools (screw drivers, hammers, drills), etc. to perform the work it is conducive to an employment relationship, especially if the payer maintains ownership and control over the tools after the relationship has terminated. Note that some employers require employees to provide their own tools, and generally provide a form T2200 Declaration of Conditions of Employment to allow the employee to deduct such costs from their income.
3. Can the worker sub-contract their work or hire assistants?
In a sub-contract agreement, the worker can typically decide who performs the work and how it is performed, subject to the terms of the agreement. A relationship where the worker cannot sub-contract out their duties is conducive to an employment relationship.
4. What is the worker’s degree of financial risk and opportunity for profit?
Is the worker reimbursed for all their costs or are they required to pay their fixed monthly costs? Does the worker have to pay their own operating expenses? Are they financially responsible if they don’t get the job done? Is the worker required to make capital investments in the payer’s business? Does the worker have a business presence (website, physical location, etc.)? Can the worker increase their chance of profit by managing costs and accepting multiple sub-contract agreements at the same time? Relationships where the worker has no financial risks and no opportunity to increase their profit are conducive to an employment relationship. Note that commissions and bonuses are not considered opportunities to increase profits for these purposes.
* If you live in or your business is resident in Quebec, different rules may apply to you.
What Happens When You Get it Wrong?
If a payer has hired a worker under a sub-contract agreement, and the worker is later found to be an employee, the payer may be exposed to legal and financial liabilities under the various provincial labour laws (severance, vacation pay, etc.). The payer could also be liable for paying the employer’s and employee’s portion of the CPP and EI that should have been withheld, as well as for failure to withhold penalties and interest under the Income Tax Act. The penalty is typically 10%, but can run up to 20%, of the amounts not withheld. In addition to this there will be annual interest on overdue amounts at the CRA’s prescribed rates.
What is a Personal Services Business?
Payers will often require contractors to incorporate a company rather than contracting with the individual directly. This is done because it is legally impossible for a corporation to be an employee in Canada, thus the above factors are irrelevant in the eyes of the payer. It’s a simple solution for the payer; however, it pushes several burdens on to the contractor that the contractor should consider prior to entering into such an agreement.
First and foremost, the contractor will now be responsible for maintaining a corporation, which means they will be responsible for:
- Hiring a bookkeeper to keep proper books and records for tax reporting
- Hiring a corporate accountant to prepare yearend financial statements and tax returns, which are much more complex, and expensive, to prepare than personal tax returns
- Abiding by all the annual provincial legal responsibilities of maintaining a corporation
- Running payroll, calculating withholdings, and remitting them to the CRA on time (heavy penalties apply for getting it wrong), and filing annual T4 summaries and slips to report their personal earnings from their corporation
- Registering for, collecting, remitting, and reporting GST/HST/PST on the service provided
We have prepared an in-depth analysis called “Sole Proprietorship vs. Corporation vs. Partnership” where we review all the pros and cons of incorporation.
If the contractor incorporates a company, they must then consider whether the business the corporation carries on is a “Personal Services Business” (PSB) according to Canada’s tax laws. A PSB is a corporation set up to perform services that would typically be performed by an officer or an employee of that entity. A PSB is sometimes referred to as an “Incorporated Employee.” A quick way to determine if a business is a PSB is to determine if the worker would be considered an employee of the payer, if not for the existence of the corporation. You can use the four factors above to determine that.
The worker may not be considered a PSB if they participate in a third-party relationship where another company solicits and arranges contracts for the worker. Consult with your tax adviser to determine if this applies.
Consequences of Having Personal Service Business Income in your Corporation
For all intents and purposes, PSBs are only allowed to deduct salaries, wages, remuneration, and benefits paid to the ‘incorporated employee’. This means that all the other tax deductions of the PSB are denied, including:
- The small business deduction that brings the corporate tax rate to 11% (AB – 2020)
- The General Rate reduction that brings the federal corporate tax rate down 10%
- Automobile, home office, cell phone, capital cost allowance on items like computers and equipment, etc.
PSBs in Alberta are taxed at 38% (2020), and all their deductions are denied. This treatment nearly eliminates any tax advantages of having a corporation between the payer and the worker, and completely eliminates any advantages if the worker needs all of the corporation’s income to fund personal living expenses. Thus, it is important for workers to be cognizant of the additional costs and burdens of maintaining a corporation.
We typically advise workers who are forced to incorporate to accept a contract to negotiate an increased wage (above what an employee in a similar position would receive) in order to cover the additional costs of maintaining a corporation, medical benefits, and other items noted above.
You can find more information about employees vs. self-employed contractors on the government’s website here.
Are you unsure if your workers are employees or self-employed contractors? Are you worried that your corporation might be providing PSB services? We love chatting with entrepreneurs, so please reach out.
Get Expert Advice & Follow It
Talk to a tax specialist in advance of making a hire to ensure that your company understands whether its hiring employees or contractors. If you would like to discuss this with us further, please reach out — we love chatting with entrepreneurs and we’d love to hear your story.