I am a Contractor, Unless CRA Says Otherwise

While we may be uncomfortable with a little bit of gray in our business relationships, the Canada Revenue Agency (CRA) is not. One issue that has fuzzy boundaries, but must be defined for tax purposes, is the issue of employee versus contractor.

Business owners need to be concerned about the distinction because they must remit payroll taxes on behalf of employees and provide employees with reasonable notice of termination. However, these rules do not apply to contractors (although there are some cases of reasonable notice for contractors). Individuals need to be concerned about the distinction because there are certain tax write-offs that are permitted for contractors (self-employed individuals) that are not permitted for employees.

In a perfect world, without CRA, (how utopian is that?), both the employer and employee would have a predilection to achieve monetary savings by ensuring work agreements are structured as independent contractor agreements. In fact, especially in the computer consultant world, many companies require the worker to incorporate a company to further insulate the payer company from CRA.

Many employers however ignore other factors that come into play. Since they are not withholding income taxes, Workers Compensation and Employee Health Tax, the contractor (or their corporation) is liable for these taxes. I have seen many cases where the contractor does not deal with these taxes and instead comes back to the employer asking for help in paying these liabilities.

In addition, I have seen cases where the “employee” requests to be a contractor for tax purposes, but when the company no longer requires their services and their request for Employment Insurance (“EI”) is turned down (since they are self employed) they often make a claim against the employer saying they did not understand they would not be covered for EI and they really were employees. A recent case involving the Royal Winnipeg Ballet focussed on the expressed intention of the arrangement and maybe helpful in this regard in future cases.

I generally advise my clients to treat workers as employer/employee relationships when the individual is working for them several days a week. I also generally advise my contractor clients to avoid the use of corporations due to Personal Service Business (“PSB”) concerns. If CRA considers a PSB to be in place a punitive income tax is applied to the corporation. Where a contractor agreement comes under CRA’s scrutiny, the first thing CRA does is examine the agreement between the payer and the employee/self-employed contractor to determine the intent of the relationship; but intent alone is not enough. The CRA then applies 4 tests to determine if the relationship is a business relationship or an employer-employee relationship. CRA has issued RC 4110 to communicate their position.

It should be noted that much of CRA’s position is drawn from two notable cases Weibe Doors and 671122 Ontario Ltd. vs Sagaz Industries.

The tests are as follows:

Control test: A lack of control over how work is done is evidence that there is an employer-employee relationship – e.g. the payer determines how the work should be done, what work should be done and provides training. In a business relationship, the contractor would work independently and accept or refuse work at his/her own discretion.

Tool test: Generally contractors supply their own tools. “Tools” is not limited to hammers – it includes instruments, computers, vehicles and any other items that the worker uses to perform his/her job.

Subcontractor test: The ability to hire assistants or contract work out is evidence that there is a business relationship.

Risk/Opportunity test: Risk of loss and opportunity for profit are indicators that there is a business relationship.

Integration test: This test examines whether the payer’s activities are incorporated into the worker’s business or whether the worker is integrated into the payer’s activities.

The employee versus contractor issue is a minefield and employers and employees alike should consult their advisors before entering into a new agreement.

The blogs posted on The Blunt Bean Counter provide information of a general nature. These posts should not be considered specific advice; as each reader's personal financial situation is unique and fact specific. Please contact a professional advisor prior to implementing or acting upon any of the information contained in one of the blogs.

Are you a flow-through junkie?

This is the time of year when many of our clients are approached by their financial advisors to consider the purchase of a flow-through limited partnership investment as a means of reducing their personal income tax liability. Many of these limited partnerships invest in shares issued by a variety of junior oil, gas and metal exploration companies. The essence of this type of investment is that these partnerships allow exploration deductions to “flow-through” to individual investors.

In simple terms, if you pay $10,000 for a unit of an oil and gas limited partnership, you will receive approximately $10,000 in income tax deductions that can be utilized in your personal income tax return. Assuming the highest marginal income tax rate, you would save approximately $4,600 in taxes making your out-of-pocket cost $5,400 after claiming these “Flow-Through” deductions.

Most limited partnerships are subsequently rolled into a mutual fund that is saleable within two years. Carrying on with our example, let’s say that in two years the limited partnership is rolled into ABC Mutual Fund and you immediately sell your unit for $10,000. The cost base of the investment has been reduced to zero because of the deductions noted above, so you would owe capital gains tax of approximately $2,300 and net out $7,700. Your after-tax return would be $2,300 on the $10,000 investment ($7,700 on sale of mutual funds net of tax + $4,600 tax savings − $10,000 cost). You would break even if you could sell your mutual fund units for approximately $7,000.

The use of flow-through investments can also be very effective when you have capital losses you cannot use otherwise. If you have $10,000 in capital losses to utilize, in the example above, you could apply those losses against the gain and now you would realize $14,600 on the $10,000 investment since you would not owe any income taxes.   

There is an intriguing alternative to selling your mutual fund units.  If you donated your mutual fund units instead of selling them on the open market (assuming a $10,000 value) you would have no income tax liability and you would receive a tax refund of $4,600 on the donation. Therefore, in the scenario where your investment has a value of $10,000 at the time of donation, the charity would receive a $10,000 donation and your out-of-pocket cost would only be $800!

Even though a flow-through is a tax advantaged investment, it must be considered part of your resource investment portfolio. I know a couple of “tax shelter junkies” who purchase several shelters a year. These investments should always be discussed with your investment advisor because of the risks involved in investing in young resource companies and to ensure the risk allocation fits with your asset allocation.

Some advisors suggest you buy a shelter for two straight years then sell in the third year when it becomes a mutual fund and use the proceeds to buy a new flow-through in year 3 and repeat the process each year. The idea is to have a consistent tax shelter flow without adding significant additional funds. The downside to this strategy is that the tax advantage is partially negated as you will owe approximately $2,300 in capital gains tax on the sale of the mutual fund and save $4,600 in tax due to the purchase of the new flow-through.

Another timing strategy I have seen clients use is buying flow-through investments in years where oil or gold is in a downturn figuring that the downside investment risk is reduced. This strategy, while probably flawed technically, has worked fairly well for some, but of course in a rising resource market, this strategy prevents investors from buying shelters.

To summarize, the tax dog’s tail should not be wagging the investment. You should talk to your advisor about whether flow-through shares purchases should be considered in the context of your overall portfolio.

For You Couch Potatoes

This week is the beginning of the fall TV season. Two of my favorite shows, Dexter and Criminal Minds, had very disturbing endings last year and, notwithstanding their disturbing nature, they were two of the best finales I have ever seen.

In Dexter, Trinity murders Dexter’s wife Rita and Dexter finds his young son in the blood of his murdered mother mirroring Dexter’s past when he was found in his mother’s blood by Harry, the policeman who became his adoptive father. One can only imagine how Rita’s death will impact Dexter’s behaviour.

In Criminal Minds, the Reaper kills Agent Hotchner’s wife in a dramatic conclusion to the 100^th episode.

It is unusual for significant characters to suffer such dramatic deaths (especially Rita) and for me, the surprise and drama adds to the quality of these series .

Just so you don’t think I am a sadist watching both these series, my two favorite comedies also start this week.

Two and a Half Men, one of my favourites, is a well known series that may be on its last legs. A new favourite is the Big Bang Theory. Jim Parsons, who plays Sheldon Cooper, is one of the funniest characters on TV. He just won the Emmy for best Comedy Lead Actor. If you have never seen the show, I highly recommend it. This is what Wikipedia says about the show, but the description does not do it justice.

The blogs posted on The Blunt Bean Counter provide information of a general nature. These posts should not be considered specific advice; as each reader's personal financial situation is unique and fact specific. Please contact a professional advisor prior to implementing or acting upon any of the information contained in one of the blogs.

Why Didn't You Buy Apple for $25?

As an accountant, I am not allowed to provide specific investment advice; however, today I will discuss Peter Lynch, a famed money manager, and how some basic common awareness will allow novice and sophisticated investors to find growth stocks in their day to day lives.

Lynch was director of the Fidelity Magellan Fund, the largest US mutual fund during his tenure, and was almost as revered as Warren Buffet for his ability to pick stocks. In 1989, shortly before his retirement, Lynch published One Up on Wall Street where he revealed his stock-picking strategies. In 1993, Lynch followed up with a second book, Beating the Street. While One Up on Wall Street discussed specific rules Lynch employed to qualify prospective stock candidates, Beating the Street was more anecdotal.

In Beating the Street Lynch suggested average investors can beat Wall Street professionals by using information they encounter in their everyday lives. Lynch tells the story of how he invested in Hanes (for those old enough to remember, Hanes pantyhose were made famous by the TV advertisement featuring New York Jet Joe Namath in panty hose) after his wife told him about the popularity of L'eggs pantyhose among all her girlfriends.

As an aside, Lynch advised readers to look for spectacular growth in companies that; sound dull, do something disagreeable, or are spinoffs and are buying back their own stock. He cautioned readers to avoid companies touted as the next IBM or Xerox. That advice still stands the test of time.

Anyway, I digress; his point about using information that you encounter in your day to day life struck me as common sense. Day to day information could mean understanding a company in your industry, seeing rapid expansion in the company next door or watching your kids buy iPods.

Think of how much money any of us could have made paying attention to the iPod fad. Kids were suddenly walking around with white wires hanging out of their ears attached to these new fangled “walkmans”. In retrospect, how could we have missed this and not bought Apple? How about any of you with kids who play hockey? Out of nowhere, every child wanted an Under Armour shirt; why not buy Under Armour the company?

After reading One Up on Wall Street I was very cognizant of all these things and decided to follow Lynch’s advice. When a pay toll highway known as the 407 ETR sprung up near me I found out that it was partially owned by SNC Lavalin, a public engineering company on the Toronto Stock Exchange. On my daily drive to work I saw the initial resistance to the highway fees fade as people realized the highway cut down their driving time. I decided to try out Lynch’s concept so I bought some SNC stock at $12. I held he stock for a couple years and the price rose to about $14. Now, keep in mind the 407 was only a small part of SNC’s business, but I figured it would add substantial profit over time. Although I was smart enough to buy the stock, I never said I was smart enough, nor had enough patience, to hold the stock. I got tired of holding and sold out. You know what happened after that? SNC sold their share in the 407 months later for a huge profit and this, combined with a booming global engineering economy, helped the stock reach $50 or more within a couple of years.

Once you wipe the tears from your eyes about my SNC sob story, I think the point is obvious; if you pay attention to what you know and what you see around you, stocks will reveal themselves to you. You don’t have to be a sophisticated investor to get into the market.

And now, an epicurean note for those of you in Toronto who like Thai food. My son, a university student, wanted to learn how to cook better (ok, not better, but to cook something) so he asked my wife if she would find him a cooking class. After looking around, my wife was given a lead about Mengrai Gourmet Thai restaurant in Toronto. Mengrai provides 2 hour cooking lessons organized by Allan Lim, a very helpful co-owner of the restaurant.

Some of the lessons are taught by Chef Sasi, who, according to Sara Waxman of the Toronto Sun, is “the best Thai chef in Toronto.” My wife and son were taught by Sasi’s son Brandon. During their lesson they learned how to prepare lemon grass soup, Pad Thai (Canadian and street style), basil beef and a stir-fry. My son enjoyed his lesson thoroughly and I came later to taste their efforts and they were excellent.

My wife told one of her friends about the experience and she arranged a lesson for her daughter who was also going back to University. They also said they had a great time and enjoyed the food.

We returned a couple weeks later for dinner at Mengrai and thoroughly enjoyed our dinner, it has the best lemongrass soup I have ever tasted. If you want to find out about the cooking lessons or make a reservation for dinner, see www.mengraithai.com

I am a partner with Cunningham LLP, a mid-sized accounting firm in Toronto. The views and opinions expressed in this blog are mine alone and do not necessarily reflect on the position of Cunningham LLP.

The blogs posted on The Blunt Bean Counter provide information of a general nature. These posts should not be considered specific advice; as each reader's personal financial situation is unique and fact specific. Please contact a professional advisor prior to implementing or acting upon any of the information contained in one of the blogs.

Let's See Where This Goes

Why the blunt bean counter? Because I am blunt! I hear it from my clients, I hear it from my friends and I hear it from family. My clients tell me my bluntness is both my best and worst attribute. However, that is me, and although with old age I have toned it down, it is still the way I am.

I am an accountant, but not a classic bean counter. I have tried to move away from being a bean counter every step of the way. I quickly switched from counting beans to calculating tax and then I happily became managing partner and moved into quarterbacking our clients’ wealth management advisors. But I can’t hide from it, I am an accountant.

Why a blog? I always wanted to write. My chiropractor, and published author, Dr. Elaine Dembe (Passionate Longevity, Use the Good Dishes and Aging Smart) encouraged me to write a book when she discovered I had an outline in my head back in the early 1990’s. And, based on the proliferation of useless accounting and finance books, I probably should have heeded her advice.

My intention in writing this blog is to discuss accounting, tax and wealth management issues. It should be noted that Chartered Accountants cannot provide investment advice, so the discussion will not advise on whether to buy Nogold Mines Inc. (although my own portfolio holds several stocks similar to Cow Pasture Inc.). However, to keep myself and any readers besides my mom interested, I intend to cover whatever is on my mind from sports and business to restaurants, music and what have you. All blogs are subject to the censorship of an editor, appointed by my partners who fear what will come out of my mouth… or at least my computer keyboard.

That’s it for today; I will start this up and see where it goes tomorrow.

The blogs posted on The Blunt Bean Counter provide information of a general nature. These posts should not be considered specific advice; as each reader's personal financial situation is unique and fact specific. Please contact a professional advisor prior to implementing or acting upon any of the information contained in one of the blogs.