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.
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.
While self-employed people are not entitled to regular EI benefits for the loss of a job, starting January 2011 self-employed individuals may be eligible for special EI benefits such as maternity and parental benefits. There are certain requirements in order to be eligible (such as potentially paying into the EI system for 12 months prior to making a claim) but with proper planning and advice from an accountant, self-employed individuals can enjoy certain special EI benefits.
ReplyDeleteThis tip is especially useful to the young female health practitioner (i.e. doctor or dentist) who is looking to start a family in the near future.
What is the logic behind CRA's position re: . "If CRA considers a PSB to be in place a punitive income tax is applied to the corporation.". Of course that implies there is logic and that's sort of an oxymoron when it comes to CRA.
ReplyDeleteFred:
ReplyDeleteThe PSB rules were created to stop someone who was an employee suddenly incorporating to achieve a better tax result, which actually is logical on CRA's behalf. To add some trivia to this, my recollection is the PSB rules came about when Ralph Sazio the GM of the Hamilton Tiger Cats incorporated himself even though he was the full time GM and employee of the Tiger Cats.
Fred:
ReplyDeleteThe PSB rules were created to stop someone who was an employee suddenly incorporating to achieve a better tax result, which actually is logical on CRA's behalf. To add some trivia to this, my recollection is the PSB rules came about when Ralph Sazio the GM of the Hamilton Tiger Cats incorporated himself even though he was the full time GM and employee of the Tiger Cats.
Hi Mark,
ReplyDeleteMy question is in regards to incorporating for the sheer purposes of doing a computer consulting contract for 1 yr period. This is to avoid high taxation, as presently I am paying close to 45% tax rate, on a direct employee contract. What are the pitfalls of this, and best process to follow in this type of incorporation?
thanks
Ali
Ali, you need to read this blog on Personal Service Businesses http://www.thebluntbeancounter.com/2012/01/is-your-corporation-personal-service.html
DeleteIt should answer your questions and in particular read the link "The taxman cracks down on IT consultants."
Hi Mark,
DeleteThere is an exception in PSB rule that if a PSB is hiring more than 5 full time employees, the PSB rules won't apply. I wonder what's CRA's real intention on this exception?
Usually a PSB has only one individual working for one company. There is no need to have more than 5 full time employees for this working person. The exception of PSB rule sounds like CRA allows more than 5 full time people in a PSB. Does it mean that this working person can hire 6 people (his wife, father, mother and his in-laws) to split his income? Is this allowed by CRA?
Thanks,
Gary
Gary,
DeleteYou should read my blog on PSB's if you have not (http://www.thebluntbeancounter.com/2012/01/is-your-corporation-personal-service.html)
Yes, there is a five full-time rule, but that is in place for a "real" business with "real" employees. I dont think the CRA will consider your family to be full-time employees unless the facts dictate such (which I would doubt).
sadly i believe my business activity makes me a PSB. sorry if this is dumb but am i wrongly charging my client GST now?
ReplyDeleteHi Anon
DeleteNo, you should continue to charge HST. Did you read my blog on personal servie business, it is more detaield-see link under tax topics on sidebar.
CRA has ruled that I was an employee and not a contractor. Before the ruling I paid full freight for EI and CPP. What happens now? Does the employer pay me back?
ReplyDeleteWhat if a person is contracting for a business outside of Canada? I guess the CRA could rule you are an "employee," but the CRA can't force an American company (for example, it could be any other country) to withhold taxes and pay EI/CPP. Does the CRA just give up in this situation and let you be considered a contractor?
ReplyDeleteAnd what if the person is incorporated? If the CRA can't deem you an employee because it has no jurisdiction over the business hiring you, then it seems it could not deem your corporation a Personal Services Business because you are not an "employee of the person or partnership to whom or to which the services were provided..."
Anon, way to complicated a question for this blog as deals with tax treaties, permanent establishments etc. This paper talks about some of the issues, although not contractors in specific.
Deletehttp://trowbridge.ca/resources/USCompaniesinCanArticle_TTAN.pdf
This is such a minefield and makes it difficult for new contractors starting out if they have 1 major client in the beginning (which is smart business). I'm curious as to my own situation. I consider myself a contractor - but will CRA? I am a service electrician and worked for a company for 2.5 years before I became a subcontractor for them. As an employee they provided some tools, a truck, cell phone, gas, healthcare etc. As a Contactor I now perform work for them 4-5 days per week BUT, have a few other clients and am slowly growing. I have my own truck, tools, insurance, WCB, disability, liability, cell phone etc. I have done some limited marketing, have a website and logo on my truck, and have done about 10% work for other clients in my 1st year and growing that side. Although I contract out for several days of the week for them and they book calls with their clients for my services, I have the risk when jobs fall through or have issues. I have the right to refuse or take work, however no contractor will exercise that too often with his number 1 client without good reason (if I refuse to many jobs for any client they will call someone else - so I find that a silly way to differentiate). My only concern is that I only have about 10% other work this 1st 6 months (although it's growing), and that there contract is a joke and says little about the relationship. I used to hear the old 80/20 rule, that if you did over 80% of your work for 1 company you were at greater risk of being considered an employee. Is that correct or is it more based on the relationship. Also since the contract sucks, is that the week point, or is the relationship more important. Thanks for any advice
ReplyDeleteHi Anon
DeleteI agree with all your comments. Unfortunately, I do not provide specific tax advice on this blog, so I cannot comment on your situation.
I need some help, my boss is forcing me to get a contractors license for like 600 bucks out of my pocket just because he says myself and other workers are contractors, yet he makes schedules,supplies tools, truck and gas, and controls every aspect! What can I do? He also doesn't pay my taxes in my pay cheques.
ReplyDeleteSteve, this happens very often. There is really not much you can do if you want your job. You may want to engage an accountant to understand how to file as a contactor while minimizing your tax risk should the CRA reassess your employer or you.
Delete