Incorporating Independent Contractors in a Company: A Cautionary Tale
As businesses turn to outsourcing, downsizing, and economic cutbacks, they may find it advantageous to hire independent contractors to perform certain functions previously carried out by employees. However, merely labeling someone as an independent contractor is insufficient. The Canada Revenue Agency (CRA) scrutinizes the nature of the relationship to determine whether an individual is an independent contractor or an employee. This involves determining whether a master-servant relationship exists, indicating an employer-employee relationship.
While hiring independent contractors can provide significant benefits over using employees, companies must be cautious in their decision to engage them. The risk of a court or tribunal ruling that an independent contractor is an employee can lead to severe consequences for the employer, including fines, penalties, and interest under legislation like the Income Tax Act. A written agreement can help clarify the parties’ intentions and avoid misunderstandings.
Benefits of Hiring Independent Contractors for Employers
Hiring independent contractors can provide numerous benefits for employers. These advantages include:
- No need to remit the employer’s portion of premium under the Employment Insurance Act, resulting in decreased administrative costs for the employer. Additionally, employers do not need to deduct and remit premiums payable by an independent contractor under the Act.
- No requirement to deduct and remit income tax for an independent contractor.
- No need to deduct and remit employee contributions to the Canada Pension Plan, nor is the employer required to make any contributions on behalf of someone who is an independent contractor. This results in significant savings for the employer, as well as decreased administrative costs.
- Independent contractors are not entitled to legislated benefits under provisions of the Employment Standards Code, such as minimum wage requirements, overtime pay, hours of work, vacation pay, and the benefit of termination and severance pay provisions.
- No need to pay premiums under the provisions of the Workers’ Compensation Act on behalf of an independent contractor. This can result in significant savings for the employer, depending on the type of business they are engaged in.
- Employers are not required to provide benefits to independent contractors that are typically provided to employees.
CRA’S CRITERIA FOR DETERMINING EMPLOYER-EMPLOYEE RELATIONSHIPS
The Canada Revenue Agency (CRA) has established guidelines for determining whether a relationship between an employer and a worker is that of an employee or an independent contractor. In making this determination, courts and specialized tribunals usually consider several factors, including:
Control
The level of control that the employer has over how services are provided is a key factor. If the employer directs the work and how it is done, it’s more likely that the individual is an employee rather than an independent contractor. While the employer may have a good deal of control over what is to be done and how it is done in an employment relationship, this test has inherent weaknesses. For example, highly skilled employees may possess knowledge, skills, and expertise beyond the employer’s sphere of competency, making it difficult for the employer to direct their functions.
Ownership of Tools
If the individual owns the tools used to provide the service, they are more likely to be an independent contractor. However, this test is not crucial as some work does not require tools, and it is not uncommon for employees to use their own tools.
Chance of Profit
If the individual has the opportunity to make a profit for providing the service, it’s more likely they will be considered an independent contractor.
Risk of Loss
If the recipient of the service assumes all the risks associated with the service and the individual who provides the service assumes little or no risk, then it’s more likely the relationship is an employment relationship rather than that of an independent contractor.
Degree of Integration
If the services provided are only accessories to the recipient’s business, then it’s more likely the relationship is that of an independent contractor. However, if the services are critical to the business, it implies an employer-employee relationship. Courts generally consider this test only relevant if the control test is also met.
The control test is generally considered the most important test by CRA. It’s important to note that merely calling someone an independent contractor does not make them one, and it’s essential to be cautious in this decision. A written agreement clarifying the intentions of the parties can be useful in avoiding potential fines, penalties, and interest under various legislation, such as the Income Tax Act.
To determine if an independent contractor relationship exists, consider the following questions.
An affirmative response to these questions would indicate an independent contractor relationship:
- Does the recipient have control over when, where, and how the work is done?
- Are the recipient’s business activities integrated with the activities provided to the payor?
- Can the recipient work for other companies without the payor’s consent or knowledge?
- Does the recipient have the ability to hire substitutes or assistants to perform services without the payor’s approval and is responsible for their remuneration?
- Does the recipient assume any risks or provide funds for their activities?
- Is the recipient responsible for any losses, expenses, or damages caused by their work?
- Is there a foreseeable end to the project or is the relationship ongoing?
- Does the recipient provide their own supplies and equipment or reimburse the payor for using their equipment?
- Does the recipient have a separate office off the payor’s premises?
- Is the recipient ineligible for employee rights, privileges, and benefits?
- Can the payor survive without the recipient’s services and easily replace them?
- Do the recipient issue invoices and receive payment from the payor?
- Are the invoice terms and conditions similar to those of other independent contractors for similar services?
- Does a written contract support an independent contractor status?
If you’re thinking about hiring an independent contractor for your company, there are several recommendations to keep in mind:
Firstly, it’s important to have a written agreement that clearly states the nature of the relationship between your company and the independent contractor. The agreement should be for a specific period of time and state that the independent contractor is responsible for deducting and remitting income tax, Canada Pension Plan contributions, and Employment Insurance contributions. Your company should not make any remittances on behalf of the independent contractor for these contributions.
Secondly, your company should exercise very little control over how the independent contractor provides the service. You should not give specific instructions about when, where, or how the services are to be performed.
Thirdly, the independent contractor should have his or her own Workers’ Compensation Board account.
Fourthly, the independent contractor should be allowed to offer services to other companies or the public.
Fifthly, the independent contractor should not be reimbursed for any expenses; instead, the remuneration paid should cover these expenses.
Sixthly, the independent contractor should have his or her own equipment or tools to provide the service for your company.
Finally, the independent contractor should have the freedom to hire others, such as employees, to provide the services contracted for.
Summary
Although independent contractors are a popular choice for Canadian businesses due to their tax advantages, there are still risks involved. Some employers may misclassify their workers as independent contractors to save costs and avoid certain obligations. These rules are complex and can lead to penalties, so it’s important for taxpayers to seek guidance from a tax accountant to ensure their business practices comply with the regulations.