Independent Contractor or Employee
For tax purposes, employers sometimes decide to characterize a contract with an individual as an independent contractor relationship as opposed to an employment relationship.
Benefits of an Independent Contractor Relationship
Oftentimes, employers and individuals welcome this kind of working relationship because of the benefits it offers. While the organization avoids payroll taxes and employee benefit costs, the individual can write off personal expenses (i.e. a home office, travel and meal/entertainment costs) as business expenses, and pay a lower tax rate. The parties however cannot take advantage of these benefits unless a true independent contractor relationship exists.
Situations when an Independent Contractor Relationship is Challenged
The issue of whether a person is an employee or an independent contractor can arise in many different scenarios such as:
1. Whether a person is entitled to collect Employment Insurance benefits
After the termination of the relationship, an independent contractor might apply for EI benefits and be told: “If you are a contractor you are not entitled to any benefits, but if you are an employee you are entitled to about 52 weeks employment insurance benefits. What are you?”
2. Whether a Corporation is required to deduct and remit payroll taxes
As part of its routine audits, the Canadian Revenue Agency often inquires whether a corporation has retained any independent contractors. A corporation must deduct and remit payroll taxes like employment insurance and CPP premiums for employees, but not for independent contractors. The CRA wants to collect these payroll taxes.
3. Whether a Corporation is required to provide notice of termination
A true independent contractor is not entitled to any notice whereas an employee is generally entitled to reasonable notice of termination. If the employment contract is terminated after many years, and the parties haven’t discussed whether any notice of termination is required, then the issue of whether the person is an employee or an independent contractor can become very contentious.
The courts will look at the substance of the contractual relationship when determining whether an employment or independent contractor relationship actually exists.
The test that is often applied by courts and administrative tribunals is as follows:
The central question is whether the person who has been engaged to perform the services is performing them as a person in business on his own account. In making this determination, the level of control the employer has over the worker’s activities will always be a factor. However, other factors to consider include whether the worker provides his or her own equipment, whether the worker hires his or her own helpers, the degree of financial risk taken by the worker, the degree of responsibility for investment and management held by the worker, and the worker’s opportunity for profit in the performance of his or her tasks.
These factors do not constitute a non-exhaustive list, and the relative weight of each will depend on the particular facts and circumstances of the case.
Lessons to be learned:
- Make sure there is a written contract in place between the parties. It should, among other things, indicate the parties wish to create an independent contractor relationship and if possible specifically address the above-noted factors.
- Make sure there is a termination clause in the contract.
- If the independent contractor has not incorporated, he or she can generally apply for coverage as a self-employed person under the Employment Insurance Act and the Workplace Safety & Insurance Act.
If you are thinking of retaining a person as an independent contractor, please contact us at your convenience at 1-888-640-1728 or [email protected] if you have any questions.
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