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Small Business

Are you a Contractor or an Employee?

With the changing world we are living in many people have decided to venture out as a contractor. We are seeing more and more deciding this after a layoff or simply a slow down in a traditional office. What we need to understand is the difference between being an independent contractor or an employee can have a huge impact on your Canadian income tax, especially if you think you’re a contractor but the Canada Revenue Agency (CRA) decides that you are not a contractor after you’ve already filed several tax returns.

The CRA uses specific criteria to determine if you are a contractor or if you are not a contractor, you can and should take steps to protect your status as an independent contractor if you understand them and how to make sure your business is following the guidelines.

Employers Like to Hire Independent Contractors

From the business’s side, hiring a contractor can be preferred to hiring an employee for the same job because it means a lot less paperwork and responsibility and can reduce overall cost.

Contractors don’t receive benefits like health insurance or RRSP patching, pensions and other finical gains that can be offered to employees. Contractor must pay their own Canada Pension Plan contributions. If the contractor is incorporated it is generally paid within the contractors company.

A company that uses a contractor won’t do payroll, which involves withholding income tax and paying employment insurance (EI) on behalf of the employee.

Employing contractors rather than full-time employees gives companies much more flexibility to meet the ups and downs of business especially if the work is seasonal, reducing their overall labor costs and helping them to better manage cash flows.

When the Contractor Is Actually an Employee

A business hiring a contractor that is later determined to be an employee can lose big financially. The employer will have to remit unpaid taxes, and might even be subject to penalties and interest. This could be messy depending on the CPP and EI paid.

As for the contractor, business expense deductions claimed in previous years will have to be repaid. It is very important to have a clear and reliable bookkeeping system. This can have catastrophic financial repercussions in cases where the individual has claimed deductions through several prior years that were all ultimately disallowed by the CRA. The contractor could end up paying a lot more than just the taxes.

How to Determining Status

The employee business relationship are grey areas that is forever moving and changing, so it’s important to protect your independent contractor status. You will want to make sure that your work as a contractor remains independent of your employer by passing the four-point test.

The four-point test is the standard used by the CRA to determine which type of relationship exists. The CRA document Employee or Self-Employed? “sets out a method that should, in most cases, allow payers and workers to determine the nature of their relationship,” according to the Agency.

The test is based on four key points: control, ownership of tools, the chance of profit and risk of loss, and integration.

Point No. 1: Control

The primary question here is who’s running the show. You can be considered an employer if you have the right to hire or fire an employee, to determine the wage or salary the employee is paid, and to decide on the time, place, and manner in which the work is done.

A contractor in the business relationship decides how the work will be performed, it becomes very important that you maintain the right to decide where, when, and how the work is done if you want to be considered an independent contractor. Again clear documentation can help in these cases.


Point No. 2: Ownership of Tools

It might seem obvious that contractors supply their own tools, but it’s also customary for employees to supply them in some trades. Think of painters and garage mechanics.

The cost of using the tools is a much better indication of this test. Ownership of tools also ties into profits and risk. This can be critical to show you are independent. The contractor is taking the risks.

Another example would be a home-based IT worker who uses their own desktop/laptop computer. This would be indicative of self-employment. This example is fairly straight forward, but did you know Psychologist and Speech Language Pathologist also have testing material that would fall into this category as well. Test Materials can be considered tools.

Point No. 3: Chance of Profit or Risk of Loss

Your financial involvement also determines whether you’re involved in an employer relationship or a business relationship.

You are considered a contractor if you have opportunity to make a profit, and run the risk of incurring losses due to business dealings and have operating costs.

Point No. 4: Integration

Exactly how to determine such integration is not straight forward. The CRA’s publication seems to treat this point as a summary category, calling for a review of the other three factors first. They would look at many different aspects to make a decision.

One way of supporting that you have you own commercial activities is to have multiple clients. Contractors that has one client could be seen as a contracted employee.

Will Incorporating Give You Contractor Status?

Some employers seem to view incorporation as “proof” of independent contractor status. Being incorporated could be evidence showing an arm’s length relationship between a contractor and employer. But it isn’t proof of a business relationship..