The issue of whether an individual is an employee or an independent contractor can have far-reaching effects on both the individual and the company for whom they provide services. However, companies often pay little attention to either the distinction between the two statuses or the possible effects of an incorrectly described relationship. Without giving much thought to the request, companies often agree to treat individuals as independent contractors at the request of the individuals, who for their part, are simply seeking to minimize their income taxes. Many do not realize that they cannot create and maintain an independent contractor relationship merely by calling it such in a written independent contractor agreement, collecting sales taxes or ensuring that the contractor is an incorporated entity.
Rather, third parties such as Canada Revenue Agency (CRA), Workers’ Compensation boards, Employment Standards or the courts have the final say as to whether an individual is an employee or an independent contractor by testing the actual reality of the relationship between the parties. The actual reality of the relationship is assessed by taking a number of factors into account, including a) level of control over the worker’s activities, b) whether the worker provides their own equipment, c) whether the workers hires their own helpers, and d) whether the worker manages and assumes financial risks, and has an opportunity of profit in the performance of their tasks. If the actual realities do not reflect the legal relationship the parties profess to have intended, then their stated intention will be disregarded.
In particular, the issue of whether an individual is an employee or an independent contractor arises frequently in the Tax Court of Canada. This is because it is in the financial interests of the CRA for individuals to be employed by a company rather than to have an independent contractor relationship with that same company. Employees are subject to statutory deductions from their pay for Employment Insurance and Canada Pension Plan contributions. Independent contractors are not. Moreover, income tax deductions at source are not required, the calculation of income tax can differ between an employee and an independent contractor, and generally speaking, independent contractors are usually able to obtain better tax treatment than employees.
Accordingly, incorrect classification of a worker as an independent contract can expose a company to financial consequences with CRA, including unremitted source deductions for income tax, employment insurance premiums, CPP contributions and applicable penalties and interest. However, it can also expose companies to a) liability for unpaid wages and penalties for violating employment standards legislation for failing to pay vacation pay, overtime pay or statutory holiday pay, b) liability for unremitted workers’ compensation premiums, penalties and interest, and c) liability for wrongful dismissal damages for terminating the contract.
Click on the image below for a chart setting out the questions companies should be asking when assessing if a worker is an employee or an independent contractor.
Finally, employers should understand that in Canada there have been an increasing number of cases in which the courts have found that a mid-ground category of works exists: dependent contractors. While dependent contractors are indeed contractors, they have a degree of dependency to the company to which they provide services which can lead to damages upon termination for the contract which are akin to wrongful dismissal damages awarded to an employee. In other words, even when the individual is found by the courts to be a contractor, liability to the company may be far more than expected when that dependent contractor relationship comes to an end.
This guide further explains the distinctions between employees and independent contractors and why it is important for companies to pay attention to the distinctions between the two statuses.