Employee or Independent Contractor – More than Just a Label
Individuals and organizations often structure their working relationship so the individual provides services as an independent contractor, rather than as an employee.
There can be advantages for both parties in this sort of arrangement. Organizations enjoy the flexibility of engaging individuals with specialized skills or expertise on an as-needed basis, without the expense of group benefits, overhead and compliance with statutory requirements, such as paid vacations and public holidays. The independent contractor enjoys the ability to claim tax deductions for business expenses that are generally not available to employees.
For both parties, however, there are risks in mischaracterizing a worker as an independent contractor when the work relationship is actually one of employer and employee.
A legal problem may arise when someone who has been working as an independent contractor applies for Employment Insurance benefits or seeks to have his or her service credited for Canada Pension Plan purposes. Even without this sort of trigger, CRA may target and investigate a particular type of worker (e.g., hair stylists or IT contractors working within federal government departments) to determine whether individuals who have traditionally worked as independent contractors actually are. Having the relationship re-assessed by CRA can lead to liability for unremitted income tax and CPP and EI premiums, plus interest and penalties.
While tax collection is the impetus behind CRA's interest in the true nature of a working relationship, there is also the important social purpose of ensuring that workers are not improperly excluded from statutory protections afforded to employees, such as earned vacation, protected leave under employment standards legislation, EI benefits and an entitlement to notice and severance pay in the event of termination.
The question, then, is how can parties know what sort of relationship they have created?
With many employees now working from home and independent contractors often doing the same work as employees, the true nature of the relationship is not always obvious. Even though an individual may be paid through his or her corporation, receive a tax benefit, or signed an agreement stating that he or she is not an employee, that may still not be enough to establish an independent contractor relationship.
To determine whether a worker is an independent contractor or an employee, courts and government agencies apply variations of the four-part test confirmed by the Supreme Court of Canada in 20011. The test is based on the examination of the following key factors in the relationship: control, ownership of tools, chance of profit/risk of loss, and integration. One factor alone will not be determinative of the issue. CRA's "Employee or Self-Employed?" guide (available online) provides a questionnaire to help parties determine the nature of their relationship from a tax perspective.
In analyzing the degree of control exercised over an individual's work, the key consideration is "who directs the work?" In a traditional independent contractor situation, the contractor decides how the work will be performed. If the work consists of producing a report by a certain date, for example, the engaging party is interested in the final product; it does not care whether the contractor writes the report on a beach in Florida or in a home office. In contrast, employers typically direct how, when and where an employee is to perform the work. The more control an organization exerts over the work, the less likely the relationship will be found to be that of an independent contractor.
The ownership-of-tools factor looks at who owns the equipment or resources used to perform the work. A snow plough operator who ploughs 100 driveways a night, using his own operators and equipment, is an independent contractor. A driver who reports to a place of work and uses the owner's snow removal equipment to keep the grounds clear will more likely be an employee. However, as noted above, a single factor like ownership of tools will not be determinative.
If a worker has a chance of making a profit on the work or runs the risk of loss, the relationship will look more like a business relationship than an employment relationship. Using the snow plough operator example again, a winter with an unusually heavy snowfall can be financially devastating for the operator who has not provided for this contingency in the customer contract.
Finally, where an individual's work is integrated into the commercial activities of the employer, it is more likely that an employer-employee relationship exists.
In every case, courts, tribunals and tax authorities focus on the substance of the relationship, not its form.
Given the potential financial consequences of getting it wrong, individuals and corporations should seek appropriate legal advice prior to formalizing their working relationship.
1671122 Ontario Ltd v. Sagaz Industries Canada Inc. [2001] 2 S.C.R. 983