Employee vs. Independent Contractor – Canadian Income Tax Status
When providing services for a corporation in Canada, there are certain Canadian income tax and non tax advantages in being considered an independent contractor as opposed to an employee.
The advantages to the employer are as follows:
- No obligation to deduct Employment Insurance (EI) and therefore not required to pay an employer’s portion
- Canada Pension Plan (CPP) costs, including the employer’s portion, are passed on to the contractor
- Employers don’t need to include contractors in company benefit programs or offer a severance package when the contractor’s services are no longer needed.
The advantages to the independent contractor are as follows:
- They will not have income tax withheld at source
- They can deduct for Canadian income tax purposes all legitimate business expenses
- They may be able to deduct the costs of a “home office,” which will be considered a principal place of business
- They will not be eligible for Employment Insurance, so the taxpayer will not be charged premiums.
The leading case in this area is Wiebe Door Services Ltd. v. the Minister of National Revenue, [87 DTC 5025], where the courts have distinguished between a contract for services (independent contractor), and a contract of service (employee).
The Canada Revenue Agency (CRA) now applies the use of the test that the court produced; including a new fourth part stated in RC4110, which is a CRA Guide for determining whether a taxpayer is an employee or independent contractor. CRA considers the following:
- The extent to which the worker is subject to the control of the payer
- Whether the worker provides his or her own tools
- Whether the worker has a chance of profit and the risk of loss
- Whether the work being done is an integral part of the business, or only accessory to it.
CRA takes all of the above factors into consideration, with no one aspect being wholly determinative. When looking on the face of this question, there seems to be a relatively simple answer, either the taxpayer is an employee or an independent contractor. However, the income tax rules surrounding this issue are quite complicated because of the potential income tax benefits to being considered an independent contractor.
Written Independent Contractor Agreement
It is very important for employers, and independent contractors to have a written agreement between the parties. That way, if CRA attempts to claim that the taxpayer is an employee and that the taxpayer is not an independent contractor, then there will be documentation to back up the claims.
Risks for Independent Contractor
If the taxpayer files tax returns as an independent contractor and the Canada Revenue Agency determines him or her to be an employee, then business expense deductions will have to be re-included in his or her income for the year in which it was deducted. As a result of this, the income will increase for the years in which the expenses are denied and therefore the taxpayer will owe additional taxes for those years. Please note that CRA’s definition of a contractor or employee is different than that given by the Employment Standards Branch and the Workers Compensation Board.
Potential Risks and Downsides for Employers
Be aware of the risks and downsides, especially for employers. If a company is audited and the CRA rules that “contract workers” are actually employees, an employer will be responsible for the following:
- Potential unremitted source deductions
- CPP and EI employer and employee contributions for the current and previous year
- 10 % penalty on the total assessment and interest of approximately prime plus one 1% from the date each of the contributions were due.
If you are an employee or employer and would like to know if independent contractor status is available to take advantage of the tax savings and of the risks involved in such a claim, or if you need to have an independent contractor agreement drafted, give our Canadian tax lawyers a call. Effective income tax planning is required to balance the factors and we can help.
"This article provides information of a general nature only. It is only current at the posting date. It is not updated and it may no longer be current. It does not provide legal advice nor can it or should it be relied upon. All tax situations are specific to their facts and will differ from the situations in the articles. If you have specific legal questions you should consult a lawyer."