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Employee or Independent Contractor?

December 2004

 Owner managed businesses often hire contract workers for various economic and business reasons. While both the employer and contractor might consider the position to be self employment, the Canada Revenue Agency (CRA) may view the contractor as an employee.

 Both owner/managers and the contract worker must exercise care when establishing the working relationship that exists between them. Should the CRA determine that the independent contractor is in fact an employee, both the individual and the company will be obligated for payments of taxes and other levies.

Individuals cannot simply decide that they are self employed for tax purposes. To be self employed for tax purposes, they must meet a series of common law tests that are used to determine whether they are an employee or an independent contractor.

Using the common law tests, the CRA may ask:

•  Whether the individual has the flexibility to determine his or her own work schedule.

•  Whether there is a contract stating the individual is an independent contractor.

•  How much control the employer has over how the individual's work is done.

•  Who supplies the tools the individual uses.

•  Whether the individual invoices for the services rendered.

•  Whether the individual has the chance of profit and the risk of loss.

•  Whether the individual provides services to more than one client.

•  Whether the individual is to work on a specific project or has been contracted for an indefinite period of time.

No one issue will determine whether the relationship is one of an independent contractor or an employee. Depending on the type of work the person does, some of these factors may be given more weight than others.

What's at Stake?

If the CRA does not view the arrangement as being one of self employment, the worker will only be allowed the tax deductions available to an employee and not the additional deductions available to independent contractors, increasing his or her tax bill substantially.

The organization will also have a lot at stake. If the company treats a contract employee as self employed but they are found to be an employee, the company will be responsible for paying EI premiums, CPP contributions, workers' compensation and other payroll taxes. The employer will be obligated to pay these contributions and interest on the late payments and will also be subject to penalties based on the amount owing.

Request for Ruling

The issue of employed versus self employed is not always clear. Because this issue is important for both the employer and the contract worker, consider asking the CRA to determine if the relationship is one of an independent contractor or an employee. However, their bias is more than likely that the individual is an employee.

Independent Contractors Get All Those Deductions

Self employed individuals certainly do have tax advantages in their ability to deduct reasonable expenses that they incur to earn their business income, unless the expense is specifically denied in tax law. Deductions could include meals and entertainment, promotion, automobile expenses, home office expenses and capital cost allowance on assets used in the business.  They can also deduct the accounting and legal fees necessary to run their business, including the cost of having their chartered accountant prepare their personal income tax return. Personal expenses, of course, are not allowable deductions.

But there are other important considerations to their self employed status. While not having to pay employment insurance (EI) premiums may, at first blush, seem an advantage, they are not able to collect EI benefits should they find themselves out of work. The employer must match the CPP contributions dollar for dollar for its employees. Independent contractors must pay all CPP contributions themselves; however, the additional one half of the premiums is tax deductible.

Independent contractors are not entitled to company fringe benefits. To have coverage under a medical or dental plan, they would have to pay for the plan themselves. They can, however, claim the costs as a business deduction. In addition, they cannot contribute to a company pension plan.

If their taxable revenues exceed $30,000 annually, independent contractors have to register for GST/HST and charge it on the supply of most goods and services to their customers or clients. But like all businesses, they can claim input tax credits (ITCs) on their expenses and most capital purchases.

Of course, along with these advantages and disadvantages come the recordkeeping and compliance aspects. Independent contractors must keep careful records and supporting documents for income tax, GST/HST and other purposes. They must also consider whether they have provincial sales tax (PST) obligations. Generally, they should register their business name with the province. In some situations, they may also have to determine whether it is necessary to obtain a license to meet the requirements of their particular municipality.

We have all heard self employed individuals waxing on about writing off business losses. Yes, tax relief is generally available for independent contractors who suffer business losses as long as the business is carried on in pursuit of profit and is not a personal endeavour. However, for taxation years commencing after 2004, draft legislation proposes a reasonable expectation of profit test that will only allow business losses if it can be shown that the business expects a cumulative profit over the lifetime of the business.

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