Imagine that a client approaches you and says, “There’s a website developer I want to hire on a six-month contract. If I hire her as a contractor and keep her off the payroll, that should work, right?” This is a topic often discussed in my law practice. Business owners tend to favour the flexibility of contractor positions, but they face significant risk if they don’t fully understand how the Canada Revenue Agency (CRA) differentiates between employees and individuals who are self-employed (i.e., independent contractors). Neither the CRA nor the legal system like to see employees disguised as contractors.
Where to start: Understanding the legal perspective
The first principle to understand is that a worker is defined neither by their title nor the wording of their contract (e.g., “Independent Contractor Agreement”). Rather, it is the substance of the worker’s role that determines their category.
Let’s revisit the example of the web designer. Before figuring out what your client’s obligations are to the CRA, you must first determine which category the new worker falls under. Under the law, there are three categories:
- Independent contractor; and
- Dependent contractor.
Most professionals will be familiar with the first two categories, but many will need to better familiarize themselves with the third, as it’s a concept that has been recognized by the courts in a few Canadian provinces. The term “dependent contractor” refers to a worker who may be employed on a contract basis but is in reality a contractor/employee hybrid. To determine if a worker is a dependent contractor, the following questions should be asked:
- Is the worker largely limited in their services to one principal?
- Is the worker subject to the control of the principal?
- Does the worker undertake a risk of loss or possibility of profit apart from their fixed remuneration?
- Are the worker’s activities part of the principal’s business? (In other words, whose business is it?)
- What is the duration of the worker’s relationship with the principal? (The more permanent, the more dependent.)
- To what degree do the worker and principal rely on each other, and do they co-ordinate their conduct?
Under the law, if the relationship bears more resemblance to an employer/employee relationship than an employer/contractor relationship, the worker will be considered an employee for the purposes of determining severance owed—regardless of the contract wording or the parties’ intentions. The CRA, too, will consider the worker an employee.
Returning to our hypothetical scenario, then, it would be incumbent on your client to obtain more information from the web designer. For example:
- What other clients does this person have?
- Is it necessary for her to do the work at your client’s business premises or can she do the work elsewhere?
- Does she have the authority to subcontract work to others without your client’s approval?
If your client is the web designer’s only client, she may be considered a dependent contractor if she is:
- Not managing or seeking other clients while she’s working on your client’s contract;
- Not taking on any of the business risk; and
- Is working solely to promote your client’s business and not her own.
However, if the web designer can do all the work needed from home; can hire people as she sees fit (as her retainer with your client allows her to incur subcontractor expenses); and will be working with your client’s business for only a short period of time, she may be considered a true independent contractor.
It is important to remember that every situation is determined according to its facts, and each situation is unique. When analyzing specific circumstances, it’s always beneficial to speak with an employment lawyer.
Next: Understanding the CRA’s point of view
Once you determine that a worker is not an employee under the law, your next step is to figure out if the CRA would agree with your categorization. The CRA considers seven key factors1 when determining the relationship between the worker and the payer (i.e., the person/entity who retains the worker’s services):
- The level of control the payer has over the worker’s activities.
- Whether it’s the worker or the payer who provides the tools and equipment.
- Whether the worker can subcontract the work or hire assistants.
- The degree of financial risk the worker takes on.
- The degree of responsibility the worker holds for investment and management in the payer’s business.
- The worker’s opportunity for profit.
- Any other relevant factors, such as written contracts.
When reviewing a worker’s situation, the CRA first looks for any common intent between the parties. If none is found, the CRA then reviews any contract that’s in place, examines the parties’ testimony and actions, and looks at their respective intentions.
It’s important to remember that the CRA has a review bias, in that it usually looks to see if someone falls under the “employee” category and is employed under a contract of service. It doesn’t necessarily consider if someone falls under another worker category. Be mindful of this perspective if you’re thinking about seeking the CRA’s ruling on a worker’s status.
The need for contracts and contract reviews
Ultimately, a reclassification by the CRA can have significant consequences for a business. If a contractor is reclassified as an employee, the employer will have to pay the CRA unpaid taxes, make past CPP and EI remittances, and pay any applicable penalties. There can also be surprising monetary consequences for a payer, including the obligation to pay the newly classified employee vacation pay and other benefits owed for past services.
Whether you’re an employer yourself or an advisor to business owners, what this risk emphasizes is the importance of having a contract in place with workers of all types. From both a business management perspective and a financial management perspective, any payer should have these agreements in place. At the same time, business owners must exercise caution with regard to employment legislation. This legislation varies from province to province, and payers are responsible for knowing what their specific obligations are as employers. Ultimately, the best way for payers to protect themselves as employers is by reflecting these provincial obligations in their employment agreements.
Payers must also be cautious when using independent contractor agreements that contain employment language. Referring to the CRA process described earlier in this article, if a contract reads like an employment agreement, it will not matter that the parties have called it a contractor position.
Finally, it’s not enough to put contracts in place. Payers also need to review these contracts on a regular basis. Positions and roles can evolve over time, and someone who legitimately starts as a contractor may become a dependent contractor or an employee over time. Failure to navigate and properly document these changes can lead to a reclassification by the CRA, with the consequences discussed above.
Know the rules, and consult the experts
Retaining the services of workers can be a complex area for any business owner. The risk of reclassification keenly emphasizes the importance of knowing provincial legal requirements and federal tax obligations, and—fundamentally—the importance of having solid relationships with key professional advisors who can provide the right guidance.
- See the CRA publication Employee or Self-Employed? (RC4110(E) Rev. 18).
Alana Dale-Johnson is a partner at Singleton Reynolds in Vancouver. She co-chairs the firm's corporate commercial group and chairs its wills and estates group.