"Is my worker an employee or an independent contractor?" This is a common question that we often come across from our business clients. While there are pro's and con's to both, the classification is subjective and requires a great deal of judgement. Getting the correct classification is important as it can have an impact on taxes, employment deductions and other benefits available.
We are often approached by businesses to consult and determine which type of relationship they have: an employee-employer or a worker-payer relationship. Many times, after careful analysis of the facts and circumstances, we have noticed that there is a misclassification of individuals in these areas or it wasn't as clear cut as originally thought. For some, the lines are clear but for others they become quite blurry. In these situations, an in-depth analysis and review should be made to understand the facts and circumstances in order to properly categorize your workers.
Please explore our resource below to assist you in understanding the differences between an employee and an independent contractor.
Employee vs. Independent Contractor
There are significant differences between an employee and independent contractor that can impact both the business and the individual. Understanding this relationship can help you determine how to classify each individual who works for your company that may not easily fit into one category.
An individual who is deemed to be an employee is subject to the following:
Limitations in terms of deductions available
The employer is required to withhold and remit payroll taxes on your behalf (subject to CPP and EI)
The employer is required to make CPP and EI contributions
Workplace Safety and Insurance Board (WSIB) remittances are required by the employer
An employee-employer relationship is governed under guidelines of the Employment Standards Act (ESA) which provides protection of severance, pension, injury and compensation rights
On the other hand, an individual who is deemed to be an independent contractor is subject to the following:
The contractor can deduct all reasonable business expenses related to generating income from the business (with certain exclusions)
More autonomy in how the work is completed and ability to share in the profit/loss of the job
Reduce payroll related expenses. The business is only required to match CPP contributions as a self-employed individual is typically EI exempt
Individuals are not governed by the ESA and as a result would not have the same access to job protection
Depending on the side you're on (employee or employer), it may be advantageous for you to be classified as an employee or independent contractor as it can help you save on payroll related costs or gain access to significant business expenses to reduce your taxable income.
Classification Guidance Tests:
Since the definition of an employee is not specifically defined in the income tax act, there is a great deal of complexity in making this judgement. As a result, some guidance has been made available that can help make this determination using case law. Court rulings have provided some precedents which have been summarized into three tests.
1. Economic Reality Test
2. Integration Test
3. Specific Result Test
NOTE: Please note that there is no one specific test that can result in a clear-cut determination. All of the facts and circumstances in the situation must be assessed together.
Ultimately, you want to determine what the true intent of the working relationship was between the two parties when they entered in the working arrangement.
Economic Reality Test
This test can help to determine the nature of the relationship and can typical be broken down into three sub-tests: the control, the ownership, and the profit/loss test.
Control Test:
The control test looks to determine who has the ability to dictate the terms of the working relationship. This includes which party has the right to provide instructions and guidance on what work needs to be done, when and how.
In a situation where the payer has final say on what needs to be completed, how the work is be done and the worker requires permission to work for others, it is usually seen as an employee-employer relationship.
Ownership Test:
This test focuses on the ownership of tools and equipment and takes into consideration who in the relationship owns or provides the equipment/ tools to execute the required work. The CRA states that the important factor to consider here is the significant investment required to purchase tools and equipment along with the maintenance and operating costs associated with them. When the worker owns the tools and equipment, they are able to control how they would use them and how the work will be completed, which links back to the control test.
Profit And Loss Test:
This test needs to be looked at from the perspective of the worker and not the payer/ the business. The profit and loss test helps analyze factors such as whether the worker has the ability to make a profit or incur losses from the working relationship or must cover operating costs. When this holds true, there is evidence that the individual is a contractor.
For example: An employee normally does not have the ability to benefit from profit or incur losses if they complete a project or task under budget. Any labour efficiencies usually stay with the business and the employee is paid for their respective work effort. The CRA has noted that even though an employee’s income can vary due to bonus or commission structures based on performance in their employment contract, this increase in income is not normally viewed as profit (not the excess of proceeds over expenses). On the other hand, a contractor normally has a chance to make a profit or loss on their work as they negotiate the rates to be charged and will incur the expenses related to completing the task. If their expenses come in below the proceeds, the contractor will generate a profit.
Integration Test
The integration test should be analyzed from the viewpoint of the taxpayer/worker since it looks at whether the individual is "economically dependent" on the business/payer. The term economically dependent refers to the total income the taxpayer receives from that specific business compared to all other sources and access to benefits made available to employees of the organization.
For example: If Jane had total income from all sources of $110,000 but received $100,000 from ABC Inc., it would imply that Jane is economically dependent on ABC Inc.
Specific Results Test
Lastly, the specific results test looks at examining the nature of the relationship between the taxpayer and the payer. In an employee-employer relationship, usually the employee provides their services to the employer during specific working hours without reference to a specific result. Typically the work is ongoing. However, in a situation where it’s a worker and payer relationship, the payer agrees to certain specific work that has to be completed. In this relationship, the worker is hired to achieve a certain objective and it is left up to them to determine how the work will be carried out to reach the objectives.
As mentioned at the start of this article, no one test should be used in determining the nature of the working relationship as many factors need to be considered. There is a great deal of professional judgement involved and there can be significant taxes and penalties assessed if the classification is made incorrectly.
We suggest you contact our professionals to help you go through the tests and analyze your overall situation to ensure you have the right determination going forward to avoid any issues that may arise in the future. The CRA has a great resource and guide which highlights these concepts in more detail and provide situations and examples on when an individual might be considered an employee or independent contractor. There are cases referenced in this guide which can be reviewed to see how certain rulings were made. For more information click here.
Disclaimer: The above information is a summary that highlights some of the concepts and factors that can be considered when making the determination between an employee vs. a contractor. The information provided above can change based on your specific situation and a professional should be consulted when making complex determinations.
We hope this material assisted you in understanding the difference between an employee and independent contractor. If you require any assistance in navigating through the above resources, please feel free to contact us. We are always here to help!
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