Do you hire individuals to perform tasks for your business? Do you have domestic helpers such as nannies or caregivers? Ensure that you understand the nature of the relationship and that you report the payments appropriately.
This is a topic that arises fairly regularly in the courts – has an individual been hired as an independent contractor, or are they in fact an employee?
The distinction is very important, as the two classifications have very different tax consequences. If a person is hired as an independent contractor, the contractor will be earning business income, and must report this accurately as part of their own tax return. The reporting obligations on the hiring party are relatively minimal in this respect (a T4A slip must be issued in some cases).
However, if the person is classified as an employee, the obligations on the employer are quite burdensome. For example, the employer must deduct income tax, Canada Pension Plan (CPP) contributions and Employment Insurance (EI) premiums from amounts paid to the employee, and must report and remit these source deductions to the CRA. The employer must also report the pay on a T4 slip, and may have provincial reporting obligations as well (e.g. Worker’s Compensation).
Employers also have their own share of CPP and EI amounts to pay in respect of the employee.
If an employer incorrectly classifies a worker as an independent contractor rather than an employee, and doesn’t make the required remittances, the penalties can be significant.
There is no definitive test to determine whether someone should be treated as a contractor or as an employee. In addition, entering into an agreement with the individual where you both agree to one status or the other does not guarantee that the CRA will agree with this status if the circumstances suggest otherwise.
Each relationship must be considered on its own merits when determining employee/ contractor status. The courts have developed a list of factors, each of which tend to indicate either an employee relationship or a contractor relationship. All of these factors should be analyzed and a conclusion can then be drawn on the balance of factors.
The factors usually considered are:
Degree of control over work – if the payor closely controls and oversees the manner in which work is performed, and the time at which the work is done, this is more indicative of an employer-employee relationship than if the worker has control over this.
Provision of tools – if a worker uses the payor’s tools to perform the work, this suggests that they are more likely to be an employee than if they use their own tools for work.
Subcontracting work – Can the worker bring in their own assistants to help with the job, or to fill in for them at times? This suggests that they are an independent contractor, as employees normally cannot do this.
Financial risk – does the worker shoulder the burden of potential losses (or an obligation to fix mistakes with no further pay) if the work is not performed adequately? Employees are not usually on the hook for such losses, while independent contractors usually are.
Opportunity for profit – Employees usually have a fixed salary or pay per hour and, other than potential bonuses, are generally not entitled to a share of profits directly. Independent contractors, on the other hand, are more likely to benefit from an efficient job through increased profits.
The recent Tax Court of Canada appeal of Balatoni v. Minister of National Revenue is a good example of such a misclassification. In this case, the taxpayer owned an industrial kitchen and hired two pastry chefs to bake strudel for hotel and convention centre customers.
The chefs were required to follow a strict family recipe belonging to the taxpayer when baking, and the taxpayer trained the chefs personally in this regard. The work was undertaken in the taxpayer’s industrial kitchen, using equipment supplied by the taxpayer.
The chefs were paid an hourly rate for their services, and if one chef was unable to work, the other chef stepped in. Neither chef had a written contract.
When the chefs lost their jobs and applied for EI, the taxpayer took the view that the chefs were independent contractors, as she rarely visited the kitchen. The Minister disagreed.
The Tax Court reviewed the specific facts of the case and found against the taxpayer, ruling that the chefs were in fact employees. The Court cited, amongst other things, the fact that the taxpayer had control over chefs’ work (through the strict family recipe which had to be followed), and that all equipment was provided by the taxpayer.
The court also noted that the chefs could not hire assistants (one chef would simply step in for the other if required) and that the chefs had no risk of loss or opportunity for profit.
Thus, the chefs were employees, were entitled to EI, and the taxpayer would end up liable for payroll deduction obligations.