Businesses in Canada primarily hire workers under one of two designations: employees or independent contractors. There are several key differences between these two designations, for both employers and the people they hire. The Canada Revenue Agency (CRA) has criteria that must be met to classify someone as an independent contractor. Businesses should be careful to avoid misclassifying an employee as an independent contractor, as this can often result in liability and financial penalties. Those who believe they have been misclassified as an independent contractor may have grounds for a lawsuit. You can learn more about whether you are considered a Canadian employee or independent contractor by contacting Canadian tax lawyer Jeremy Scott at (902) 403-7201.
What Is the Definition of an Independent Contractor in Canada?
Employees and independent contractors both work with businesses, but there are many important distinctions between these two types of worker classifications. In general, the main difference is the contractual agreement between the business and the worker. Independent contractors are self-employed and provide specific services to businesses. They may complete similar tasks as some employees, but they are not full-time workers. Instead of receiving a paycheck, an independent contractor usually bills their client (the company) through an invoice.
The Canada Revenue Agency has set four broad categories that can determine whether a worker is a contractor or employee.
The issue of control is central in distinguishing between an independent contractor and an employee. Employers have the right to hire and fire employees, set their wages, and decide when, where, and how the work should be completed. The Canada Revenue Agency defines control as “the ability, authority, or right of a payer to exercise control over a worker concerning how the work is done and what work will be done.”
Conversely, an independent contractor has more control over how a project will be completed, their work schedule, and the setting in which the work will be done.
Independent contractors must provide their own tools and equipment.
Employees and independent contractors each have different financial stakes in the relationship with the company. Contractors have the chance to make a profit, but also face the risk of suffering losses related to delays, materials, equipment damage, or bad debts. Employees are not at risk of suffering any financial loss. In addition, any worker who is responsible for operating costs should be classified as an independent contractor.
Employees are generally considered an integral part of the company’s daily operations. The CRA looks for an absence of qualities like integration, continuity, subordination, security, and loyalty in the business relationship. These qualities are generally indicative of an employer-employee relationship, rather than an agreement with an independent contractor.
In Canada, independent contractors have the option to classify their operations as either sole proprietorships or incorporated businesses. Each option has its own pros and cons, and the right choice will vary depending on the needs of the independent contractor.
According to the Canada Revenue Agency, a sole proprietorship is an unincorporated business with one individual as the owner. Generally, a sole proprietorship makes more sense for independent contractors, consultants, and freelancers who plan to operate completely independently, without hiring any employees. Since sole proprietorships only consist of one individual, the owner of the proprietorship will face liability if the business is sued. They also must pay employment insurance and income taxes are paid at the personal tax rate. Income is also taxed even if it is not removed from the business.
Benefits of sole proprietorships include:
- The ability to deduct business expenses
- Eligibility to split income with a spouse
- Inexpensive to establish
You can learn more about whether you should pursue a sole proprietorship or incorporate by contacting Canada tax lawyer Jeremy Scott.
Incorporating as an independent contractor is a more expensive and time-consuming process, but it can yield many long-term benefits not found in sole proprietorships. Incorporated contractors may also deduct expenses. Some of the unique benefits of incorporating include:
- Limited liability
- No Employment Insurance premiums
- Long-term savings plan
- Money may be left in the corporation and taxed at a lower rate
- More access to startup funding in the form of grants
- The option to fundraise by selling bonds or shares to investors
Independent contractors generally have more complex tax situations than employees, including additional tax duties. Employees have their income taxes, Canadian Pension Plan (CPP), and Employment Insurance (EI) automatically deducted from each paycheck. This makes filing an annual income tax return relatively simple, and for most employees, their tax responsibilities end here. In some cases, employees may receive a refund.
An independent contractor also needs to file an income tax return, but they are required to manage these filings on their own. Sole proprietorships do so by calculating their net income and remitting tax payments for each period. An incorporated independent contractor needs to file both a personal and corporate income tax return. In addition, independent contractors are required to collect GST/HST taxes from their clients, remit these taxes regularly, and claim GST/HST that has been paid against the amount that has been collected.
Canadian employers must be very careful to ensure that no employees have been improperly classified as independent contractors. Misclassification of a Canadian employee or independent contractor can result in serious penalties from the Canada Revenue Agency, as well as other federal and provincial agencies. These penalties may include:
- Penalty charges between 10% and 20% of unpaid income tax, employment insurance, and CPP premiums, plus interest;
- Premiums for workers’ compensation, plus interest and fines;
- Unpaid CPP premiums (both the employer and worker share)
- Minimum wage, vacation pay, overtime, and parental leave
In addition to these penalties, employers who have misclassified employees are at a liability risk if the employee files a wrongful dismissal lawsuit following early contract termination.
Independent contractors have a wide range of unique tax concerns and should make sure to fulfill all Canada Revenue Agency requirements to avoid costly penalties. Additionally, employers must ensure that anyone who completes work for them is properly classified. If you are an independent contractor or business owner with questions related to whether someone should be classified as a Canadian employee or independent contractor, contact Jeremy Scott Law at (902) 403-7201 to learn more.