A question I get very often from business owners is whether or not their workers should invoice as a contractor (self-employed) or be put on payroll.
There are clear tax advantages for the company and the worker to be considered a contractor. The individual does not have to contribute towards employment insurance (EI) or the Canadian Pension Plan (CPP), if you’re in Quebec, then you contribute towards the Quebec Pension Plan (QPP) and the Quebec Parental Insurance Plan (QPIP). Additionally the contractor does not have to withhold any income tax on his invoices, like would an employer on an employee’s pay stub. This means more cash flow upfront. Furthermore, a contractor would be able to write off eligible business expenses, thus lowering his taxable income.
An employee would be subject to paying payroll taxes, and withholding tax on each pay. This means less cash flow per pay. However, earning employment income allows employees to contribute towards an RRSP. Self-employed individuals do not have this option.
The business engaging the contractor would also have some tax relief. First, there would be no need to pay the employer portion of the payroll taxes. Second, there is an added administrative cost associated with hiring employees. In practice, we factor in roughly an additional 10% on top of gross salaries as total cost associated with hiring employees. Thus, it’s more expensive for business owners to hire internally than it is to pay contractors.
Even though it’s more advantageous for both parties to operate as a contractor, the relationship is exposed to the criteria the CRA uses in determining the employee vs contractor relationship. Despite having a contract in place that states that the worker is a contractor, the nature of the working relationship is what will be scrutinized by the CRA. If left unchecked, the consequences could be hefty in interest and penalties after the CRA conducts an audit.
We take a look at the top 4 factors used in determining this relationship below. Take a peek and apply them to your unique situation.
Factor 1 - Control
The first test the CRA will use in order to determine an employee vs contractor relationship is to determine who in the relationship is in a position of control. This means who decides where, when and how the work gets completed. Even though some employers allow flexibility in working hours and how the work gets done, this does not mean that the worker has control.
Factor 2 - Ownership of tools and equipment
Who has ownership of the tools that the worker uses? If it’s the business, then that’s typically a sign of an employee relationship. If the worker owns most of the tools and equipment, then that could lead towards a contractor relationship. Ultimately, a contractor who is truly working for themself would have ownership of tools and equipment to perform their duties.
Factor 3 - Dependence on the organization
Typically, a contractor will have multiple clients in the regular course of business. There is no financial dependence on one client particularly which points to a contractor relationship. On the other hand, where the contractor has a single client, which represents 100% of the revenues, this points more towards an employee relationship as there is a major financial dependence.
Factor 4 - Financial risk
Employees get salaries and are reimbursed for expenses. They do not have any fixed or operational expenses and thus don’t have any risk of incurring losses. They periodically receive a paycheck regardless of the financial risk of the employer.
Contractors, on the other hand, have a risk of incurring losses because they tend to have fixed monthly costs. For example, think of an IT consultant that has rent and utilities to pay for his office regardless of whether this person has any clients. If an individual is exposed to the risks and rewards or either profit or loss, then that can be indicative of a contractor relationship.
There are numerous other criteria and subtleties to consider when determining the employee vs contact relationship but the ones mentioned above can certainly help. This issue is quite common and open to interpretation so when in doubt, you can either speak to a professional or request a ruling from the CRA.
A final point to make is that the criteria in Quebec are slightly different than the rest of Canada. If you operate a business in Quebec or have workers in Quebec, ensure that your CPA is knowledgeable with the lay of the land in La Belle Province.
Before I let you go, I ask; Are your workers employees or contractors?
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