If you’re a Canadian business owner, there may come a time when you need to move assets into a corporation—whether you’re incorporating your sole proprietorship, setting up a holding company, or reorganizing your existing business for tax or estate planning purposes. The challenge? Such transfers can trigger significant immediate taxes on any gains built up over time.

That’s where Section 85 of the Income Tax Act, commonly known as the Section 85 rollover provision, comes in. This election allows a taxpayer to move eligible assets into a taxable Canadian corporation on a tax-deferred basis, meaning you won’t have to pay tax right away on any built-up gains. Instead, you can push that tax liability into the future, giving you more flexibility and control over your cash flow.

This strategy is especially valuable for sole proprietors who are ready to incorporate and take advantage of benefits like lower small business tax rates and limited liability. It’s also widely used by existing corporations that want to reorganize their assets or transfer property into a holding company as part of a broader tax or estate plan.

In this article, we’ll walk through how the Section 85 rollover works, who qualifies, the rules you need to follow, and some common examples to help you see it in action.

What Is a Section 85 Rollover?

Generally, under subsection 69(1), when a taxpayer disposes of property to a non-arm’s length party, the proceeds of disposition are deemed to equal the fair market value of the property. For example, when you transfer your property as a sole proprietor to a corporation and the property in question has accrued gains, it will be transferred at fair market value, which could create a large tax bill.

A Section 85 rollover is a tax election under the Canadian Income Tax Act that allows a taxpayer (the transferor)  to transfer eligible assets to a taxable Canadian corporation (the transferee) in exchange for shares and other non-share consideration. By transferring assets under Section 85, the transferor can avoid triggering immediate capital gains tax at the time of transfer.

Purpose of the Section 85 Rollover

The Section 85 election is a cornerstone of Canadian tax planning and the primary purpose is tax deferral. As such, the rollover exists to provide flexibility and tax efficiency in business structuring. Without it, every time assets are moved into a corporation, owners would face immediate taxes on any appreciation in value—even though nothing was actually sold for cash. Its primary purpose is to enable tax-efficient transfers of property to a corporation. Common uses include:

• Business incorporation – Transfer assets to your new corporation without immediate tax consequences.
• Succession and estate planning – Reorganize family business ownership for smoother generational transfer.
• Capital gains crystallization – Trigger specific gains strategically to use exemptions or offset losses.
• Corporate reorganizations – Move assets between related companies as part of restructuring.
• Tax deferral – Shift income-generating property into a corporation to benefit from lower corporate tax rates.

However, while the Section 85 can result in deferral of tax, the purpose is not to eliminate or reduce the overall tax liability.

Requirements for a Section 85 Election

To successfully use a Section 85 rollover, there are some key conditions that must be met:

1. Eligible Transferor  – The transferor must be an individual, corporation, or trust. The transferor can also be a partnership, provided that all partners are resident in Canada. . 
2. Eligible Transferee – The transferee must be a taxable Canadian corporation. In other words, the receiving entity has to be incorporated in Canada and subject to Canadian tax rules. This ensures that the rollover can’t be used to shift assets outside Canada without immediate taxation.
3. Eligible vs. Non-Eligible Assets - Not every type of property qualifies for a Section 85 rollover. 

Eligible property includes:

• Capital property (depreciable and non-depreciable) – such as equipment, buildings, land, shares etc. 
• Certain inventory (excluding real property inventory)
• Canadian and foreign resource property

Non-eligible property includes:

• Real property held as inventory (i.e land bought for resale by a developer). 
• Prepaid expenses
• Personal-use property
• Accounts receivable 

4. Shares consideration – The consideration must include at least one share of the corporation. Non-share considerations (“boot”) may also be included but it cannot exceed the elected amount/cost of the property transferred. If non-share consideration exceeds the cost/elected amount, a gain will be triggered to that extent. Common non-share consideration includes cash, promissory note or assumption of liabilities.  
5. Joint election filing – Both the transferor and transferee must file Form T2057 by the earlier of the tax filing deadline of the transferor and transferee for the year in which the transfer took place. 
6. Elected amount limits – The elected amount is the transfer price jointly chosen by the transferor and the corporation. This “elected amount” becomes the transferor’s proceeds of disposition and the transferee’s (purchaser’s) cost of the asset. The elected amount must fall within between these two general limits:
   • Lower limit: cannot be less than the fair market value of the non-share consideration (“boot”) received by the transferor.  
   • Upper limit: cannot exceed the fair market value of the property transferred.

Special Limits:

• For inventories and non-depreciable capital property, the lower limit cannot be less than the lesser of:
  • FMV of property 
  • Cost amount of the property transferred.
• For depreciable properties, the lower limit cannot be less than the lesser of:
  • FMV of property
  • Cost amount of the property transferred
  • Undepreciated Capital Cost (UCC)

For in-depth technical rules on elected limits, see CRA’s Income Tax Folio S4-F5-C1.

Typical Scenarios and Examples

Example 1: Incorporating a Sole Proprietorship and Transfer of Assets

Maria runs business as a sole proprietor and owns building with:

• Original cost (cost): $100,000
• Fair market value (FMV): $300,000

Maria wants to transfer the building into her newly incorporated company (Opco) in exchange for shares and a $60,000 promissory note.

• Without a Section 85 rollover, Maria has a capital gain in the amount of $200,000 on the building ($300,000 FMV – $100,000 cost).
• With a Section 85 rollover, Maria and Opco can choose an elected amount anywhere between the building’s cost ($100,000) and its FMV ($300,000).
• If Maria transfers or elects at $100,0000, Maria avoids triggering immediate capital gains tax because the transfer value equals her original cost.
• The $60,000 promissory note (boot) reduces the adjusted cost base of the shares Maria receives. The ACB of Maria’s shares on the transfer is $40,000 (elected amount of $100,000 - $60,000 of boot or cash received). 

In this way, Maria defers her $200,000 gain until she disposes of her shares in the future.

A summary of the transaction is illustrated below:

How to File a Section 85 Rollover (Form T2057)

To take advantage of the Section 85 rollover, the parties must file Form T2057: Election on Disposition of Property by a Taxpayer to a Taxable Canadian Corporation and complete the following steps:

1. Identify eligible assets for transfer
2. Valuation – Obtain fair market valuations, especially for goodwill and real estate.
3. Incorporate the corporation – Ensure the receiving company is properly set up with the right share structure.
4. Draft a transfer agreement – Document the assets transferred and the consideration received. Ensure a price adjustment clause is included in the purchase agreement. 
5. Complete Form T2057 – Both transferor and transferee must file.
6. Meet the deadline – File by the earliest of either party’s tax filing due date.
7. Maintain records – Keep valuations, agreements, and calculations in case of CRA review.

The Section 85 rollover is one of the most valuable planning tools available to Canadian business owners. It enables you to incorporate, reorganize, or plan succession while deferring immediate tax liabilities.

That said, the rules can be complex. Proper valuations, transfer agreements, and timely filing of Form T2057 are critical. For this reason, most entrepreneurs rely on professional tax advisors to guide them.

By understanding and applying this powerful rollover strategy, you can grow and restructure your business in a tax-efficient way, deferring taxes until a more strategic time in the future.

Whether you're incorporating, restructuring, or planning for succession, our accountants can guide you through the complexities of the Section 85 rollover. As a full-service accounting firm in Hamilton , our experienced tax accountants are ready to provide the expertise and support you need. Contact us today.

If you want to learn more about other tax and accounting topics, explore the rest of our blog!

Disclaimer

The information provided on this page is intended to provide general information. The information does not take into account your personal situation and is not intended to be used without consultation from accounting/tax professionals. NBG Chartered Professional Accountant Professional Corporation will not be held liable for any problems that arise from the usage of the information provided on this page.

In the complex world of taxes, mistakes can happen. Whether it's a simple oversight or a deliberate omission, the consequences of inaccurate tax filings can be daunting. However, the Canada Revenue Agency (CRA) offers a solution through its Voluntary Disclosure Program. This program allows taxpayers to correct their past tax errors without facing criminal prosecution and in some cases, penalties. In this article, we will explore the benefits, eligibility criteria, and other important aspects of the Voluntary Disclosure Program.

What is the Voluntary Disclosure Program?

The Voluntary Disclosure Program, commonly known as VDP, is a program offered by the Canada Revenue Agency to allow taxpayers to correct errors or omissions in their tax returns. This program is designed to encourage taxpayers to come forward voluntarily and rectify their mistakes, providing prosecution relief and in certain cases, penalty and interest relief.

Benefits of the Voluntary Disclosure Program

Participating in the Voluntary Disclosure Program can offer several benefits to taxpayers. Firstly, as mentioned above, it provides relief from penalties that would typically apply to errors for failing to file or filing incorrectly or other omissions. This can result in significant savings for taxpayers who may have otherwise faced substantial penalties.

Secondly, the VDP allows taxpayers to correct their tax filings and become compliant with the tax laws. By voluntarily coming forward and rectifying their errors, taxpayers can avoid the stress and uncertainty of potential CRA audits or investigations. It provides an opportunity to start with a clean slate and ensure future tax compliance.

Additionally, under the VDP, taxpayers may be eligible for some interest relief on the taxes owing. The relief is typically half of the total interest owed, providing further financial benefits to participants.

Furthermore, by participating in the Voluntary Disclosure Program, taxpayers can avoid criminal prosecution related to the disclosed information. The CRA agrees not to pursue criminal charges for the disclosed tax matters, providing peace of mind and legal protection.

However, it should be noted that the purpose of the program is not to grant taxpayers an opportunity to avoid paying the taxes they owe but rather to offer relief for mistakes that would likely attract a penalty. As such, CRA offers a higher level of relief to those who are correcting an error that is made unintentionally rather than to taxpayers who intentionally avoid paying their tax obligations. The VDP is available for various types of tax disclosures, including income taxes, import duties, GST/HST, excise taxes, and source deductions.

Limited Relief vs. General Relief (Changes as of March 1, 2018)

On March 1, 2018, the CRA modified its policies to narrow the eligibility and to ensure taxpayers who were intentionally avoiding their tax obligations are not provided relief under the VDP. Hence the CRA introduced two streams: Limited Relief and General Relief. These streams determine the level of tax relief available to taxpayers based on their specific circumstances. Let's explore the key differences between the two streams:

• Limited Relief: The Limited Relief stream is reserved for taxpayers, where CRA has reason to believe that the non-compliance was a result of the taxpayers intentionally avoiding their tax obligations. Under this stream, taxpayers are eligible for relief from criminal prosecution charges and gross negligence penalties. However, there is no interest relief or other penalty relief beyond gross negligence penalties.
• General Relief: The General Relief stream applies to all other taxpayers who do not fall within the Limited Relief category. This stream offers relief from penalties, including gross negligence penalties, and provides some interest relief on taxes. The interest relief is typically half of the total interest owed.

Once you file the application, which program the taxpayer qualifies under depends on a number of factors set out by the CRA such as the dollar amounts involved, the number of years of non-compliance, the sophistication of the taxpayer, and how long it ultimately took the taxpayer to correct their error.

Tax Situations That Can Benefit From Applying

The Voluntary Disclosure Program can be used to correct errors under a wide range of tax situations. Some common examples include where, a taxpayer:

• failed to report taxable income accurately,
• claimed ineligible expenses on a tax return,
• did not file tax returns for previous years,
• did not report income from foreign sources that is taxable in Canada on the tax return, and
• did not file required information returns, such as the Foreign Income Verification Statement (Form T1135).

These errors can occur due to various reasons, such as oversight, misunderstanding of tax laws, or intentional non-compliance. In many cases, if a taxpayer hasn't filed for the previous year or several previous years, filing a form or return late can result in an automatic penalty. In those cases, it is beneficial to go through the VDP to seek relief on some penalties and interest.

Eligibility for the Voluntary Disclosure Program

To be eligible for the Voluntary Disclosure Program, certain criteria must be met. The CRA under the new Voluntary Disclosure Program sets out the following five conditions:

1. The disclosure must be voluntary, meaning that the CRA should have no prior knowledge of the tax issue being disclosed.
2. The disclosure must be complete, including all relevant information for the tax years affected by the error or omission. It is crucial to provide accurate facts and documentation to support the disclosure.
3. The taxpayer must owe taxes as a result of inaccurate or missing tax filings. The VDP does not apply to situations where a taxpayer is eligible for tax refunds.
4. The tax returns being disclosed must be at least one year past the filing due date, unless part of a broader disclosure for older years.
5. The taxpayer is required to estimate and pay the tax owing upfront as part of the disclosure process.

It is important to note that the CRA has the discretion to accept or reject voluntary disclosures. Therefore, it is essential to ensure that all eligibility criteria are met and that the disclosure is prepared accurately and thoroughly.

Seeking Professionals: Lawyers and Accountants

While taxpayers can prepare and submit their voluntary disclosure applications independently, it is advisable to seek professional assistance, especially in complex cases. Lawyers and tax accountants can provide valuable guidance throughout the process and ensure that the application meets the requirements of the CRA.

In straightforward cases, where no significant sums or complex issues are involved, a chartered professional accountant (CPA) can handle the VDP application on behalf of the taxpayer. However, in cases where significant amounts or risks are at stake, involving an experienced lawyer specialized in tax disputes can be beneficial. The lawyer can act as the primary adviser, communicate with the CRA, and engage the CPA to prepare the necessary filings.

It is important to involve professionals early in the process to assess the eligibility for the program, evaluate the potential risks and benefits, and provide strategic advice to ensure a successful outcome.

Conclusion

The Canada Revenue Agency's Voluntary Disclosure Program offers taxpayers a lifeline to rectify their tax errors and omissions. By voluntarily coming forward and correcting their past tax filings, taxpayers can avoid penalties, criminal prosecution, and the stress of potential audits or investigations. The program provides relief from penalties, interest, and potential legal consequences, allowing taxpayers to start fresh and ensure compliance with the tax laws. However, it is important to meet the eligibility criteria, prepare a comprehensive disclosure, and consider involving professionals to navigate the complexities of the process. By taking advantage of the Voluntary Disclosure Program, taxpayers can correct their tax mistakes and enjoy peace of mind in their tax affairs.

If you are looking for an accountant in Hamilton for professional guidance on submitting your application under the CRA's voluntary disclosure program, contact us today. We are a full-service accounting firm in Hamilton that have experienced tax accountants that can ensure your disclosure is handled correctly.

If you want to learn more about other tax and accounting topics, explore the rest of our blog!

Disclaimer

The information provided on this page is intended to provide general information. The information does not take into account your personal situation and is not intended to be used without consultation from accounting/tax professionals. NBG Chartered Professional Accountant Professional Corporation will not be held liable for any problems that arise from the usage of the information provided on this page.

In recent years, there has been a significant increase in the number of Canadians working from home. With the rise of remote work and self-employment, many Canadians are utilizing their homes as their primary place of business. This shift in the work landscape has led to an increased interest in the tax implications of having a home office. The Canada Revenue Agency (CRA) recognizes that individuals incur additional expenses when working from home and allows you to claim a home office expense deduction on your tax return to reduce taxable income. However, it is important to understand the rules and guidelines set by the CRA to ensure that your claim is valid and avoid any potential issues

In this article, we will provide valuable information and insights to help you navigate the process of claiming a home office expense deduction on your tax return. We will cover the eligibility criteria, eligible expenses, specific guidelines for self-employed individuals and employees, and the common mistakes to avoid.

Home Office Expense Deduction for Self-Employed Individuals

To be eligible to claim a home office expense deduction, you must meet certain criteria set by the CRA. These criteria are designed to ensure that the home office is used for business purposes and that the expenses claimed are reasonable and justifiable. If you are self-employed, you can deduct home office expenses if you meet one of the following conditions:

• Principal Place of Business

The first criterion is that the home office must be your principal place of business. This means that you use your home office more than 50% of the time for business-related activities. It should be the primary location where you carry out your work and conduct the majority of your business operations.

• Regular and Continuous Use

In addition to being your principal place of business, the home office must be used on a regular and continuous basis for meeting clients, customers, or patients. This requirement applies to individuals who use their home office to meet with external parties as part of their business activities. Regular and continuous use implies that the home office is an essential and ongoing component of your business operations.

It is important to note that occasional or sporadic use of a home office may not meet the criteria for claiming the home office expense deduction. The CRA expects the home office to be actively and consistently used for business purposes.

Calculating the Home Office Deduction

Once you have determined that your home office meets the eligibility criteria, you can proceed with calculating the home office expense deduction. The deduction is based on a proportionate calculation method that considers the size of your home office relative to your entire home.

Proportionate Calculation Method

The proportionate calculation method allows you to deduct a reasonable portion of your household expenses that are directly related to the operation of your home office. The deduction is calculated by determining the percentage of your home's square footage that is used for your home office.

To calculate the percentage, divide the square footage of your home office by the total square footage of your home (including areas such as bathrooms, kitchens, and hallways). For example, if your home office occupies 200 square feet in a 1000 square foot home, the calculation would be as follows:

200 / 1000 = 0.20 or 20%

This means that you can deduct 20% of your eligible home office expenses from your business income.

Eligible Expenses for Self-Employed Individuals

If you are self-employed, the CRA allows you to deduct a variety of eligible expenses that are directly related to the operation of your home office. Some common eligible expenses include:

• Mortgage interest: You can deduct the portion of your mortgage interest that corresponds to the size of your home office.
• Utilities: Expenses such as water, heat, electricity, and internet can be deducted based on the proportionate calculation method.
• Property taxes: The portion of your property taxes that applies to your home office can be claimed as an expense.
• Maintenance: Costs associated with repairs and maintenance of your home office are eligible for deduction. This may include cleaning services for your office.
• Rent: If you are renting your home, a portion of your rent can be claimed as an expense.
• Insurance: Expenses related to home insurance coverage can be deducted based on the proportionate calculation method.

It is important to note that the expenses claimed must be directly related to the operation of your home office. Expenses that are unrelated to your home office or are considered personal expenses cannot be claimed as deductions. In addition, based on CRA guidelines, certain expenses that have been incurred on account of capital should not be fully deducted as home expenses. These can include items such as computers, printers, filing cabinets, chairs, desks, lamps etc. Since these are capital expenses, they should be deducted over a period of several years through the Capital Cost Allowance mechanism.

Lastly, note that one cannot use home expenses to create or increase a loss for the year. You do have the option to carry it forward to another taxation year. Furthermore, it is essential to accurately maintain records and documentation to support your claim in case of an audit.

Home Office Expense Deduction for Employees

Employees who work from home may also be eligible to claim a home office expense deduction from their taxable income, but the rules and restrictions are more stringent compared to self-employed individuals. To claim home office expenses as an employee, you must meet specific requirements outlined by the CRA.

Restrictions and Requirements

Whether you are a salaried employee or a commission-based employee, you can only claim home office expenses if you are required to pay for them yourself and your employer does not reimburse you. This means that if your employer provides a designated workspace or reimburses you for home office expenses, you cannot claim these expenses on your tax return.

To support your claim, your employer must complete Form T2200, Declaration of Conditions of Employment. This form certifies that you are required to use part of your home as a workspace for employment purposes and that you are not reimbursed for your expenses.

It is important to understand that the expenses you can claim as an employee are more limited compared to self-employed individuals. You cannot claim expenses such as mortgage interest or property taxes. However, you may be eligible to claim other eligible expenses, such as office supplies or phone and internet expenses, if they are not reimbursed by your employer.

Common Mistakes to Avoid

When claiming a home office expense deduction, it is crucial to avoid common CRA audit triggers that could raise red flags with the CRA or result in the denial of your claim. By understanding these mistakes, you can ensure that your claim is accurate, reasonable, and in compliance with the CRA guidelines.

1. Inflated Home Office Expenses

One common mistake is claiming inflated home office expenses. It is important to be realistic and reasonable when determining the size and expenses of your home office. Claiming excessive expenses could trigger an audit from the CRA and result in further scrutiny of your other deductions and expenses.

2. Misclassifying Expenses

Another mistake to avoid is misclassifying expenses. It is essential to correctly categorize your expenses as either eligible or ineligible for deduction. Capital expenses, such as furniture or equipment purchases, are generally not deductible as home office expenses. These expenses may be subject to separate depreciation rules and should be handled accordingly. Similarly, the principal portion of your mortgage is not deductible.

3. Rounding Up Home Office Expenses

Rounding up your home office expenses is another mistake to be cautious of. While it may be tempting to simplify your calculations by rounding up, it is best to provide accurate and detailed figures. Rounding up may draw additional attention to your claim and could lead to further scrutiny from the CRA.

4. Failure to Break Down Expenses

Failing to break down your home office expenses into different categories can also raise concerns with the CRA. It is important to provide a clear breakdown of your expenses, separating them into relevant categories such as utilities, insurance, and maintenance. This level of detail helps to validate your claim and demonstrate that the expenses are directly related to your home office.

Conclusion

Claiming a home office expense deduction on your tax return can provide significant tax benefits for self-employed individuals and eligible employees. By understanding the eligibility criteria, calculating the deduction accurately, and avoiding common mistakes, you can maximize your tax savings and ensure compliance with the CRA guidelines.

It is recommended that you work with qualified tax accountants, to ensure that you can deduct all your home office expenses that you are entitled to claim. If you are looking for an accountant in Hamilton for professional guidance, contact us today. We are a full service accounting firm in hamilton that has experienced tax experts to cater to all your tax needs.

If you want to learn more about other tax and accounting topics, explore the rest of our blog!

Disclaimer

The information provided on this page is intended to provide general information. The information does not take into account your personal situation and is not intended to be used without consultation from accounting/tax professionals. NBG Chartered Professional Accountant Professional Corporation will not be held liable for any problems that arise from the usage of the information provided on this page.

Are you unsure whether you should classify someone as an employee or a contractor? The Canada Revenue Agency (CRA) has specific guidelines that determine the distinction between the two. Understanding these guidelines is crucial for businesses to ensure compliance and avoid potential penalties. In this article, we will delve into the differences between an employee and a contractor and the key factors used by the CRA to determine employee vs contractor status. By the end, you will have a clear understanding of the factors that determine a worker's employment status, the rights and responsibilities associated with each, and the implications for both employers and workers.

Whether you're an employer looking to hire or a worker seeking clarity on your employment status, this article will provide you with valuable insights to navigate the complex world of worker classification in Canada. So, let's dive in and unravel the intricacies of employee vs contractor differences!

Definition and differences between an employee vs contractor

You are probably familiar with the terms "employees" and "contractors," but you may not fully understand the distinctions between them. These two categories of workers are mutually exclusive, which means that an individual cannot simultaneously be both an employee and a contractor for the same employer. Moreover, there are significant practical differences between these two worker classifications that have implications for both the worker and the business. We will look at the differences between employee vs contractor from both the worker's perspective and also the employer's perspective.

Contractor

In contrast to employees, contractors are individuals who provide services to clients under a contract for services. Contractors are considered to be in business for themselves and as such they are responsible for their own taxes, income reporting, and expenses.

The advantages of being a contractor include:

• Contractors have more autonomy and control over how the work is carried out.
• They also have more freedom in setting their own rates, hours worked, and job tasks than employees do.
• Contractors do have an opportunity to make more profit.

The disadvantages of being a contractor include:

• Contractors do not receive benefits or are protected by employment standards legislation.
• Contractors assume greater financial risk.

From the employer's perspective, as contractors are not entitled to benefits, the employer is not responsible for payroll deductions such as income tax, CPP contributions, and EI premiums. Additionally, the employer is not required to provide vacation pay or statutory holidays to contractors. For these reasons. employers sometimes prefer hiring contractors instead of employees as they can save costs associated with these obligations. Contractors also provide employers with a more flexible workforce, as they are able to hire and terminate contracts easily compared to employees.

Employee

An employee, as defined by the CRA, is an individual who performs services for an employer under a contract of service.

The advantages of being an employee include:

• Employees typically have a long-term relationship with the employer and are entitled to benefits such as vacation pay, sick leave, and pension contributions.
• Employees are protected by Employment Standards Legislation, which includes minimum wage laws, overtime pay, and protections against wrongful dismissal.
• Employees are entitled to the employer portion of the Canada Pension Plan (CPP) and Employment Insurance (EI) benefits.

The disadvantages of being an employee include:

• The employer has a great deal of control over the employee's work, including how, and when the work is performed.
• Employees are typically expected to work a specific number of hours per week and adhere to established policies and procedures set by their employers.
• Employees don't have an opportunity to share in the profits of the business and instead are paid based on a fixed salary.

In the context of an employer-employee relationship, the employer has an obligation to deduct the appropriate payroll deductions from the gross pay of the employee. This includes income tax, Canada Pension Plan (CPP) contributions, and Employment Insurance (EI) premiums. In order to comply with regulations, employers are required to send both the deducted amounts and the employer's portion of CPP contributions and EI premiums to the CRA. The employer is also responsible for providing vacation pay and statutory holidays, as well as any other benefits specified in the contract of employment.

Factors to determine employee vs contractor status

Determining whether someone is an employee vs contractor is not always a straightforward task. It involves considering several factors that contribute to the nature of the work relationship.

Based on CRA guide on Employee or Self-employed, the first step in determining whether a person is an employee or a self-employed individual is the intention of the parties. While the actual working arrangements may differ from the initial intent, understanding the intentions at the outset can provide valuable insights. According to CRA, both parties should have a clear understanding from the onset of whether they intended to establish an employer-employee relationship or a business relationship.

The parties' intentions can be determined through either a written contract or a verbal agreement. In some cases, the intention is evident and both parties are in consensus, thus establishing a shared intent. However, there are instances where the two parties have differing interpretations regarding the nature of their working relationship, resulting in the absence of a common intent.

The second step is to evaluate the relationship between the parties. Hence the central question CRA addresses in this step is:

Is the person performing services as an independent contractor or as an employee?

The purpose of this step is to determine if the actual relationship is consistent with the intent. To answer this question, CRA looks at the following key factors to determine whether you are an employee or an independent contractor:

Control

This factor looks at the degree of control held by the payer and the payer’s right to exercise control over how and when the work is performed. For an employee, the payer has direct control of how and when the work is performed. For example, they may dictate the methods, provide detailed instructions, and closely monitor the progress.

In contrast, contractors have more autonomy and independence in deciding how and when to carry out their work. In addition, they have the ability to accept or refuse work from the payer as well as the right to provide their services to different payers at the same time.

Ownership of tools and equipment

This factor considers the significance of the investment in the tools and equipment by the worker or the payer to accomplish the work. Employers usually provide employees with the necessary tools and equipment to perform their job while retaining the right of use over the tools and equipment.   In certain cases, the employee may have to provide their own tools but courts have acknowledged that this itself does not mean the worker is self-employed.

Contractors on the other hand are responsible for providing their own tools and equipment, and they retain ownership and control over them. They are also responsible for the repair, maintenance and insurance.

Degree of financial risk

This factor primarily focuses on the degree of financial risk taken by the employee. As an employee, you typically do not bear the financial risk associated with the business. Employees receive a fixed salary or wages and are not directly responsible for any operating expenses or losses the employer may incur. Lastly, the working relationship between an employee and employer is continuous.

Contractors, on the other hand, take on significant financial risk and bear the risk of losses. Their income may vary as they have fixed operating costs relating to the operation of their workspace and hiring third parties to help with the work.   Compared to an employee, the working relationship between a payer and contractor is limited to a specific job rather than being an ongoing relationship.   

Opportunity for profit

An evaluation of the level at which an employee can control his or her income and expenses.  Employees generally have limited opportunities to earn more than their fixed salary or wages. They don’t share in the profits or incur the losses associated with the business.

Contractors, on the other hand, often have the opportunity for increased profit. Their income may vary based on the success of their work, and they are able to negotiate higher fees for certain tasks or projects if they are successful in delivering them. This provides them with a greater incentive to perform well.

Degree of responsibility for investment and management

This factor considers the degree of responsibility for investment held by the worker. Generally, employees do not have to make any investment to provide the services to the employer.      

In contrast, contractors typically have to make significant investments to provide the services. This could entail hiring staff and paying third parties to provide the business.  

Subcontracting work 

This factor looks at whether the worker has the authority to subcontract work or hire assistants. Employees typically cannot subcontract their work or hire assistants and thus have to perform the services personally.

Contractors have the freedom to hire other parties to do the work and the payer has no control over who they hire.  This gives contractors more flexibility in managing their own business operations and allows them to expand their services without relying on the employer.

Ultimately, it is important to consider all relevant factors in order to determine if an individual is an employee vs contractor. Based on CRA guidance, the significance of each factor will vary based on the specific facts and circumstances of each case. No single factor can singularly define the employment connection. Instead, CRA analyzes each factor as part of the larger scenario to ascertain the overall nature of the relationship between the worker and the payer.

Frequently Asked Questions

Are subcontractors considered self-employed in Canada?

Yes, subcontractors in Canada are considered self-employed. As a result, they are required to remit their own taxes, such as income tax and HST. In addition, they need to file their T1 personal tax return and report their income on Form T2125 and claim all their eligible business expenses.

How to pay taxes as an independent contractor in Canada?

As an independent contractor, it is your responsibility to self-manage your taxes. This includes:

• Keeping track of your income and expenses throughout the year to ensure accurate tax filing.
• Registering for a GST/HST number if you are earning more than $30,000 CAD in one year.
• Calculating and remitting your taxes on a quarterly or annual basis depending on the type of income you are earning.
• Filing your T1 personal tax return and reporting your income on Form T2125, as well as claiming all eligible business expenses you incurred throughout the year.

Do contractors have the same rights as employees?

No, contractors do not have the same rights as employees. Generally, contractors are considered to be self-employed and are not subject to the same labour laws as employees. This means that they do not have access to the same benefits such as vacation pay or parental leave, nor are they entitled to certain workplace protections like minimum wage or overtime pay. Furthermore, employers are not responsible for withholding payroll taxes such as CPP or EI on behalf of their contractors.

Why is it important to determine whether a worker is an employee or self-employed?

It is important to determine whether a worker is an employee vs contractor because there are different legal and tax implications for each type of work arrangement. For example, employers are required to withhold payroll taxes such as CPP and EI on behalf of their employees, whereas they do not need to do so for contractors. Additionally, employees are entitled to certain workplace protections that contractors may not have access to. Therefore, it is essential that businesses take the time to accurately evaluate the working relationship in order to correctly classify individuals.

Conclusion

In conclusion, understanding the distinction between employee vs contractor is crucial for businesses operating in Canada. By correctly classifying individuals, employers can ensure compliance with tax laws, avoid legal and financial consequences, and provide fair treatment to their workers. It is essential to consider the key factors used by the CRA, such as control, financial risk, subcontracting work, intentions of the parties etc.

Seeking professional advice when needed can provide clarity and guidance. Businesses should regularly review their working relationships and contracts to ensure they accurately reflect the nature of the engagement. By prioritizing proper classification, businesses can maintain a healthy and compliant workforce. If you are looking for an accountant in Hamilton, that can provide clarity between employee vs contractor relationships for your business, contact us today.  We are here to help!

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Disclaimer

The information provided on this page is intended to provide general information. The information does not take into account your personal situation and is not intended to be used without consultation from accounting/tax professionals. NBG Chartered Professional Accountant Professional Corporation will not be held liable for any problems that arise from the usage of the information provided on this page.