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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

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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

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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

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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

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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!

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.

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Written by Neena Gambhir

I'm a Chartered Professional Accountant and have been navigating the waters of public accounting for over a decade. I've had the privilege to work with all sorts of clients – from small family-owned businesses to those big names on the stock exchange, spanning various sectors. Through these experiences, I've gathered a ton of knowledge, especially when it comes to Canadian corporate and individual taxes. I've also got a solid handle on the ins and outs of partnership, trust, and estate taxes.

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