For many employers, there seems to be confusion in deciphering the difference between what constitutes an Independent Contractor from an employee. The Canada Revenue Agency (CRA) recognizes this grey area and has created a formula to clarify the difference and how this impacts taxes paid by the employer.
Hiring Independent Contractors
An Independent Contractor is hired for specific tasks. When the task(s) are complete, the Independent Contractor submits an invoice outlining the work completed and the amount owed by the employer. As there are no payroll deductions or benefits that need to be paid, an employer may view this as less expensive than paying an employee.
An employer is responsible for paying employee payroll taxes which include Canada Pension Plan (CPP), Employment Insurance (EI), and income tax. On top of that the employer is also responsible for the employer’s share of CPP and employment insurance. These are the basic payments that are required by CRA. For some small businesses, there is also the added expense of a benefit package that might include medical, pensions, or WorkSafe BC.
As it may seem less expensive for an employer to only hire Independent Contractors, this could become a grey area and problematic if unclear to CRA. As a small business owner, it is important to protect yourself by distinguishing what it truly means to hire an Independent Contractor vs an employee. To know for sure, CRA follows a four point test to determine the status is an Independent Contractor vs employee.
CRA Four Point Test
A Four point test is a standard procedure used by CRA to determine the relationship type that exists with an employer. The guide RC4110 provides details to determine if the relationship with the employer as an Independent Contractor or as an employee. In order to be clear, CRA has developed this four point test.
The main issue to ask is who is in control? Does the employer have the right to;
- Hire and fire?
- Pay a wage or salary?
- Decide what hours to work?
- Location of the work to be done?
- How the work is to be done and completed?
If the answer to all the above is yes, then CRA would determine this as an employee of the business.
As an Independent Contractor, CRA recognizes the right to decide;
- Where the work will be done
- When it will be done
- The amount of time to complete the work
- How the work will be done
- Setting the standards that will be met
By meeting all the above criteria, CRA would deem the work to be completed by an Independent Contractor
Ownership of Tools
This is sometimes a tricky area since both an Independent Contractor and an employee could supply their own tools especially amongst trades. As this can be seen as vague, CRA uses the cost of the tools as an indicator. Equipment or large tools that are purchased, rented, or require a large investment as well as costly maintenance, often indicate an Independent Contractor. This is because the Independent Contractor incurs all the losses when needing to replace or repair any of the tools or equipment.
Chance of Profit/Risk of Loss
This falls under the amount of financial involvement you have with the employer. The questions to ask
- Will you be making a profit completing the work?
- Any risk of incurring losses due to bad debts such as not being paid for work done?
- Having to pay for any damage to equipment or materials?
- Are there delays in completing the work?
- Cover operating costs?
If the answer is yes to all the above, CRA would view you as an Independent Contractor.
The integration section of the test combines the three other points as a review.
If the work is being done as a commercial activity, a business relationship probably exists; therefore independent contractor.
A noticeable integration is when an individual calls themselves “independent” and has only one client. CRA will perceive this as a red flag and lean toward this as an employer-employee relationship. If you are incorporated, take note from RC4110, having a single client puts the small business and the perceived independent contractor in danger of being declared a personal services corporation by CRA. This could affect the amount of tax owing to CRA by both parties.
Protect yourself as an Independent Contractor
To protect yourself as an Independent Contractor, have a signed contract between you and all the employers. Make sure to focus and include in the contract the first three points in CRA four point test. Provide quotes for any work proposals. Have a separate business bank account. Do not deposit any earnings into your personal account. If you are still uncertain of your status contact Banka & Company, CPA for more clarity hire as an Independent Contractor, or as an employee.