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The Danger of Hiring Nothing But Independent Contractors

Posted by Stacey Jones

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Aug 20, 2013 11:45:00 AM

Independent ContractorBoth employers and employees can benefit from independent contractor arrangements. Employers like working with independent contractors because they don't have to pay CPP, EI, income tax, pensions, and benefits. The contractors themselves also appreciate the arrangement because they can write off reasonable business expenses and avoid the bureaucratic hassles that accompany working within a business.

Working in an independent contractor framework seems like a win-win situation for both employer and employee, so what's the catch?

The CRA is strict about the definition of an independent contractor because they know that some people use independent contractors to avoid paying taxes and benefits. To draw a clear line on the issue, the CRA has formulated a four-point test to determine whether or not someone is an employee or an independent contractor.

Abiding by this four-point test is critical to you as an employer. If the CRA finds that you're not following the regulations governing independent contractors, you could be subject to back taxes, CPP contributions, and EI deductions for the time spanning your employee's involvement with your company. This is not just an issue for large corporations. Any business, large or small, could find itself facing huge financial penalties if the CRA finds that it hasn't followed its guidelines regarding independent contractors.

The guidelines specifically examine control, ownership of tools, profit/risk, and integration.

1. Control

Essentially, the CRA wants to know who is in control of the work done.  If the employer specifies how the job will be done and directs the worker's daily activities, the worker is an employee, not an independent contractor.

This doesn't mean that the employer doesn't have any say in a project. Of course, the employer can impose reasonable limits. For example, the employer can say, "The brochure needs to be printed by March 22nd," but the independent contractor should be in charge of how the project is accomplished.

2. Ownership of Tools

In most cases, independent contractors must own and maintain their own tools and equipment. If a worker reports to work at a business and uses the business' equipment, that person is an employee. If, on the other hand, the work is done at the independent contractor's office or home on the worker's own equipment, it's much more likely that the CRA will consider this worker an independent contractor.

3. Profit/Risk

Employees don't have many opportunities to take risks or incur profits outside of their agreed-upon wages. Yes, employees incur losses when they travel to work and pay parking fees, but these do not classify as risks in the eyes of the CRA. Also, employees may earn bonuses, but again, this is not what the CRA has in mind when discussing risks.

Profits and risks come into play when an independent contractor can turn down work or choose to take a loss for various reasons such as doing work for charity, trying to secure better contracts, or obtaining a client at a loss to secure future business or gain prestige. Also, independent contractors can set their own rates, even varying their rates for certain projects, which is not a privilege employees usually enjoy.

4. Integration

How integrated is the worker into the company? This can be difficult to determine and quantify, but the CRA uses it as one of their criteria for determining a worker's status. Contractors are less integrated than employees in the company's day-to-day affairs. They often come in only occasionally, or they work at the office when handling specific projects.

The Rules Are a Grey Area

It can be difficult to know if you're compliant, as each situation is gauged on a case-by-case basis, based on the personal interpretation of circumstances by the specific CRA Auditor you are dealing with. Rather than running the risk of having independent contractors be assessed as employees, it can be well worthwhile to seek professional advice before getting into any trouble.

What Are You Leaving to Chance by Handling Payroll on Your Own

Topics: Payroll Tax, Payroll Service Provider, Canadian Payroll, Canadian Payroll Deductions, CRA Audit, CRA, Remitting Taxes, Canada Revenue Agency, Independent Contractor, CRA Compliant, CPP, EI

Stacey Jones

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