IMPORTANT: This post is specific to Canada. If you are not a Canada business/taxpayer then it is probably not applicable to you.
It’s all the rage to hire casual or fixed-term staff as “contractors” and not put them on payroll. This is often advantageous to the employer because you avoid expensive things like payroll taxes, workers comp, holiday pay or annual leave, tax withholdings, statutory holiday pay, sick leave, termination criteria, personal grievances etc. But in many cases this is incorrect and could lead to significant issues for you. It doesn’t matter what you call the position, the question of whether they are an employee or an independent contractor is a question of fact – not a choice! Sometimes people confuse the idea of someone on a fixed-term contract with being a contractor. These are not the same thing. Someone on a fixed-term contract can (and usually is) an employee. In employment language we talk about an “Independent Contractor” or an “Employee.” Employees include casual, short-term, fixed-term, part-time, full-time, and permanent staff. An Independent Contractor is not an employee and is not paid through payroll. Employees should always be paid through payroll.
If you recruit someone and pay them as a contractor and then something goes wrong and they file a complaint you could end up with significant costs and penalties. The tax department routinely conducts “Trust” audits (this includes a detailed review of your payroll and GST accounts) and will always look at payments to contractors to find employees that you have misclassified. It is far better to do it right in the beginning and reduce your risk. We always recommend that you assume that all individuals hired are employees unless PROVEN otherwise (remember, it is not a choice – it is a question of fact).
The courts have come up with a number of general factors that they look at when deciding if someone is an Independent Contractor. But before we get into those – let’s look at that phrase “independent contractor.” Those two words pretty much sum up the issues. Someone is an independent contractor (rather than a dependent employee) if they operate as a business independently from your business and operate under a contract for service. A contractor runs their own business. As a general rule that means having multiple customers. If you are their only customer then they are probably not in business for themselves, they are an employee. If they have no expenses to provide what they do (travel to work and normal clothing doesn’t count) then they are probably not in business.
So here are the general tests – they are not in order and none are more persuasive that the others – you look at them all in totality.
- Control – do they control their own work, set their own hours, have staff or can subcontract the work?
- Tools and Equipment – do they supply their own tools, computers, equipment, transport etc?
- Integration – are they presented to the public as an integral member of your team, or as external? (I call this the “sniff” test – if they smell like an employee to your customers then they probably are)
- Chance of Profit/Risk – are they in control of how much they can make? Are they free to accept other customers? Can they manage their own expenses? Are they taking on financial risk or just receiving a wage/salary for time spent?
- Intention of the parties – do both parties agree and intend this to be an independent relationship (evidence of a contract is not enough to prove this, but certainly helps)?
Documenting your Contractor Relationship
So, if on the FACTS of the circumstances, you are hiring an Independent Contractor, here is what you should do as the employer to ensure that you lower your risk:
- Have a written contract. Make sure that you have the agreement to the status of independent contractor in writing. It’s good to include a clause where the contractor agrees that they are responsible for their own taxes and agrees to reimburse you if any competent authority holds you liable for any tax withholding (please talk to a lawyer).
- Document the reason you believe that this is a contractor not an employee. It’s always good to record your reasoning and rationale as it existed when the decision was made. If you wait until it becomes a problem, you will probably fail to provide suitable evidence.
- Insist on invoices. If they are in business for themselves then they will be used to sending invoices for services performed. You need this to justify your expense deduction. Simply sending them a payment based on the hours they worked is what you do for an employee. Businesses send invoices to request payment. If they are earning above the GST registration threshold then they should be charging you GST (or appropriate HST/QST rate) on top of their fee ($30K per year in Canada, $60K in NZ). They must include their GST registration number and the details of the tax on the invoice – if it’s not there adequately then refuse to pay the amount until they submit a valid invoice. My general rule is this: No invoice, no payment!
- Issue the appropriate tax forms. In Canada you should issue a T4A each year for all service providers (especially all individuals).
Frequently Asked Questions
Here are some general issues that get asked a lot:
- A company can’t be an employee, so if you are recruiting a company then they will always be an independent contractor.
- Just because they have a GST number doesn’t mean that this is a true independent contractor relationship.
- If someone works for you just once, they are probably still an employee not a contractor.
- No, you can’t just “choose” to treat someone as a contractor.
- Really, it’s not a choice!
Here are some really long and boring resources from CRA (Canada) and IRD (NZ) that may be helpful.
If you are the contractor, incorporating and engaging as a contractor may solve the problem for your employer, but it may also create problems for your tax. Your company may be deemed to be a “incorporated employee” (officially known as a “Personal Services Business”) and subject to some very strict tax rules. Talk to an accountant before you make this decision.
