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If you’re a small business owner, you’ve likely struggled with the question of whether to classify your team members as employees or self-employed individuals. While the differences between the two may be hard to understand, the classification of each has major implications on a person’s entitlement to Employment Insurance (EI) benefits, as well as how they are treated under other legislation such as the Canada Pension Plan and the Income Tax Act. If all of this is making your head spin, don’t worry, we feel the same way! Which is why we sat down with Knit People’s Senior Accounting Associate Guriqbal ‘Guri’ Singh to find out what is the difference between employee and independent contractor (also known as a self-employed individual).
Five Factors To Consider
While you may think that you’re an independent contractor, the CRA may see things differently. Therefore, it is important to keep in mind the factors that the CRA considers for determining contractor status. This test is outlined in the document Employee or Self-Employed? (RC4110) and “sets out a method that should, in most cases, allow payers and workers to determine the nature of their relationship.” To make it easier to understand this test, we’ve broken down each point.
One of the biggest differentiators between an employee and an independent contractor is the level of control. According to the CRA, “Control is the ability, authority, or right of a payer to exercise control over a worker concerning the manner in which the work is done and what work will be done.” When examining control, it is important to focus on both the payer’s control over the worker’s daily activities and the payer’s influence over the worker.
In most cases, a relationship based on continuity, loyalty, security, subordination, or integration is characteristic of an employee-employer relationship. However, if the relationship is not one of subordination, the worker would likely be considered a self-employed individual.
2. Ownership of Tools/Equipment
Another factor considered by the CRA is the ownership of tools and equipment. In this case, “What is relevant is the significant investment in the tools and equipment along with the cost of replacement, repair, and insurance.” In the case of an employee-employer relationship, the payer often provides all of, or most of, the tools and equipment required for work and is responsible for all repair, maintenance, and insurance costs.
Conversely, self-employed individuals are often required to supply the tools and equipment necessary to complete a contract. This includes all repair, maintenance, and insurance costs. Self-employed individuals also often supply their own workspace and are responsible for the costs of maintaining it.
3. Financial Risk
The question of whether someone is an employee or independent contractor is also tied to the chance of profit or risk of loss. In most cases, employees will not have any financial risk. They are not responsible for any operating costs and they are not financially liable if they do not fulfill the obligations of the contract. However, this also means that employees often do not have an opportunity to profit. In this case, the notion of profit does not usually include increases in income tied to increased productivity, such as commissions.
On the other hand, self-employed individuals can have a financial risk and can incur losses because they pay fixed monthly costs even when work is not currently being done. In this case, the worker is financially liable if the obligations of the contract are not fulfilled. Yet self-employed individuals also have opportunities for profit because they have the ability to pursue and accept contracts as they see fit. They can also negotiate prices for their services and increase their proceeds or decrease their expenses to maximize their profit.
4. Responsibility of Investment and Management
The CRA also considers the degree of responsibility for investment and management held by the worker. If the worker is an employee, they will have no capital investment in the payer’s business and no business presence.
Conversely, if the worker is a self-employed individual, the worker has capital investment, manages his or her staff, hires and pays people to help with the work, and has a business presence.
5. Subcontracting Work or Hiring Assistants
A final factor that the CRA uses to differentiate between employees and self-employed individuals is whether the worker can subcontract work or hire assistants. This is largely because subcontracting workers or hiring assistants can affect the risk of loss or chance of profit. If the worker is an employee, they will not be able to hire helpers or assistants. They must do the work personally and cannot hire or send in replacements.
If the worker is a self-employed individual, he or she does not have to carry out the work personally and can hire another party to either help or do the work for them. In this case, the payer has no say over who the worker chooses to hire.
Why Hire An Independent Contractor?
If self-employed individuals have so much independence, you might be wondering why employers would hire them over an employee. For employers, the benefits of hiring an independent contractor include:
- Contractors don’t get benefits or pensions, and they have to pay their own CPP contributions.
- As an employer of an independent contractor, you are not responsible for as much administration: you do not run payroll, do not track vacation pay, do not have to to withhold income tax, pay the employer's share of CPP, EI, or transfer as much data if switching software providers.
- There is often no paid training needed for independent contractors.
- The flexibility of labour costs involved in hiring independent contractors can help employers better manage cash flows.
While this may seem like a good deal for employers, if someone is hired as a contractor and later deemed an employee, there are massive ramifications:
- The employer must remit unpaid taxes and may be subject to penalties and/or interest.
- CPP and EI premiums must be paid.
- Any business expense deductions claimed by the "contractor" must be repaid.
Thus, it is important that independent contractors take care to ensure that their status is clearly defined as such. Of course, you should always consult with your accountant or contact the CRA if you are unsure about your classification.
For more information about what is the difference between employee and independent contractor, please consult the CRA’s Employee or Self-Employed? (RC4110) guide.
Disclaimer: This article provides general information and should not be construed as tax advice. Since tax rules may change over time and can vary by location and industry, please consult a CPA or tax advisor for advice specific to your business.