If you “do work” for a company, are you an employee or an independent contractor? And why does it matter?
For tax purposes, it matters a lot. Generally, being an independent contractor is much preferable from a tax point of view. If your relationship is that of an independent contractor (i.e., you are carrying on business), then:
- You will not have tax withheld at source. Instead, you can keep all the funds you collect until you have to pay your income tax to the Canada Revenue Agency, next April 30. (However, by September 15 of the second year of doing this, you will normally have to start remitting quarterly installments.)
- You can deduct for tax purposes all legitimate business expenses, except those that are specifically prohibited by the Income Tax Act. Essentially, the way you calculate income is no different than in any other business; it’s total revenues minus the expenses of doing business.
- You may be more likely to be able to deduct the costs of a “home office,” which will be considered your principal place of business. (The company’s site, at which you do some or much of your work, is not your place of business, so it does not prevent you from claiming home office expenses.)
- You will not be eligible for Employment Insurance, so you will not be charged premiums.
- You will be required to pay double Canada Pension Plan (CPP) premiums, which are collected on your tax return. For 2008, assuming your earnings are over $44,900, you will save $711 in EI premiums but will pay $2,049.30 extra CPP contributions. (In Quebec, you pay Quebec Pension Plan (QPP) instead of CPP.)
- You can choose a year end for your business that is not December 31, but there is generally no tax advantage or saving in doing so.
- Your income for tax purposes will include amounts that you have invoiced, even if you have not yet received payment, and may also include “work in progress.”
- Your personal income tax return filing deadline will be June 15 instead of April 30. (However, any balance you owe must still be paid by April 30, or interest will run on the balance from April 30.)
On the other hand, if you are en employee, then:
- You will normally have income tax, CPP (or QPP) contributions and employment Insurance premiums withheld at source by your employer. If too much tax is withheld, you will receive a refund after you file your tax return in the spring.
- You can only deduct for tax purposes the expenses that are specifically allowed by the Income Tax Act. Very few expenses are allowed to employees (certain work-related travel expenses, for example.)
- You generally cannot deduct expenses of a home office, unless, for example, the company requires you to have such an office and you spend most of your work time at home rather than at the company.
- Your income tax return filing deadline will be April 30. If you miss the deadline, a penalty of 5% (escalating by 1% per month to 17% for 12 months) automatically applies to any unpaid balance of tax.
- You must pay tax on all employment income you receive in the calendar year, but not on amounts that you have earned (worked) but not yet been paid for.
- You do not charge or collect GST on your income.
- You may be taxable on certain employment benefits that would not necessarily be taxable to you as an independent contractor.
Being an employee or an independent contractor does not just depend on what you and the company call your relationship. If you want to be an independent contractor, you have to establish that you are in fact independent and not an employee.
Not surprisingly, the Canada Revenue Agency will often take the position that you are really an employee. This is especially likely if there is only a single company paying you income (i.e., you only have one “client). However, you may be still able to show that you are not an employee.
There is no clear or definitive test to apply. The Courts have come up with a number of guidelines, but each case depends on its facts.
The following criteria are important:
- Do you receive typical employee benefits, such as sick leave, termination pay, a pension plan, group health plan coverage, life insurance and/or stock options? If so, you are more likely to be considered an employee.
- Who controls your work environment, what you do and when you do it? Are you required to be at a particular office from 9-5 each business day, or are you paid more for getting a task done than for putting in time? If the former, you are more likely an employee.
- Whose equipment or tools do you use? Do you provide your own? If not, you are more likely an employee.
- Are you an integrated part of the company, or do you provide a separate service that can be easily dissociated from the company’s core operations? For example, if you manage a plant, you are more likely to be considered an employee than if you provide occasional safety training to employees.
- Do you personally have any chance of profit or bear risk of loss, or will you simply be compensated for your time? If you are simply paid for your time regardless of the results, you are more likely an employee.
- How have you and the company classified your relationship? If you have a contract stating that you are an independent contractor, the Courts are more likely to accept that, provided the other criteria do not point strongly in favour of an employment relationship.
For example, you should decline most of the traditional employment benefits, and simply opt to issue regular invoices to the company to pay for your services, plus disbursements such as travel or long-distance phone charges that you incur. Of course, you will want to discuss with the company how your compensation is calculated; normally, as an independent contractor, you would charge a significantly higher hourly rate than as an employee, to make up for the lack of benefits and the lack of severance protection if your contract expires and is not renewed.
You should have a contract signed by both parties that states that you are an independent contractor and not an employee. As well, you should avoid having a business card with the company’s name on it, and appearing on the company’s internal telephone list. That makes you look more an integrated part of the company, and less like an outside consultant or contractor.
Finally, if you are an independent contractor and your total billings exceed $30,000 per year, do not forget to register for and invoice the GST as 5% on top of your billings. (If you are in Nova Scotia, New Brunswick or Newfoundland, this is normally 13% Harmonized Sales Tax instead of 5% GST; in Quebec it is GST plus 7.5% Quebec Sales Tax on the GST included amount.) The company generally will not care about this; most businesses recover all the GST they pay out by claiming input tax credits, so the GST you add to your invoices will not cost the company anything unless it is in the business of making “exempt” supplies (such as financial services or certain health care services).
Recently, Canada Revenue Agency has increased its review of employees’ T4 slips and Sub Contractor Reporting Forms to identify situations where a company has treated a person as an independent contractor, and has reassessed various businesses treating the person as an employee, with very severe source deduction penalties, as well as significant Canada Pension Plan, Employment Insurance and accumulating non deductible interest costs.
We would be pleased to discuss and review your situation and minimize the impact that a Canada Revenue Agency audit could have on your business, so call us today at 905-528-0234 or email Joe at firstname.lastname@example.org.