Hiring an Employee vs Contractor – Why is it important to you?Admin
So you’ve decided to hire contractor – great! You get to save on the employer’s portion of Canada Pension Plan (CPP), Employment Insurance (EI), and the hassle of remittance, managing payroll and more. But let’s take a step back, and make sure that you and the Canada Revenue Agency (CRA) are on the same page.
Why It Is Important
The last thing you want is to be penalized by the CRA because they deem the relationship to be employer-employee. These penalties can be quite hefty. Generally speaking, employers are responsible to withhold payroll taxes which include income tax, CPP, and EI only for employees and not contractors. A misclassification of the relationship can result in a 10% penalty for failure to deduct the appropriate payroll taxes, or 20% for second occurrence in the same calendar year. In addition, CRA levies a penalty for late or failure to remit payroll taxes. Late remittance penalties can quickly escalate based on the following chart.
|1 – 3||3%|
|4 – 5||5%|
|6 – 7||7%|
|7 or more||10%|
Similar to the penalty for failure to deduct, late or failure to remit penalty can also be increased to 20% for second occurrence in the same calendar year.
As you can see, proper classification between a contractor and an employee is critical to avoid the unnecessary payroll penalties (along with interests). The penalties are compounded if you have mistakenly treat more than one worker as a contractor. As such, it becomes pivotal to look at all the facts collectively in order to determine your relationship with your worker.
Factors to consider
The question here is: Who is determining how and what work needs to be done. Do you provide detailed instructions to your worker or does he/she perform most of the tasks independently? How much supervision does the worker require in order to complete the job? Can the worker provide their service to other employers?
If the employer effectively has control over how the job should be carried out, even if the contractor agreement says otherwise, the CRA may consider the relationship to be employer-employee and you will be subject to payroll tax obligations.
Tools and equipment
If tools and equipment are involved, the question becomes who has ownership of these items. This is especially important as the value of the tools or equipment increase. Who is responsible for the tools or equipment, including repair and maintenance costs? Who retains the rights to the tools? Who is providing the workspace?
The context of the job plays an important role. A truck driver with his own truck would likely be considered a contractor due to the ownership of the primary tool for the work involved. A mechanic on the other hand, may own some of their tools but still be in an employee-employer relationship due to the circumstances of the job.
Can the person you hire turn around and subcontract out their work? If they can, it is an indication that you have a contractor relationship.
Whether the worker has financial risk involved is also a major factor in determining the type of relationship he/she has with you. Employees usually don’t assume any financial risks with their employment. For example, employees do not pay for overhead and rent whereas contractors generally incur business related expenses. Is the worker responsible for subcontracting fees or does the company reimburse the worker? Is the worker only hired on a project basis or does the worker get the same pay on a fixed schedule? Is the worker financially liable if they do not fulfill their obligations?
Opportunity for profit
The last factor we need to consider is whether the worker has a chance for profit or loss. Does the worker have the ability to generate additional profit or is there a risk of incurring a loss? Contractors or self-employed individuals have the ability to pursue additional jobs and contracts, which can result in significant difference in profitability. They also have operating expenses which need to be managed in order to increase overall profits.
Below is a handy comparison chart, which needs to be analyzed collectively to determine the relationship between you and your worker. Each situation is unique and facts dependent. If in doubt, check with your accountant to ensure you are handling the situation appropriately.
|Follows instructions||Have authority on how to perform their job|
|Can terminate their employment anytime||Restricted to the terms of the contract on finishing the job|
|One employer||Able to have more than one employer for their services|
|No risk of profit or loss||Opportunities for additional profit|
|Works on agreed upon hours||Controls when the work is being done|
|Hired for an undetermined period of time||Hired for a defined period of time|
|Tools provided by employer||Supplies the tools|
|Expenses reimbursed by employer||Expenses paid out of pocket|
|Paid on a fixed schedule||Paid on a project basis|
|Work is being supervised||Minimal to no supervision|
|Employer retains rights to the tools after the relationship ends||Contractor retains rights to the tools after the relationship ends|
|Employer provided workspace||Workspace may not be provided by employer|
|Not financially liable if employee does not fulfill the requirements of the job||Can be financially liable if the job is not completed as per the contractual agreement|
|No upfront cots||Worker may have capital investment or incurred upfront costs|
|Entitle to the same rights and benefits offered to other employees||No employment benefit|