When bringing people in to work with your business, the distinction between an “employee” and an “independent contractor” is not just an administrative detail; it carries significant legal implications, particularly in the realms of tax and employment law.
If a court, the Ministry of Labour, or the Canada Revenue Agency (CRA) finds a worker has been “mischaracterized” by being treated as an independent contractor when they are an employee, this can have serious and expensive implications.
Employees: A Power Imbalance
The relationship between employers and employees is governed by not only employment contracts but also employment standards legislation and the common law. The law sees employees as the party with less power in the bargaining process and therefore imposes safeguards to protect the rights of employees. Any ambiguity in the employment contract is interpreted in favour of the employee. Employees are entitled to minimum employment standards such as minimum wage, vacation and vacation pay, overtime pay, notice of termination, etc.
Independent Contractors: A Business-to-Business Dynamic
In contrast, an independent contractor relationship is viewed as a business-to-business engagement and can provide employers with more flexibility in addressing their business needs. Independent contractors assume responsibility for their taxes and maintain control and discretion over their work. Notably, they are not covered by Employment Insurance (EI) or the Canada Pension Plan (CPP), and they are not afforded the same protections under employment laws. Independent contractors are not entitled to minimum employment standards, and the only terms governing the relationship are those recorded in the contract as negotiated by the parties. The contractor is considered to have equal bargaining power in the relationship with the employer.
Factors that will indicate that a worker is truly an independent contractor include that the worker:
- has an existing business;
- has control over their hours of work;
- can perform work for other clients;
- can hire their employees;
- invoices the employer for their services rather than being paid through payroll;
- performs their services with minimal supervision from the employer;
- has the freedom to decline assignments from the employer;
- has a chance of profit but also bears the risk of loss.
However, none of these factors are determinative on their own, and each situation needs to be assessed on a case-by-case basis.
The Risk of Mischaracterization
Employers should ensure they are characterizing their workers correctly, as mischaracterization can carry substantial risks. Courts and the CRA will look beneath the surface of the relationship to determine whether the arrangement aligns more closely with an employment or contractor relationship.
Key Points to Consider:
- Legal Protections: Employees benefit from statutory legal protections and minimum entitlements, while contractor relationships are governed by whatever terms are negotiated in the contract.
- Tax Implications: Misclassifying a worker may result in unintended tax consequences, with employers potentially facing liabilities for unpaid taxes and benefits.
- Employment standards: A misclassified worker may be entitled to retroactive payment for minimum employment standards, such as vacation pay, public holiday pay, and termination pay.
- CRA Scrutiny: The CRA may look into contractor relationships that appear to mirror employment, to ensure proper remittance of payroll taxes.
Final Considerations: Substance Over Form
Employers need to balance the different benefits and risks of working with independent contractors vs. employers. While working with independent contractors may seem less risky on its face and reduces liability for things like termination pay, benefits, and paid time off, there may be other significant risks if the worker isn’t truly an independent contractor.
A critical takeaway for employers is that the label assigned to the relationship matters far less than the actual characteristics of the day-to-day working arrangement. Courts and the CRA look beyond semantics, focusing on the true nature of the relationship. While what the parties intended does matter, the tangible aspects of the working dynamic carry greater weight in the eyes of the law.
Got Questions? Reach out to us today for guidance and ensure compliance.
