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Are You a Contractor or an Employee?

Part 1: Independent Contractor vs. Employee: How to Tell Which You Are

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Contractor sitting in back of van taking a break

Is he a contractor or an employee?

Image (c) Adrian Weinbrecht / Getty Images

Are you an independent contractor or an employee? If this question sends shivers down your spine at tax time, you’re not alone.

The difference between an employee relationship and a business relationship is not cut and dried and having the Canada Revenue Agency determine that you’re an employee after all can have very expensive repercussions for both you and your employer.

Employers like to hire independent contractors. Hiring a contractor means a lot less rigmarole than hiring an employee and can be less expensive, too. Contractors don’t get benefit packages or pensions and pay their own CPP/QPP contributions. As an employer of an independent contractor, you don’t have to withhold income tax or pay a share of CPP/QPP or EI.

The big tax advantage for the independent contractor, of course, is the potential for tax deductions. Generally, a self-employed person can deduct all reasonable business expenses.

Sounds great, doesn’t it? But if a business hires a contractor who is later deemed to be an employee, both parties lose big as unpaid taxes, penalties, interest, CPP and EI premiums will all have to be paid.

Because the employee relationship and the business relationship is one of those gray areas that is constantly in flux, it’s important to do what you can to protect your independent contractor status.

First, you need to be aware of the “four-point test” that the Canada Revenue Agency uses to determine which type of relationship exists. “Employee or Self-Employed?” (RC4110) “sets out a method that should, in most cases, allow payers and workers to determine the nature of their relationship.”

The method is based on four key points; control, ownership of tools, chance of profit/risk of loss, and integration. Let’s look at each of these from the point of view of the contractor.

1. Independent contractor vs. employee: Control

The primary issue here is who’s running the ship. Does the employer have the right to hire or fire, determine the wage or salary to be paid, and decide on the time, place, and manner in which the work is to be done? Then an employer-employee relationship exists. Note that “if the employer does not directly control the worker's activities, but has the right to do so, the notion of control still exists.”

On the other hand, in a business relationship, the worker decides how the work will be performed. As a contractor, then, it’s important that you maintain the right to decide where, when and how the work will be done. If it comes to the test, and you can show that you were the person responsible for planning the work to be done, choosing the hours of work, and/or setting the standards to be met, for example, you’ll have a much better chance of being deemed a contractor rather than an employee.

2. Independent contractor vs. employee: Ownership of tools.

An obvious point, one would think; a contractor would supply his own tools. However, because it’s customary for employees to supply their own tools in some trades (think of painters and garage mechanics, for example), the cost of using the tools is a much better indication, according to the Canada Revenue Agency. “When workers purchase or rent equipment or large tools that require a major investment and costly maintenance, it usually indicates that they are self-employed individuals, because they may incur losses when replacing or repairing their equipment.”

What else does the Canada Revenue Agency take into account when examining the independent contractor vs. employee situation and what can you do to protect your tax status as a contractor? Click to continue reading.

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