The determination as to whether a person is an employee or an independent contractor can be a difficult exercise and a source of uncertainty. The use of contractor / consultants within the IT professional services industry is commonplace. Ensuring “onside” tax compliance is important as taxpayers have frequently been engaged in disputes with Canada Revenue Agency (CRA) as to the proper nature of a relationship.
Individuals may prefer independent contractor status to allow for a greater range of expenses that may be deducted against income. Expenses will generally be deductible if they have been incurred to earn income and are reasonable. An independent contractor will not be subject to EI premiums, but will be responsible for both the employee and employer portions of CPP premiums.
The employee versus independent contractor issue can be circumvented by providing services via a corporation, i.e. the individual’s corporation cannot be considered an employee of the payer. However, the individual will then be concerned with whether the corporation is earning income from a Personal Services Business (which has restrictive tax implications).
The issue of whether an individual would be an employee or independent contractor is a question of fact. There is a “four-in-one” test which has generally been replicated by CRA in their policies. The four factors used in the test are:
- Control – how much control does the taxpayer have over their work?
- Chance of profit / risk of Loss – does the taxpayer have an ability to increase income and is there a risk that the taxpayer could have financial loss?
- Ownership of tools – does the taxpayer provide the tools to complete the contracts?
- Integration – is the taxpayer integrated into the payer corporation?
In addition, The CRA provides relevant information via a guide called RC4110 – Employee or Self-Employed?
Setting up a proper structure and related agreements that support independent contractor status is key to avoiding potential difficulties with the CRA. In the event of an audit by CRA, business expenses may be denied and this may lead to additional tax and interest. In some circumstances the CRA may also propose to assess penalties. A proactive review by your tax or legal professional can help you to minimize the tax you pay on business income. For more information, please contact me at firstname.lastname@example.org.
Jim McConnery, CPA, CA, TEP