Employee or Self-Employed? [Feb 25, 2018]

A question accountants are often asked is whether it is better to work as an employee or a sub-contractor. At first glance, the idea of making an employee a sub-contractor looks pretty beneficial to all concerned: the employer no longer pays deductions, and the employee, now a subcontractor, can write off his or her expenses. Unfortunately, it’s not quite as simple as that. Whether or not someone is an employee or self-employed has been challenged over and over again by Canada Revenue Agency, and to determine which category the person falls into, the courts have developed a four-test system:

The control test is to determine what degree of control you or the company has. If the company can tell you what, when, where, and how to do the job, then you may be considered an employer. If you, however, can do the job as you choose, but within an agreed-upon time and under certain regulations, then you may be considered legitimately self-employed.

The integration or organization test looks at how closely your work is tied to that particular company. If you are as tied to the organization as any employee, that is, if you act in the same manner as an employee, then you would likely be considered to be one.

The economic reality test is the most basic, and often the easiest one for you to determine by yourself. This test is to determine your ability to earn a profit, and your exposure to risk. If you supply your own tools or equipment (not just a power-saw), if you are able to make a profit or are at risk of incurring a loss, you may be considered self-employed. If, however, you supply no equipment, put up no funds, and are exposed to no risks or liabilities, you would most likely be considered an employee.

The specific results test determines whether you are doing a specific job for a specific amount of time, or whether you simply do the same job over an ongoing period of time with no expected date of completion. The courts will use one or all of these tests to determine where you fit in.

So what does all of this mean to you? In a nutshell, if the only difference between you being an employee or being self-employed is whether or not you are having deductions taken off your cheque, then you are an employee, and if that is the case, claiming as a self-employed subcontractor can end up being an expensive enterprise for both the employer and the employee. As an employee, if Canada Revenue Agency denies your claim of being self-employed, then the expenses that you have deducted for your business will be denied, and you may be looking at penalty and interest charges. As an employer, if you have been paying someone as a sub-contractor and CRA decides that they are an employee, then you will be required to make all of the past remittances, i.e. CPP and EI, along with penalty and interest, and depending on how many years are being assessed, that could be a sizeable amount.

This is an ongoing debate that we often have with clients, and the typical question is, ‘Why can’t you pay him as a sub-contractor if that’s what he wants?’  First of all, it may very well look like a good idea to the employee at the time, but should the time come when he needs to collect EI, it suddenly quits looking so good, and that’s when the problem starts. This leads to the question, ‘But what if you have a contract?’  It doesn’t matter. You and I may decide to write up a contract that allows you to drive 140 kms an hour when you’re doing errands for me, but try to convince the officer who pulls you over that it’s legitimate. You cannot make a contract that is outside of the law.

Self-employed sub-contracting can be a very advantageous situation for both parties, and can represent considerable savings on taxes and deductions, but only if it’s a legitimate business. Before entering into any sub-contracting agreement, make sure that you’re operating within the guidelines that Canada Revenue Agency requires, in order to avoid problems and costly penalties later.

Lindsey Cox, MBA can be reached at lindseycox [at] coxandcompany {dot} ca