Are your contractors at risk of being classified as employees?
When an organization hires workers, there are two ways those workers can be engaged: (1) as an employee under a ‘contract of services’ (more commonly known as an employment agreement); or (2) as an independent contractor under a ‘contract for services’. What is the difference?
There are significantly different legal and financial impacts
An employment agreement (whether in writing or not) creates an employment relationship between the organization and the individual. That relationship invokes a number of legal obligations for the organization, which include:
- Complying with minimum standards for employment conditions established under the Employment Standards Act
- Complying with minimum standards for employment conditions established by case law (except to the extent a written employment contract excludes those standards)
- Complying with employment-related prohibitions under the B.C. Human Rights Code
- Complying with standards for workplace safety and insurance coverage under the Workers’ Compensation Act
- Making deductions from an employee’s wages for Canada Pension Plan, Employment Insurance, and income taxes
If an individual works as a contractor, the organization—in relation to that individual—does not have to comply with most of the above-listed obligations (except certain of those in the Workers’ Compensation Act). With less required compliance, hiring an individual as a contractor can be less costly for an organization, and therefore more appealing.
Where organizations can run into trouble is where they have attempted to hire an individual as a contractor, but at some point in the relationship (often after it sours and the worker’s contract has been terminated) the worker argues that they were in fact an employee. Some ramifications to the finding that a worker was an employee include:
- the hiring organization becoming liable for non-compliance with minimum notice periods prescribed by the Employment Standards Act, and for payment of severance pay to the employee
- the hiring organization having to pay to the Receiver General all Canada Pension Plan and Employment Insurance deductions that should have been made over the course of the employment, plus penalties and interest
Intention doesn’t matter
But hiring someone as a contractor is not as simple as agreeing the relationship will be classified as a contractor relationship and not an employment relationship. In deciding if an individual is a contractor or employee, courts take a completely objective approach, meaning that it doesn’t matter what the organization and individual intend. For example, stating in a contract that the individual is a contractor is insufficient to establish that relationship.
Sometimes an organization will argue that because one or more of the following factors are present in the relationship, the worker should be considered a contractor. However, an employment relationship can nonetheless be found despite many of these factors being present.
- Worker invoices organization and collects GST
- Worker has more than one job
- Worker’s written agreement with the organization states the worker is a contractor
- Organization doesn’t make deductions from the worker’s pay for Canada Pension Plan, Employment Insurance, or worker’s income taxes
- Worker provides its own tools or vehicle
- Worker is unsupervised and chooses its own hours
- Worker receives a commission
How courts determine contractor vs employee status
The main test courts rely on is a 4-part test that looks at: (1) who controls when, how, and where the work is performed; (2) whether the worker has the ability to subcontract their services; (3) whether the worker owns their own tools; and (4) whether the worker’s performance affects that worker’s profits and losses from providing services to the organization. The circumstances will also determine how much weight a court places on any one of those factors, meaning that simply because three factors might indicate a contractor relationship, the fourth could tip the scale back in favour of finding an employment relationship.
Alongside the 4-part test, courts will occasionally look at an ‘integration test’, which asks whether the individual engaged to perform services is performing them as a person in business for themselves. This test considers the mutual reliance of the organization on the worker (because it needs the worker), and the benefits flowing to the worker as a result.
Hiring companies as contractors
Some contractors choose to incorporate a company to be the contractor, hoping to get a favourable tax rate on the income earned. A company cannot be considered an employee, so from an organization’s perspective, engaging that company as a contractor would pose no risk the company would be found to be an employee.
However, there can be a tax risk to the company for operating as a contractor if the nature of the company’s duties are analogous to those of an employee (again relying on the contractor vs employee tests, above). If the company’s duties for the organization were such that the shareholder was essentially just an incorporated employee, then that company could be classified as a “personal services business” under the Income Tax Act. This is problematic because a personal services business cannot claim the Small Business Deduction (a low corporate tax rate on the first $500,000 of income), cannot claim the general corporate rate reduction, and cannot make all of the standard business deductions. The effect of these drawbacks is that the income earned could result in more overall taxes than if the worker had simply earned that income personally, as an employee.