When is an Independent Contractor Really an Employee and
Why Does it Matter?*
As an employer, you may be faced with the decision of whether or not to hire a
worker as an independent contractor, rather than as an employee.
There are important consequences to this decision which must be carefully
considered. Often, it is the worker who makes the request to be hired as an
independent contract, as there are certain tax advantages to being “self-employed”.
However, how the parties label their relationship is not determinative. The courts
and, importantly, CRA will examine the nature of the relationship to determine
whether the worker is, in fact and in substance, in business for himself
(independent contractor) or is actually an employee.
The consequences of hiring and paying a worker as an independent contractor who
is later determined, in substance, to be an employee are potentially far reaching and
may result in considerable additional costs to the employer, including termination
and tax obligations.
Please note, however, that the reverse is not an issue. I have yet to hear of a case
where a worker labeled and paid as an employee later alleges that he is, in fact, an
independent contractor.
Other than taxation, there are no significant legal
advantages to being self-employed. An employee, on the other hand, has
considerable potential benefits under the Employment Standards Act and at
common law.
Please note that this paper assumes a non-unionized workplace. In the unionized
context, rights and obligations are set out in the collective agreement and reference
must be made to that document.
Whether an individual is an employee or an independent contractor has important
consequences with respect to:
1. Income tax. An independent contractor is responsible for paying his or her
income tax and HST directly to CRA. The employer does not withhold
taxes, EI or CPP premiums. HST, however, will likely be payable. If the
worker is an employee, the employer is required to remit source deductions
to CRA (income tax, EI and CPP premiums).
2. Entitlement to Employment Insurance Benefits. Employees are covered.
Independent contractors are not.
3. Employment Standards Act (ESA) requirements.
The ESA covers
employees, not independent contractors. Employees therefore have the
benefit of the minimum employer obligations pertaining to vacation pay,
leaves, overtime, termination, severance, etc. mandated by the ESA.
4. Termination entitlements/obligations. As mentioned above, the ESA
mandates minimum entitlement to notice and/or severance applicable to
employees. Independent contracts do not have this statutory protection. In
addition, at common law, an employee may also be entitled to “reasonable
notice”, absent any written contract to the contrary. Independent contractors
are not covered by the ESA and would usually have a lesser entitlement to
notice at common law, assuming the parties do not have an agreement which
includes a termination clause.
As stated above, what the parties choose to call or label the relationship is not
conclusive, since it is the real relationship between the parties that must be
examined, not just the formal relationship. The test is substantive.
Independent contractor = self-employed = in business for himself.
At the highest level, the test is whether it can fairly be concluded that the worker is
in business for himself.
How is this determined? What factors will a court or CRA consider?
The common law
At common law, the courts will look at a variety of factors to determine the nature
of the relationship. Prior to the 20th century, the relationship of employee and
employer was characterized as that of master and servant. This underscores the
fact that an employer controls and directs the relationship and an employee is
required to obey the employer’s demands (within reason, of course).
Control:
The right to control performance of the works is regarded as the most important
factor. Control of the work includes not only control of what work is to be done by
the employee, but also how the work is done.
Whose business is it?
Does the individual supply her own tools/equipment? Does she have a chance of
profit or risk of loss? In short, is the person carrying on business for herself or
merely for the employer?
Exclusivity:
If the worker is dependent on one company and has little or no business with
anyone else, the worker is more likely to be regarded as an employee. Similarly, a
requirement that the worker work exclusively for the employer is often taken as a
sign of an employment relationship. There is a significant risk, therefore, that an
independent contract that works for only one employer or requires the employer’s
consent to work for anyone else would be found to be an employee
Designated task v. general retainer:
Where a person is engaged to provide a specified end result, rather than “services”,
she will more likely be considered independent. An open ended commitment to
provide a specified number of hours of service/week is more akin to an
employment relationship.
Not one factor is determinative, but all of the factors are considered as a totality, to
determine the issue on a balance of probabilities. Which side of the scale is
heavier than the other?
CRA
Perhaps the most important practical consequence of properly characterizing the
relationship is taxation. If the worker is an employee, the employer is responsible
for deducting and remitting CPP, EI and income tax from remuneration. An
employer who fails to deduct and remit for an employee will be responsible for the
employee and employer’s share, plus penalties and interest.
When CRA examines a relationship, the key question is whether the person is
engaged to perform the services as a person in business on his or her own account
or as an employee. Did the parties intend to enter into a contract of service
(employer/employee) or a contract for services (business relationship).
CRA will examine the following elements:
Control
The level of control the employer has over the worker’s activities. Control is the
ability, authority, or right of an employer to exercise control over a worker
concerning the manner in which the work is done and what work will be done. It
is the right of the employer to exercise control that is relevant, not whether the
employer actually exercises that right. It is the employer’s control over a worker
that is relevant, not control over the end result of a product or service purchased.
The worker is more likely an employee where the relationship is one of
subordination. Where the employer controls both the results and the method used
to do the work. Where the employer controls the method and amount of pay.
Where the worker requires the employer’s consent to work for someone else. The
employer provides training and/or direction on how to do the work. The employer
has the final word.
The worker is more likely to be independent where she works independently
within a defined framework. Where there is no one overseeing of his or her
activities. The worker is free to work when and for whom he or she chooses and
may provide services to different “employers” at the same time. The worker can
accept or refuse work from the employer.
Tools/equipment
Whether the worker provides tools and equipment. Self-employed individuals
often supply the tools and equipment required for a contract.
If the employer supplies most of the tools and equipment and is responsible for
repair, maintenance and insurance costs, the worker is likely an employee.
Similarly, if the employer reimburses the worker for the use of tools and
equipment.
The relationship of independent contractor is supported where the worker has made
a significant investment in the tools and equipment and the worker retains the right
over the use of these assets and/or where the worker supplies his or her own
workspace and is responsible for the costs to maintain it.
The right to subcontract
Whether the worker can subcontract the work or hire assistants. The worker may
be an independent contractor if he or she does not have to perform the service
personally and can hire someone else to do the work.
Profit/loss
The degree of financial risk the worker takes.
An employee is not usually responsible for any operating expenses and the
employer determines and controls the method and amount of pay.
An independent contractor can hire and determine the rate of pay of helpers and is
usually hired for a specific job rather than an ongoing relationship. An
independent contractor is financially liable if he or she does not fulfill the
obligations of the contract and will advertise and market his or her services.
The degree of responsibility for investment and management the worker holds. An
independent contractor will usually have capital invested, manages his or her own
staff, hires and pays its own helpers.
The worker’s opportunity for profit. Profit means income exceeding expenses.
Being entitled to commissions is not the same as “profit”. An independent
contractor is usually compensated by a flat fee and incurs expenses in performing
the service.
Termination Rights and Obligations
Employees are entitled to the minimum entitlement specified by the ESA: vacation
pay, statutory notice and severance, etc. Unless there is a valid and binding
employment agreement which provides otherwise, employees are also entitled to
reasonable notice at common law.
The ESA does not apply to self-employed individuals. At common law, however,
the law has increasingly implied reasonable notice similar to employees for
independent contractors. The written agreement should therefore carefully set out
the parties expectations in this regard.
The benefits of a written contract
To be enforceable, a contract does not have to be in writing. Most employees, for
example, do not have written contracts. The basic terms of an oral contract are
evidenced by the parties’ conduct and other terms are implied (common law) or
imposed (ESA).
However, to avoid ambiguity and manage risk, it is always advisable to have a
written agreement. Once all of the factors described above have been carefully
considered and a decision made as to whether or not to hire the worker as an
employee or independent contractor, the terms of that agreement should be
presented to the worker and finalized prior to engaging the service or services.
The agreement should clearly cover all aspects of the relationship including duties,
pay, term (defined or indefinite), termination provisions (resignation, cause,
without cause), and restrictive covenants (if applicable).
*This paper is intended as general information only. You are encouraged to
consult with an employment lawyer to obtain professional advice with respect to a
particular fact situation you encounter in operating your business.
Paul Veugelers, M.A., J.D. is a partner of SBMB Law, a full service law firm in
Richmond Hill, Ontario. Paul’s practice is restricted to employment law and
family law.
For more information, please contact Paul at
pveugelers@sbmblaw.com or view our firm website at sbmblaw.com.