May 13, 2002
Employee or self-employed?
Employee or self-employed?
By Debbie Thiessen, B.B.A., C.A., Edmondson Roper Chartered Accountants
For several years, the issue of distinguishing between employment and self-employment status has been an area of concern for both those providing a service and those paying for a service.
The incentive for both parties to structure arrangements as self-employment, often referred to as sub-contracting, has been heightened in recent years for several reasons, including increasing CPP premiums, payroll taxes in some provinces, and the potential for self-employed individuals to deduct more expenses than can employees.
The main advantages of a self-employed structure for the SERVICE PROVIDER are as follows:
- Expenses are deductible to the extent they were incurred for the purpose of gaining or producing income from that business. The eligible expenses include many that are not deductible from employment income.
- The self-employed individual is not required to pay EI premiums on self-employment earnings, and
- CPP contributions are calculated and payable when you file your Individual Income Tax Return, instead of on a monthly basis. The main advantages of hiring self-employed sub-contractors, from the perspective of the person PAYING FOR A SERVICE, are as follows:
- No withholdings are required on payments made to sub-contractors (i.e. tax, CPP and EI), nor is the payer required to remit their own portion of the CPP and EI resulting in an overall cash savings to the payer; and
- The sub-contractor does not fall under the "Employment Standards Act" so the payer is not required to pay the sub-contractor vacation pay, nor any other benefits that employees receive. The income tax benefits of being classified as self-employed far outweigh those of being classified as an employee. The benefit arises in the availability of tax deductions, as noted above. As an employee, deductibility of expenses incurred are limited and are only deductible to the extent that:
- The employer required the employee to pay their own expenses;
- The employee was required to carry on the duties of the employment away from the employer's place of business;
- The employee was remunerated in part or in whole by commissions (or similar amount); and
- The employee was not reimbursed for the expenses incurred.
- Eligible tax-deductible expenses are broader for the self-employed individual, thereby decreasing taxable income, which in turn results in lower taxes received; and
- Less cash flow from employers due to decreased monthly payroll remittances;
- Reduced provincial payroll taxes, for those provinces which levy this tax. Given these opposing objectives or views, how does one determine employment versus self-employment status and, if not already self-employed, how does one achieve that status?
The distinction between employee and self-employed sub-contractor is not always obvious and there is no one distinguishing factor. Determination of status is a question of fact, considering all available evidence.
The Income Tax Act of Canada ("the Act") defines "employee" as "includes officer." The Act defines "employment" as "the position of an individual in the service of some other person and "servant" or "employee" means a person holding such a position." There is not clear or concise wording within the Act to determine if you are in an employee-employer relationship, or if you have hired a self-employed sub-contractor. Neither does the Act define sub-contractor or distinguish between employee and sub-contractor.
Guidelines to determine "employee" status versus "self-employed" status have been established by case law and a series of tests that are used to determine status. The leading case in this determination is Wiebe Door Services Ltd. V. M.N.R [87 DTC 5025]. The most commonly referred to tests are as follows:
- Ownership of tools
- Chance of profit or risk of loss, and
If an individual is supervised by the "employer," and the work is done at the employer's place of business, with the employer assigning tasks and work load, along with hours of start and stop times, and guarantees terms of employment, the individual under this test alone would be considered an employee. When an individual is considered self-employed, a principal and agent relationship exists. The principal has the right to direct what the agent has to do. When an individual is considered an employee, a master-servant relationship exists and the master has not only the right to direct what the individual has to do, but also the right to say how and when it is to be done.
Another key factor in this regard is whether or not the individual provides service to more than one party. Normally, an employee works for only one employer.
Ownership of tools
If the individual provides their own tools to perform the work duties, and provide their own means of transportation in order to carry out the duties, the individual could be considered self-employed, under this test alone.
Chance of profit or risk of loss
If a job has not been properly performed, and the individual is required to redo or correct their work at their own expense, the individual would be considered self-employed. Where the individual's means of financial support is independent of such results, the individual would normally be considered an employee. In such a case, the financial risk rests with the employer rather than the person doing the work.
If the work performed forms an integral part of the employer's business, the individual could be considered an employee versus self-employed. In a self-employed sub-contractor situation, the work, although done for the business, is not integrated into it but is only an accessory to it. If the work is subject to co-ordinated control within other aspects of the business, it is most likely an employee-employer relationship.
Although these tests have been used as guidelines in determining employment versus self-employment status, they do not yield absolute answers. They are guidelines only and none of these tests should be taken in isolation. All factors should be taken into account and you must look at the relative weightings of all factors.
If you have hired an individual as a sub-contractor and CCRA determines that the individual is actually an employee, you will be subject to interest and penalties on the withholdings that were required, as well as be required to remit the employer's portion of CPP and EI with respect to that individual. A CPP/EI ruling of employment will result in the issuance of T4 slips, which creates a presumption of employment income. This ruling may then restrict the type of expenses that are deductible to that individual, and could result in additional income tax and interest reassessments against the individual.
It should be noted that self-employed individuals may be required to register for and collect GST on the services for which they invoice their customers.
Canada Customs and Revenue Agency ("CCRA") has attempted to formalize the criteria in determining employment status with a guide called "Employee or Self-Employed?" (RC4110), available from any Tax Services Office. Although this guide may not give you a definite answer as to your status, it will provide you with a starting point and give you an idea of the types of factors that CCRA will consider. If you wish certainty, you can apply for a ruling from CCRA by contacting Business Windows at 1-800-959-5525.
Since this is an area of interest to CCRA, and an unfavorable ruling can have adverse consequences on both parties, readers are advised to consult their professional advisor before attempting to structure their affairs as self-employment.
Debbie Thiessen is a Chartered Accountant at Edmondson Roper, specializing in tax for small businesses and owner managers. She is in the final year of her In Depth Tax course with the Canadian Institute of Chartered Accountants. Edmondson Roper is a regional C.A. firm with three offices located in the Fraser Valley of British Columbia.