Did You Hire an Employee or a Contractor?
Employee or contractor, that is the question that we get from many business owners. It’s important to know the answer because getting it wrong can be very costly and cause problems with the Canada Revenue Agency.
Here’s what we will cover in this article:
Factors to consider to determine the difference between an employee and a contractor.
How to tell if you’ve hired an employee or a contractor.
What’s the difference to a business owner?
Which is better to hire?
Employee or Contractor - Factors to Consider
When determining if you are working with an employee or a contractor, there usually isn’t a black and white answer.
The key question to be answered is whether the worker is carrying out services as a person in business for herself (contractor), or as an employee. In this article, we’re using the word contractor to mean a self-employed individual.
To make the determination, a number of factors are considered and then the overall working relationship as a whole points to either an employee or contractor.
Let’s list the factors and then go into more detail for each one.
Factors to consider include:
Intention - What was the intent when the working relationship began?
Control - Who controls how and when the work is done?
Tools and Equipment - Who provides the tools to do the job?
Subcontracting Work - Can the worker hire an assistant or subcontractor to help?
Financial Risk and Reward - Does the worker have any financial risk, or on the flip side, any opportunity for profit?
Investment - Is the worker required to make any investment in order to provide the services?
The first question to ask is what the intent was when the working relationship was established.
Did the two parties intend to enter into an employer-employee relationship or was it intended to be a business relationship? This is known as either a contract of service (employer-employee) or contract for services (business relationship).
The intent of both parties is a good starting point, but intent and reality can often be very different. For example, both parties may have intended the services to be provided as a contractor, but the actual facts point to an employer-employee relationship.
The remaining factors will help either support the original intention, or will reveal the actual form of the working relationship (according to CRA’s criteria).
Who controls when and how the work is done? This is a key factor in determining the working relationship. We want to assess the degree of control or independence.
If the payer has more control over how and when the work is done, this points towards an employer-employee relationship.
Let’s look at common examples of control factors that indicate employee and some that indicate contractor.
Control Indicators - Employee
The payer will often direct how and when the work is accomplished and will scrutinize the work that is completed.
The payer dictates both the method the work is completed and the results of the work.
The payer controls the method and amount of pay. Salary negotiations can still happen, but it’s ultimately the payer who dictates this in an employer-employee relationship.
If the worker requires permission to work for other payers, this points towards an employer-employer relationship.
The worker receives training or direction on how to do the work from the payer or other workers.
The worker is subordinate (lower in rank) to the payer in the general work environment.
Control Indicators - Contractor
Contractors most often work independently from the payer.
The worker doesn’t have anyone overseeing her activities and dictating how and when they are completed.
The worker is free to work for other payers and can provide services to many different payers at the same time.
The worker can accept or refuse work from the payer; there is no obligation to do the work as in a subordinate relationship.
The working relationship has no degree of continuity or loyalty as there is with an employer. The contractor can continue or stop working for the payer as she likes.
Tools and Equipment
The next factor to consider is who provides the tools and equipment necessary to complete the job.
Generally speaking, an employer will provide tools and equipment for her employees whereas contractors will have their own and will use it to complete the work.
It’s true that employees do sometimes have to provide their own tools to complete their work which is why this is just one of many factors to consider.
Tools and Equipment Indicators - Employee
The payer supplies most of the tools and equipment needed to complete the work.
The payer is responsible for maintenance and upkeep of the tools and equipment.
The payer owns and retains the right to use the tools and equipment.
The worker is reimbursed for any equipment purchases.
Tools and Equipment Indicators - Contractor
The worker provides the tools and is responsible for repairs and maintenance.
The worker has made a significant investment in the equipment and retains the ownership and rights to use them.
The worker supplies her own workspace and does substantial work from that site.
Can the worker hire an assistant or subcontract the work to someone else? This is a relevant factor that will help determine the nature of the working relationship.
Generally, employees cannot hire out an assistant or subcontract their work whereas a contractor can.
Subcontracting Work Indicators - Employee
The worker is not allowed to hire an assistant or subcontract the work out.
The worker is not able to send someone to do the work in her place.
Subcontracting Work Indicators - Contractor
The worker doesn’t have to complete the work personally. She can hire someone else to help out or to complete all of it.
The payer does not have a say in whom the worker hires.
Financial Risk and Reward
Understanding whether the worker has any financial risk or opportunity for profit will help determine the nature of the working relationship.
If the worker does have financial risk or opportunity for profit, that is an indicator for contractor and not employee.
Employees don’t normally have the risk of a loss from completing the work. They also usually have a set amount of remuneration they’ll receive for completing a service so no opportunity for profit.
Financial Risk and Reward Indicators - Employee
The worker is not usually responsible for paying any of the operating expenses required to complete the work.
The worker is not financially liable if they don’t fulfill her obligations.
The worker is not normally in a position to realize a business profit or loss. They receive the agreed upon remuneration.
The worker is entitled to benefit plans that are normally only offered to employees.
Financial Risk and Reward Indicators - Contractor
The worker as able to hire helpers to assist in the work and pays them out of her own pocket.
The worker completes much of the work from her own workspace and incurs expenses related to operating that space.
The worker is hired for a specific job rather than on an ongoing basis.
The worker can be financially liable if she doesn’t fulfill the obligations of the contract.
The worker doesn’t receive benefits from the payer like an employee would.
The worker continues to advertise her services outside of the current working arrangement.
The worker is paid by a flat fee and incurs expenses while carrying out the services. This leads to a variable amount of profit or even a loss if expenses get out of hand.
Is the worker required to make any investment in order to provide the services?
A significant investment is evidence that the relationship is that of a payer and contractor, not of an employer and an employee.
Investment Indicators - Employee
The worker has no funds invested in the payer’s business.
The worker does not have to provide significant tools or equipment to complete the job.
The worker does not have a business presence.
Investment Indicators - Contractor
The worker has capital invested in completing the job. This could be in the form of cash directly or in the form of providing equipment.
The worker hires and pays others to help with the work.
The worker has established a business presence.
Now that you’ve looked at all of the factors, it’s time to make a determination. Have you hired an employee or a contractor?
Putting it All Together - Employee or Contractor?
Determining the nature of the working relationship requires considering each of the factors noted above and coming to a conclusion. The conclusion is based on the working relationship as a whole and is subject to professional judgement.
If all of the factors indicate one type of working relationship, then it’s quite clear and you can proceed.
Unfortunately, it’s not always clear after looking at the whole picture. You may find that a worker sets his own schedule and uses his own tools, but has no control over how the work is completed and isn’t able to hire an assistant. That’s two indicators each way… what now?
Thankfully, there is help available to make the determination.
Request a Ruling from CRA
If after reviewing all of the factors you’re not sure of the working relationship, you can contact CRA and request a ruling.
There are a couple of ways you can do this:
My Business Account - If you have a My Business Account setup, use the “Request a CPP/EI ruling” link to start the process.
Mail a Form - A business owner or authorized rep can fill out the Request a Ruling form and mail or fax it to your tax centre.
If you’ve already been paying your worker as either contractor or employee, there is a time limit for the ruling request. The deadline is June 30th of the following year. For example, if you’re requesting a ruling for 2019, the ruling must be requested by June 30, 2020.
Consult Your Accountant
Your accountant can also give you a hand making the determination. Once you’ve assessed the factors together, your accountant can use her professional judgement to guide you.
We’ve seen many of these scenarios have helped to make the determination of employee or contractor. Reach out and we’ll be happy to help.
Now that you know the factors to consider and how to make the determination between employee and contractor, let’s look at whether one is better than the other.
Employee Vs. Contractor - What’s the Difference?
We will get into the pros and cons from the standpoint of the business owner (employer or payer). However, to help explain the pros and cons, we’ll first look at the differences between how contractors and employees are treated under some key regulations.
Payroll Remittances - Employers are required to withhold and remit payroll deductions to the Receiver General. This is not the case for contractors.
Canada Pension Plan - Employees generally pay into CPP which allows the employee to collect more Canada Pension when they retire. It also adds a cost to the employer as a matching employer CPP contribution required.
Employment Insurance - Employees also generally pay into EI which helps them to qualify for EI benefits. This also adds a cost to the employer as there is an employer portion of EI to be paid.
Vacation Pay - There are requirements for employers to pay a minimum amount of vacation pay to employees. This is not the case when paying contractors.
Workers Compensation - WorkSafe or WCB premiums are paid on employee wages, whereas they are not always paid on contractor payments.
Termination and Severance Pay - There are specific guidelines and requirements for severance pay when terminating an employee.
Overtime Pay - There are also requirements for increased pay during overtime work for employees. This isn’t required when paying contractors.
Once we understand the regulatory differences, we can begin to see some pros and cons of hiring employees vs. contractors.
Employee or Contractor - Which is Better?
As a business owner, which type of worker is better? There won’t be a definitive answer that applies to everyone, but we can look at the benefits for each and decide from there.
Benefits of Hiring a Contractor
Lower Cost - It is often less expensive to hire a worker as a contractor and not an employee. This is because the payer doesn’t have to pay for CPP, EI, Vacation, Overtime or severance pay.
Less Administrative Work - With employees, you have to remit payroll source deductions regularly, prepare T4s each year and ROEs when employees quit. With contractors, you can just hire for the job and pay the contractor’s invoice.
More Flexible - It’s generally easier to hire a contractor for short term work or for a specific job than to hire an employee.
Benefits of Hiring an Employee
Long Term Work - If you have an ongoing need for a worker, hiring an employee will usually fill that role better than a contractor.
Building Knowledge in the Business - Hiring employees allows you to retain talent and knowledge within your business. If you hire a skilled contractor, they leave with their knowledge and skills once the job is done.
Training and Supervision - If the work needs to be done a specific way, hiring an employee will give you greater control over how and when work is completed.
Loyalty - Well treated employees can be loyal and hard-working assets to your business.
Boiling this down, we can say that it’s generally more expensive to hire an employee. However, if you are looking for a long-term worker who can be trained and will build knowledge within your business, an employee may be your best option.