Are you looking for help to expand your small business, but are unsure whether to use a subcontractor vs employee?
This decision can have a huge impact on your Canadian business income and taxes, particularly if you think you’re using an independent contractor but the Canada Revenue Agency (CRA) decides that they’re not, actually. It’s important to know what, in the eyes of the government, the differences are between employees and self-employed contractors.
Small Business Tax Risks
An individual is an employee if the payer and the worker have an employer-employee relationship, a contract of service, also known as an employment contract. You, as the payer, control what type of work someone does and how it should be done. The CRA generally considers you to be an employer if you:
- pay salaries, wages, bonuses or tips to your employees
- provide certain taxable benefits to your employees (ex: allowance or car)
An independent contractor uses a contract for service, meaning that you as the payer control only the outcome of the work. The best indicator of whether an individual is a contractor is whether they, the person providing the services, can hire a subcontractor to do some of the work. With a contractor, you must accept that someone else might do some of the work. Some companies have asked employees to work as contractors to reduce their overall costs and liability. Many people have found themselves accepting what really seems like a full-time job, presented as an independent contractor position. In this type of situation, individuals may find themselves receiving few of the advantages of being self-employed while taking on the risk of having no safety net should they be let go.
If a worker or payer is not sure of the worker’s employment status, either of them can request a ruling to have it evaluated. A ruling will prove whether a worker is an employee or is self‑employed, and whether that person is eligible for pension or insurance. If either the worker or payer does not agree with the decision, they can file an appeal within 90 days after being notified of the ruling. The Government of Canada wrote an IPG is to ensure a uniform purpose to determining the existence of an employer/employee relationship.
Importance of Employee Status
Although a written contract might say that an individual is self-employed and working under a contract for services, the CRA will consider intent to see if the individual is truly self-employed or if there is evidence of an employer-employee relationship. They gather all the details on how the relationship is structured, and then examine all the possible factors to assess the nature of the relationship. The language used when the relationship was formed is very important, as the CRA will assess the intent between the “worker” and the “payer”.
Who controls the work done, and when and how it’s done? Who owns the tools and equipment used? Does the worker’s only pay come from this payer? Does the worker provide specific services for short periods or has the worker been contracted to provide service to the company over an indefinite period of time? Is there a relationship of subordination that exists between the worker and the payer? Central to any answer is whether the worker is performing their duties as a person in business on their own account.
An employer who is found to have not deducted the required Canada Pension Plan contributions or Employment Insurance premiums, then has to pay both their share and the employee’s share of any contributions and premiums owing, plus penalties and interest. That could potentially trigger a full-scale payroll audit by the CRA.
As well, it’s important to differentiate if a worker is actually an employee because employees have certain entitlements and protections under health and safety legislation, and labour standards. If the worker is considered an employee, your company would be responsible for remitting all payroll taxes and withholding tax on their earnings as well as reporting those earnings on a T4 slip every year.
The boundary between self-employed worker and paid employment can sometimes be blurry. Due to globalization, volatile markets, new technologies and more, the 21st century has seen the development of self-employed freelancers, consultants and independent contractors. So much so, that self-employment is entirely common in today’s workplace.
Advantages of Subcontractors
Subcontracting can be both financially and operationally advantageous for your business. Subcontractors come with a lot less paperwork and responsibility, as your company is not responsible for remitting their payroll taxes, including income taxes, Canada Pension Plan contributions, Employment Insurance premiums, and other benefits, including pensions and life insurance. All common employee benefits increases their costs substantially. Instead of a fixed cost like an employee, a subcontractor is a variable cost. With a seasonal subcontractor, you don’t have to worry about meeting payroll when there’s no work coming in.
For the subcontractor, the main benefit would be the potential for tax deductions that are not available to employees. A self-employed person can deduct all reasonable business expenses. To be considered a reasonable, the purchase has to be appropriate to business and used in an attempt to make money. It’s best to check with an accountant to figure out whether a business expense you want to claim as a deduction is considered “reasonable” or not.
Because of the different tax implications for subcontractor vs employee, the CRA is careful in differentiating between them and you need to be too. Your business should report all payments made to the subcontractor on a T4A slip. Since so many factors should be taken into account when drafting agreements with subcontractors, it’s important to have the relationship between your company and a subcontractor to be clearly documented in a written contract.
Choosing Subcontractor vs Employee?
Subcontractors can work extremely well in industries where specific skills are in high demand. These self-employed workers often charge more per hour than an employee, but they’re also a lot less paperwork and responsibility. But, although this individual may enjoy tax benefits, being self employed lacks many of the benefits including job security, benefits, liability and stress due to uncertain schedules and uneven cash flow.
When growing a small business in Canada, hiring a subcontractor vs employee can make great sense. If you choose to hire a subcontractor, take time to understand your business’ legal and tax obligations. Not knowing is not a credible reason for failing to comply with Canadian laws.
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