If you “do work” for a company, are you an employee or an independent contractor? And why does it matter?
For tax purposes, it matters a lot. Generally, being an independent contractor is preferable from a tax point of view, though there are some drawbacks.
If your relationship to the company is that of independent contractor (i.e., you are carrying on your own business and providing services to the company), then:
- You can deduct for tax purposes all legitimate business expenses, except those that are specifically prohibited by the Income Tax Act. Essentially, the way you calculate income is no different than General Motors or Apple: total revenues minus the expenses of doing business.
- You will not have tax withheld at source. Instead, you can keep all the funds you collect until you have to pay your income tax to the Canada Revenue Agency, next April 30. (However, by September 15 of the second year of doing this, you will normally have to start paying quarterly instalments.)
- You are more likely able to deduct the costs of a “home office”, which will be considered your principal place of business. (The company’s office, at which you do some or much of your work, is not your place of business, so it doesn’t prevent you from claiming home office expenses.)
- Your income tax return filing deadline will be June 15 instead of April 30. (However, any balance you owe must still be paid by April 30, or interest will run on the balance.) But if you miss the filing deadline, a penalty of 5% (escalating by 1% per month to 17% for 12 months) automatically applies to any unpaid balance of tax.
- You will not be required to pay Employment Insurance premiums. (The downside is that you will not be eligible for EI if you stop working.) However, you will be required to pay double Canada Pension Plan (CPP) contributions, which are collected on your tax return. For 2019, assuming your earnings are over $47,400, you’ll save $860 in EI premiums but will pay $2,749 extra CPP contributions. (In Quebec, you pay Quebec Pension Plan (QPP) instead of CPP.) You do get a deduction and/or partial credit on your income tax return for the CPP or QPP contributions, however.
- Your income for tax purposes will include amounts that you have invoiced, even if you have not yet received payment, and may also include “work in progress”.
- You are usually required to register for GST/HST and charge GST/HST on your services, in which case you can normally claim input tax credits to recover all GST/HST you pay on your business purchases.
On the other hand, if you are an employee of the company, then:
- You will normally have income tax, CPP (or QPP) contributions and Employment Insurance premiums withheld at source by your employer. If too much tax is withheld, you will receive a refund after you file your tax return in the spring.
- You can only deduct for tax purposes the expenses that are specifically allowed by the Income Tax Act. Very few expenses are allowed to employees (certain work-related travel expenses, for example). However, you can claim the Canada Employment Credit on your tax return; this credit, which is worth $183 in 2019, is available only to employees.
- You generally cannot deduct expenses of a home office, unless the company requires you to have such an office and you spend most of your work time at home rather than at the company.
- Your income tax return filing deadline will be April 30 (unless you have a spouse or common-law partner who is self-employed). If you miss the deadline, a penalty of 5% (escalating by 1% per month to 17% for 12 months) automatically applies to any unpaid balance of tax.
- You must pay tax on all employment income you receive in the calendar year, but not on amounts that you have earned (worked) but not yet been paid for.
- You are usually eligible for Employment Insurance, and required to pay EI premiums.
- You do not charge or collect GST or HST on your income.
- You are subject to tax on most employment benefits. As an independent contractor you generally will not receive such benefits.
Being an employee or an independent contractor doesn’t just depend on what you and the company call your relationship. If you want to be an independent contractor, you have to establish that you are in fact independent and not an employee.
Not surprisingly, the CRA will often take the position that you are really an employee. This is especially likely if there is only a single company paying you income (i.e., you only have one “client”). However, you may be still able to show that you are not an employee.
There is no clear or definitive test to apply. The Courts have come up with a number of guidelines, but each case depends on its facts.
The following criteria are important:
- Do you receive typical employee benefits, such as sick leave, termination pay, a pension plan, group health plan coverage, life insurance and/or stock options? If so, you are more likely to be considered an employee.
- Who controls your work environment, what you do and when you do it? Are you required to be at a particular office from 9-5 each business day, or are you paid more for getting a task done than for putting in time? If the former, you are more likely an employee.
- Whose equipment or tools do you use? Do you provide your own? If not, you are more likely an employee.
- Are you allowed to hire other people to do part of the work? If you are required to do the work personally and are not permitted to delegate it to others that you hire, then you are more likely an employee.
- Do you personally have any chance of profit or bear risk of loss, or will you simply be compensated for your time? For example, if you make a mistake in your work, are you required to fix it on your own time? If you are simply paid for your time regardless of the results, you are more likely an employee.
- How have you and the company classified your relationship? If you have a contract stating that you are an independent contractor, the Courts are more likely to accept that, provided the other criteria do not point strongly in favour of an employment relationship.
You should decline the traditional employment benefits (e.g., pension plan, drug plan, dental plan, sick leave, vacation time, life insurance, stock options, use of a company car), and simply opt to issue regular invoices to the company to pay for your services, plus disbursements such as travel or long-distance phone charges that you incur.
You should have a contract signed by both parties that states that you are an independent contractor and not an employee. As well, you should avoid having a business card with the company’s name on it, and appearing on the company’s internal telephone list. That makes you look more like an employee of the company, and less like an outside consultant or contractor.
Finally, if you are an independent contractor and your total billings exceed $30,000 per year, don’t forget to register for and invoice the GST or HST.