When working with business owners, advisors should be aware of the different tax-planning concerns stemming from employer-employee and payer-independent contractor relationships. Each has pros and cons, which I outlined in a previous article.
For staff, establishing an employee relationship normally means automatic eligibility for employment insurance, reduced CPP premiums (employers and employees each pay half) and avoiding GST/HST collection and remittance requirements. Disadvantages include limited deductibility of employment expenses and mandatory payroll deductions (income tax, CPP and EI premiums), which impact cash flow.
Independent contractor relationships generally offer more flexibility for staff on how work is performed, and provide a broader range of deductible expenses. Independent contractors, however, are normally required to collect and remit GST/HST and are subject to quarterly income tax instalments.
From the owner/payer’s perspective, the employer-employee relationship can mean increased costs (employer-funded CPP, EI and retirement and health benefits may be required), but the employer has a greater level of control over how work is performed. The independent contractor relationship normally requires less of a commitment from the owner.
Where workers and business owners incorrectly define the nature of their working relationship, interest and penalties can arise in respect of unpaid income, payroll and/or sales taxes for current and/or previous tax years.
CRA guide RC4110 (Employee or Self-employed?) defines factors that should be considered in determining the nature of a working relationship. They include:
- the level of control the owner has over the worker;
- whether or not the worker provides tools and equipment to do the job;
- whether the worker can subcontract the work or hire assistants;
- the degree of financial risk taken by the worker; and
- the worker’s opportunity for profit.
Despite CRA guidance on how worker-payer relationships should be determined, there have been a plethora of court cases in response to CRA audits. A recent Tax Court of Canada case, Michelle Porotti v. Minister of National Revenue, offers insight into how federal and provincial courts normally define worker-payer relationships.
Porotti, a worker with Royal Ascot Care Centre Ltd., appealed a CRA decision that she was working as an independent contractor and not an employee. The period in question was January to August 2012. Porotti’s position was that she was working as an employee, which presumably would have reduced her personal CPP premium cost and allowed her to avoid GST remittances. Her relationship with Royal Ascot ended in 2012 after a falling out concerning the collection of GST.
The question before the court was whether Royal Ascot’s working relationship with Porotti was employer-employee or payer-independent contractor.
The judge said the test to be applied in determining whether a worker is employed or self-employed comes from a 2013 Federal Court of Appeal case, 1392644 Ontario Inc. v. Minister of National Revenue. In that case, a two-step process was suggested as a way to determine worker status.
The first step would determine the subjective intent of the worker and payer: What did the worker and payer intend the relationship to be? This is often determined by a written contract or the behavior of the parties, such as invoices for services rendered, registration for GST purposes and associated income-tax filings.
The second step determines whether the facts of the case are consistent with the parties’ expressed intentions. Did the worker control how his/her work was performed? Did the worker define his/her work hours? Who provided the tools and equipment required to do the job? Who assumed risk for the quality of work performed?
The answers to these questions should be consistent with the intent determined in step one. If consistent, the working relationship is likely easily defined. If not, step two would likely carry more weight as it more closely and more realistically defines the legal effect of the relationship.
Applying this two-step process, the judge in Porotti’s case found that for step one, both Porotti and Royal Ascot “clearly intended an independent contractor relationship.” Evidence included Royal Ascot’s policy of hiring non-nursing staff as independent contractors; the absence of payroll deductions on remuneration paid; Porotti’s provision of invoices for work performed and a resume from Porotti indicating she was self-employed. Porotti also attempted to collect GST, a practice not required by employees.
In reviewing step two, the judge looked specifically at the following: control of work; provision of equipment; ability to hire helpers; management and assumption of financial risk and opportunity for profit.
In the case of control of work, the judge found Royal Ascot treated Porotti as an independent contractor who was hired for a specific task she mainly managed without direction, except for reasonable reporting to Royal Ascot. This strongly favoured an independent contractor relationship.
In the case of provision of equipment, despite the fact Porotti used her own vehicle to perform errands for Royal Ascot, the latter generally provided the necessary equipment for the job, including an equipped office. This factor favoured an employment relationship.
The judge did not find the ability to hire workers a significant factor in this case and did not give it much consideration.
The management and assumption of financial risk also wasn’t given weight since the parties did not focus on it.
In the case of opportunity for profit, Porotti took an entrepreneurial approach to her working relationship (evidenced by the manner in which she sought out additional work from Royal Ascot), so the judge determined this factor suggested an independent contractor relationship.
The judge concluded the facts of the case supported the parties’ intent of an independent contractor relationship. Consequently, Porotti’s claim she was working as an employee was denied and her appeal dismissed.
While CRA allows workers and payers to arrange their affairs as they see fit, their chosen status must be reflected in the actual terms and conditions of the working relationship. While many consider this an accounting concept, financial advisors can help business owners and staff understand the dangers of an inaccurate assessment and avoid unwanted penalties, interest and lost time due to a CRA audit.