Tax Matters: Employee vs. Self-Employed
by Michael L. Crawford, BA(Hons), CMA
Are you an Employee or are You Self-Employed?
In Canada there are many opportunities for all kinds of work. When you work, you are either an employee or self employed. Whether you are an employee or self employed will affect your rights and responsibilities under various pieces of legislation some of which are the Canada Pension Plan, the Employment Insurance Act, Workplace Safety and Insurance Board (WSIB) and the Income Tax Act. This article will focus on determining where you fit in and why your status is important.
When the Canada Revenue Agency (CRA) considers the relationship between a payer and a worker they examine whether there was an agreement to enter into a “contract of service” (employer/employee relationship) or a “contract for services” (self employed/ business relationship). The difference in words between these two concepts is subtle but the difference in meaning is large. The CRA has a number of tests or guidelines to help them determine the nature of the relationship. Theses tests are:
- Ownership of Tools and Equipment
- Ability to Subcontract
- Financial Risk
- Degree of Investment and Management
- Opportunity for Profit
- Other Relevant Factors
Control refers to the payers ability to direct how, where and when the work gets done. The degree of control in a factory is quite clear. Employees show up, take their assigned spot and perform their assigned duties in a prescribed manner. The control test starts to struggle with professions such as Engineering, Medicine and other technical industries where the payer has little influence or control over the workers daily activity.
Tools and Equipment
CRA looks at the “…significance of the investment in tools and equipment along with the cost of replacement, repair and insurance.” The greater the investment the more likely the worker is self employed.
Ability to Subcontract
Simply put employees cannot hire assistants. They must perform the work themselves. If you are self-employed you have the right to sub-contract someone else to do the work but you also have the responsibility to pay the sub-contractor.
As an employee, you go to work, you do your job and you receive a paycheque. You are entitled to be reimbursed any money spent by you personally on the company’s behalf. There is little to no risk. Self-employed individuals usually have fixed costs which must be paid whether or not any work is done (e.g. rent and utilities).
Degree of Investment and Management
In many ways this test is similar to financial risk. Is the worker required to make an up front investment in order to undertake and complete the project in question.
How much control does the worker have over hiring individuals to work on the project? The deployment of assets related to the project? The greater the investment and management control of the worker the more likely the worker is self employed.
Opportunity for Profit
Self-employed individuals are free to seek work from more than one payer. They may choose to seek out contracts or not as they see fit. Self-employed individuals have a high degree of control over selecting what expenses they may incur. Self-employed individuals can be held financially responsible if work is not completed as agreed.
Employees receive a predetermined and fixed amount of compensation on a regular basis.
Employees are not liable if the terms of a contract are not met (although they can be terminated if their performance caused or contributed to the failure of the completion of a contract).
Other Relevant Factors
Other relevant factors may include, but are not limited to, whether or not a written contract between the worker and the payer exists. Are the payer and worker dealing at arms length (i.e. are they related to each other by blood or marriage)? What is the standard practice within the industry?
It is important to note that no single test will confirm or deny a worker’s status one way or the other. In fact the CRA states that in considering these various tests “[we] look at the answers separately and then together”
It is also noteworthy that when the CRA looks at a payer/worker relationship they are more interested in substance over form. In other words, there may exist a written contract that says the worker is self employed but all the other tests indicate that he or she is really an employee, then CRA will deem the worker an employee and enforce the Income Tax Act accordingly. For more information the Canada Revenue Agency provides a handy guide titled Employee or Self Employed?
It has been my professional experience that other government bodies will usually follow the Canada Revenue Agency’s lead. Therefore, if the CRA determines that a worker is an employee, the payer (employer) will be liable for payments required under the Canada Pension Plan, WSIB and potentially the Income Tax Act.
Advantages and Disadvantages
Most of the time the relationship between a payer and a worker are clearly defined and there is no need to worry about if you are an employee or self-employed.
Whether you are an employee or self employed, both have their advantages and both have their disadvantages.
When you are an employee you are usually not responsible for the final outcome of a project. The responsibility rests with the owner of the company. As an employee you are protected by various pieces of legislation that regulate the number of hours you may work, your workplace environment (health, safety, freedom from harassment including but not limited to race, religion, sexual orientation and age). Generally, if your employment is terminated you will be eligible for Employment Insurance (EI) Benefits. Often, in addition to a salary or wage, employees received other benefits such as enhanced health and dental coverage (beyond the basic level provided by the government), car or travel allowance, employee discounts, signing bonuses and so on. You will notice that an employer deducts Employment Insurance (EI) and Canada Pension Plan (CPP) from your paycheque. In addition to what they deduct from the paycheque they must also contribute a portion themselves on your behalf. You receive a paycheque whether the company makes a profit or not (although if the company goes too long without making a profit your job and your paycheque may be in jeopardy!)
So being an employee seems like a good arrangement what’s the downside? One potential downside is control. As an employee you will have varying degrees of control in how you perform your job. You may be forced to follow rules and procedures you disagree with (although you are protected if you refuse to perform unsafe work or to perform an illegal act). You may be required to work hours that are not always convenient and scheduling time off for personal needs may be a challenge although most employers are flexible about medical appointments and similar issues).
You do not share in any profits of the company. Even if your company has profit sharing for employees the amount you receive will be tied to some factor such as your base level of compensation and/or the number of years you have been with the company.
When you are self-employed you are in complete control. You are beholden responsible to only the customer, whose main focus is the outcome and not how you got there. You may set your own schedule, rules and procedures. Any profit you make is yours to keep, after taxes, of course. Self employed people have far more deductions from income than employees; although these deductions are regulated by the Income Tax Act the self employed still have more options than regular employees.
(Important Note: On occasion, unscrupulous business people will want to hire you as a self-employed contractor when the facts of the situation dictate that you really should be classified as an employee. Why do they do this? To save money. They do not have to pay their portion of CPP, transferring it to you, benefits or other expenses related to payroll. For the unscrupulous business person, making you self employed eliminates a lot of expenses and hassles on their side of the deal. The Canada Revenue Agency deals severely with people who abuse the system.)
So if you have complete control and get to keep all the profit, after tax, what is the downside? First and foremost there may be no profit. Profit is tied to how well you control and manage your operations. Profit is what is left after you have paid all your expenses related to your business. Increased expenses; remember the discussion about the employer making a contribution to the employee’s EI and CPP accounts; when you’re self employed you have to pay both parts of CPP (employee and employer). You do not have to pay Employment Insurance (EI) premiums but if you fail you will not be able to collect employment insurance either.
Liability. Remember the employee is not responsible for the outcome of a project, you are. If something goes wrong you may be held financially responsible. When you are self employed there are any number of laws that you must comply with depending on which industry you are in and ignorance of the law is seldom, if ever, an acceptable defense.
So which is better: Employee or Self-Employed?
That is really up to you dear reader. Are you willing to accept the risk of being self employed for the possibility of increased income? Or do you prefer the security of a steady paycheque?
The Income Tax Act and other related legislation are large and complex laws that frustrate even the professionals at times. This article is intended to increase your awareness of issues that affect you and encourage you to look more closely at the ones that relate directly to your situation. You are encouraged to seek professional guidance specific to your unique situation.