Employing Contractors and Contracting Employees

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Employing Contractors and Contracting Employees:Sorting Out Tax and Legal Issues

Shane Onufrechuk, CARichard Press, LL.B.November 10, 2011

5573299_1.ppt

Employee vs. Independent Contractor

Leading Case – Wiebe Door Services Ltd. V. MNR• 4 tests (maybe 5) Control Ownership of tools Chance of profit Risk of loss Maybe “integration”

Latest Case – Long et al v. MNR• Tests too rigid• Integration test not relevant• Legal relationships matter – but not always followed in the

courts where inconsistent Other cases

Tax Implications of Employment - Individual

Employee• Limitation on deductions

Tools Musical instruments Moving expenses etc.

• Not responsible for CPP and EI• Not taxable supply for GST/HST• Income reported on a cash basis

Employer• Obligation to withhold

EI CPP Income Tax

• T4 Reporting

Implications of Independent Contractor -Individual

Contractor• Likely has instalment obligation relating to taxes payable• Expenses laid out to earn income deductible (subject to

limitations in the Income Tax Act “ITA”)• Unless small supplier or exempt supply obligation to

collect and remit GST/HST• Income reported on an accrual basis

Service Recipient• No obligation to withhold tax• No obligation to report amount paid

Implications of Employee-Like Relationship – Corporate Employees

Personal Services Business• Defined at 125(7) of the ITA• Defined as Corporation carrying on business of providing services

where• Individual performs services on behalf of the corp• Individual or related person is a specified shareholder• Individual would “reasonably be regarded” as an officer

or employee of the services recipient but for the corporation

• Unless more than 5 full time employees or services are provided to an associated corp.

Implications of Employee-Like Relationship – Corporate Employee cont’d

Implication of being a Personal Service Corporation• Denied small business deduction• Limited deduction of expense in Corp. (same as

employee)

Purpose of legislation is to prevent the conversion of salary income into corporate business income taxed at a low rate

Consider Criterion Capital Case for officers where services provided outside of employment duties

Implications of Employee-Like Relationship – Corporate Employee cont’d

Employer• No payroll costs i.e. EI and CPP• No withholding obligations• GST needs to be paid if not small supplier or

exempt supply

Personal Services BusinessTax Planning Opportunity?

Income Tax Deferral• 25% corporate tax rate in 2011• 19% deferral over to personal rate

Absolute tax savings• Income splitting with family members• Pay out retained earnings when not a top marginal rate

Reduced Payroll costs• No EI and CPP• No T4’s etc.

Consider for high income salaried employees who have income in excess of personal needs, or a low income spouse or other adult dependants

Personal Services BusinessDisadvantages

Administrative costs and time Loss of “earned income” for RRSP purposes Dealing with stock options Change in law??

Incorporated Contractors

Similar benefits to Personal Services Business Enhanced deferral for Small Business Deduction

income SBD rate in BC presently 13.5% on first $500,000 April 1, 2012 SBD rate will be 0% in BC for an 11%

effective rate of the first $500,000 of active business income

Creates a potential 32% tax deferral opportunity Creates liability protection

Personal Services Business Implementation

1. Create family trust (if necessary)2. Have trust or principal and related family members

incorporate corporation with proportionate shareholding as desired

3. Have principal terminate existing employment contract (subject to legal advice)

4. Have incorporation entity and employer enter into a services contract with terms similar to previous employment agreement (see employment advice)

5. Have principal enter into a contract with the incorporated entity to perform services on behalf of the entity.

Stock Options

Treatment different for employees and independent contractors

Employees benefit from the stock options rules found in section 7

No 50% 110(1)(d) deduction for independent contractors

No deferral for independent contractors on the issuance of stock options

Treated as an in kind payment of fees for independent contractors

Outside the tax regime: Legal tests

Vary by tribunal Finding of one tribunal is influential, but not

determinative, for second tribunal• e.g. may be a contractor for CRA purposes and

an employee for human rights All test based on facts An agreement between the parties as to status

is not determinative

Legal test for contractor or employee status

There is no bright line test Vary by tribunal Finding of one tribunal is influential, but not

determinative, for second tribunal (e.g. may be a contractor for CRA purposes and an employee for human rights)

All tests are fact specific

Key Factors

Control Integration (but not importance) Investment Diversity Legal relationship (but not intent)

Control test

Is there control over workers?• Selection – employers select specific employees• Dismissal and discipline – employers discipline

and dismiss an employee• Method - employers control the method in which

the job is carried out• Timing – employers set when the work must be

performed • Remuneration - employers set and amend the

payment scale

Four-fold test

Control (as per prior slide) Ownership of tools – investment in business Chance of gain – contractors have a chance of

windfall profits if job performed successfully Risk of loss – contractors have chance of loss

if services performed poorly

Organizational or integration test

Is work integral to the operation of the business?

The more integrated the work is with the business, the more likely it is that the worker is an employee

Considers control: can worker set own hours and methods

Permanency test

Based on duration of the relationship The longer and more continuous the

relationship, the greater chance that it is an employment relationship

Inapplicable for many common modern contractor relationships – e.g. distributorships

Economic reality test

Combines control test, four-fold test and permanency test

Adds Diversity• Can worker perform similar services to other

parties?• Can worker actively search out other work?

Recent Cases (other than tax cases)

671122 Ontario Ltd. v. Sagaz Industries Canada Inc.• 2001 Supreme Court of Canada decision• Integration and Control

Smith v. Centra Windows Ltd.• 2009 B.C. Supreme Court decision• Continuum of arrangements• No factor conclusive (i.e. no bright line)

Recent Developments in Human Rights

McCormick v Fasken Martineau Dumoulin 2011 BCSC 713

Pardy v. Earle & Zesty’s Restaurant 2011 BCHRT 101

Human Rights test for employee status

Utilization: is one party using the services of another for its own benefit

Control: Does one party have the right to exercise control over the other

Financial Burden/Remuneration: Who controls the amount of compensation received

Remedial Purpose: Who has the practical ability to remedy the discrimination in question

McCormick v. Fasken

Law Firm: 650 equity partners worldwide; 60 in Vancouver (including McCormick)

Partnership agreement required mandatory retirement at age 65

Found to be an employment relationship

McCormick v. Fasken

Firm utilizes partner to service clients and generate IP

Partnership agreement and managing partner/executive committee control partner

Remuneration of partner a judgment call of other partners, not strictly based on billings

Forced retirement engages remedial purposes of Code

Pardy v. Earle & Zesty

Stand-up comedian hosted an open mic in exchange a $50 shared beer tab (all the comics had to share the tab)

Restaurant did advertising for open mic Comedian gets into dispute with lesbian

patrons Found to be an employment relationship Restaurant on hook for comedian’s damages

Pardy v. Earle & Zesty

Restaurant utilized comedian to attract patrons and to recruit some other comics

Comedian needed restaurant’s permission to go on-stage and restaurant controlled comedian by preventing him from going on-stage again

The shared $50 beer tab was sufficient remuneration

Restaurant had power to remedy comedian’s wrong: could have stopped show; offered apology; offered compensation

Why care?

Tax and payroll liability Insurance liability (WCB and general) Employment standards Labour Code liability Human rights liability Privacy liability Civil liability (wrongful dismissal and vicarious liability) Intellectual property liability Post-relationship obligations

How to protect yourself

If retaining a contractor:• Contract with a company, not individual• Have a written contract.

If hiring an employee:• Have a written contract.

Taxation

Employer BusinessMust make income tax withholdings

Contractor responsible for own withholding and deductions

Not taxable supply of GST/HST

Contractor usually must charge GST/HST

Limited allowable deductions

Greater income tax benefits:- more allowable deductions - income splitting

Payroll

Employer Business

Have payroll costs as must withhold and contribute on CPP and EI

Minimal payroll costs for contractor (likely paid through A/R)

Issues T4 Contractor bears payroll costs for own payroll

Contractor should render accounts

Benefits and Perquisites

Employer Business

Employers commonly provide health and welfare benefits

Businesses should not provide health and welfare benefits to contractors

Contractors lose “earned income” for RRSP purposes

Employers commonly provide perks (e.g. car allowance, club dues, etc.)

Business may reimburse contractors for expenses- Costs or costs plus

Insurance and Health and Safety

Employer Business

Must establish WCB accountMust pay WCB premiums for employees

Contractor responsible for WCBShould get clearance letter

Employee negligence usually covered by general insurance

Not insured for actions(Should ensure have insurance)

Indemnity uncommon Indemnity common

Payment issues

Employer Business

Must usually pay wages at least semi-monthly

Can contract for any fee payment scheme

Deductions from wages unlawful

Can contract to set-off claims

Hours of work

Employer Business

Non-managerial employees generally entitled to overtime

Can establish flat rate

Employees entitled to leaves (jury duty to maternity leave)

Contractors responsible for providing service

Time off

Employer Business

Employees entitled to vacation

Contractor not entitled to vacation

Non-managerial employees entitled to statutory holidays

Contractors not entitled to statutory holidays

Termination of relationship

Employer Business

Summary dismissal for just cause

Summary termination for: - non-curable or non-cured material breach- bankruptcy- act of principal

Absent just cause, notice or pay in lieu

ESA minimums

Contracted term or “reasonable” notice

Civil liability

Employer Business

Wrongful dismissal claim exposure

- approx. 24 month maximum exposure

Wrongful termination claim exposure

- approx. 12 month maximum exposure

Vicarious liability issues Vicarious liability unlikely

Privacy

Employer Business

Obligation on employer to protect employee personal information

May be no obligation of business to protect contractor information

Must implement privacy policy on collection, use and disclosure of employee information

May need to obtain consent to share personal info with contractor and ensure contractor protects that info

Human Rights

Employer Business

Must comply with human rights re. hiring and managing employment relationship

May discriminate against contractor.

Remedial legislationBroad scope of who is employee

Confidentiality and Post Relationship Obligations

Employer Business

Employee has duty of confidence

Contractor may not have duty of confidence

Consider contracting for post-employment obligations (e.g. non-compete, non-solicit, etc)

Can contract for confidentiality; consider contracting for post-relationship obligations

Fiduciary duty and loyalty

Employer Business

Key employees owes fiduciary duty

Absent professional relationship, fiduciary duty unlikely

All employees owe duty of loyalty- Conflict of interest usually cause

No duty of loyalty- May provide services to competitor absent contractual prohibition

Intellectual property

Employer Business

Employer automatically owns most employee’s works

Business usually owns none of its contractor’s works

Should contract for unowned rights- e.g. moral rights

Should contract for all IP rights

Common contractual terms for employees

Compensation Position, duties and reporting Termination Benefits and vacation

Common contractual terms for contractors

Fees and accounts Services Representation to public Termination Expenses and additional costs Insurance Authority Indemnity Set-off

5 common reasons why contractors are found to be employees

Have business cards (integration) Are part of corporate chart (integration and

control) No financial investment in their own business

(investment) Accept employee benefits, including vacation

(integration) Have authority to bind the company

(integration)

5 take away points

A contractor is in business for itself, an employee works for you.

Sort out the form of relationship at the beginning of the relationship.

Have a good written contract for both employees and contractors.

Try to stay away from close to the line. Get legal and accounting advice beforehand.

Questions or Comments