Employers and employees are often seeking ways to reduce their costs of business, maximize their tax deductible expenses or the potential expense associated with the termination of an employee.
Employers and employees are often seeking ways to reduce their costs of business, maximize their tax deductible expenses or the potential expense associated with the termination of an employee.
One of the strategies being increasingly utilized is to create what is known as “independent contractor” relationships with their workers. I would suggest that those companies and individuals considering this avenue tread carefully because inappropriately setting up such a relationship can expose the worker and the company to penalties, liability and a host of potential problems. But if you are thinking of structuring your work relationships in this way, you may find the information below helpful.
Employees are entitled to substantial statutory rights and protections. Those who choose to provide their services by way of independent contractual relations are not generally entitled to the same protections as employees. While the employee “serves” the employer, the independent contractor provides a “service”. The independent contractor relationship must be delineated from that of a “term contract employee” who serves the employer but only for a limited term. The Courts have criticized paper “independent contractor relationships” as a mode of dismantling hard-won employment protections over the last century.
The benefit to the independent contractor is the ability to deduct, as business expenses, sums related to their earning a living, which are not available for deduction by employees, the ability, based on their bargaining power, to set their own fees, and their avoidance of payment for the social safety net, apart from taxes and the CPP contributions required by law. It appears that workers are often very enthusiastic about avoiding such costs – until they need to call upon the social safety net themselves.
The Courts now recognize that an independent contractor can BECOME a dependent contractor over time – who is entitled to considerable severance upon the termination of a relationship – in certain circumstances. If you are in a relationship of this nature that is dissolving, you would be advised to contact us to determine your rights and obligations.
Substance and Form in the Determination of Status
One can’t simply call an employee an independent contractor to set up such an arrangement! Thus, a written contract merely stating that the individual is an “independent contractor” is not determinative of the issue. Courts are instead keen to determine the true substance of the relationship. That’s not to say that a contract written by the parties and the title given are of no significance. What it does mean, however, is that these are pieces of evidence rather than determinative factors.
For example, if a contract between a worker and company states that the worker is an independent contractor and contains the indicia of independence, such as non-payment of expenses and the ability to work elsewhere, the Court or Government bodies will look closer at the day to day realities of the situation. If the worker occupies an office in the workplace, has no expenses, has no other clients and is under the direction and control of a company supervisor, these daily realities may determine the status of the worker as an employee – not the statement of “independent contractor” noted in the contract.
Legal Tests
The case law is replete with “independent contractors” who, upon termination of the relationship, file for Employment Insurance or commence a wrongful dismissal claim alleging that he or she was, in essence, an employee – regardless of any written contract to the contrary. In those cases, the employers find themselves facing a bill for arrears of EI and CPP premiums, secondary liability for taxes not withheld, interest and penalties, plus potential significant termination costs, either at common-law or by statute.
A number of tests have successfully been used to assist in a determination of whether the contract is one “of service” or “for services”. The first test utilized by the Courts was whether a worker was under the control of the employer or was responsible for him or herself.
This issue concerns the level of control exercised by the company over the worker – meaning who determines where, when and how the work is to be performed. The more control the company exercises over the manner in which the worker performs his or her function, the more likely the Court is to find the relationship is one of employment. Less control is more likely to mean an independent contractor relationship. Control includes such matters as reporting relationships, discipline, the performance appraisal process and the fixing of hours and location of work.
But Beware: a worker over whom less day-to-day control was necessary or possible but who nevertheless uses the equipment of the employer and had neither chance of profit or risk of loss is generally held to be an employee, regardless of the absence of direct control.
It’s been suggested that a Fourfold Test would, in some cases, be appropriate involving:
• Control
• Ownership of tools
• Chance of profit
• Risk of loss
In Jaremko v. A.E. LePage, a commissioned salesperson who was subject to the company’s policies, discipline and its promotion process, was held to be an employee – despite considerable day-to-day freedom.
Grafted onto the Fourfold Test referred to above, is this test. The Courts state it this way:
“Where the worker’s work is integral to the business, it’s difficult for the worker to be an independent contractor (e.g. a salesman whose sales made up a large percentage of the company’s total sales was held to be an employee, because his sales were integral to the business). Those who provide IT services, short-term consulting services or security services are often considered to be independent contractors.”
Over the years, other factors have been considered in determining this issue, such as whether the parties had a previous employment relationship, whether the worker was offering his or her own service or that of the company, and what the “total relationship” was.
All of these tests, taken together, are in essence directed towards determining “whose business is it?”
Tests are like a prism, each facet of which reflects the light slightly differently, so that when each reflection is combined with the others, an overall picture is created for the adjudicator to determine whether the worker is true independent and entitled to the benefits of independence, or deserves the protection of employment status.
Contract Issues
Both independent contractor relationships and employment relationships are contract relationships. Many employees have a contract with their employer. It would be rare, however, to find an independent contractor or company who does not expect a formal agreement in an independent contractor situation. In such contracts, the worker is specifically stated to be an independent contractor, and responsible for G.S.T. and taxes is allocated to the contractor. Express termination and proprietary provisions commonly appear.
Another difference between employment and independent contractor agreements is the treatment of briefer severance/notice periods.
In theory, statutory obligations (the Employment Standards Act) which affect employees, have no impact on independent contractors. However the nominal characterization of a relationship as independent is insufficient to prove the point. If your worker is found to be an employee, various regulatory regimes will come into play:
Employers are required to deduct income tax at the source from the wages or salaries of their employees. Independent contractors are not subject to deductions at source and in addition, have the benefit of taking significant deductions to which the employees are not entitled. Thus, Revenue Canada always has a significant interest in this issue.
If it’s found that a worker is an employee under the Income Tax Act, the worker is responsible for paying all resulting back taxes, and many of his or her expenses may be disallowed. Interest and penalties will also ensue. However, the company can also be penalized for failing to properly withhold income tax. Liability is up to the amount the employer should have withheld from fees or wages, plus a 10% penalty, which increases to 20% on a second violation.
These two regulatory regimes come into play when a worker who is nominally an independent contractor has his or her relationship with the company terminated. Employment Insurance is the more significant because it provides benefits which, as an independent worker, the worker has ostensibly excluded from his or her working life altogether.
Employment Insurance is funded through employer and employee contributions. If an independent contractor files for benefits, benefits will be granted if the Employment Insurance Commission is of the view that the work constituted employment. Once this occurs, employer liability for its share of the premiums and for sums not deducted at source is assessed, and levied against the employer.
Both the employee’s entitlement to Employment Insurance and the employee’s liability for these changes are ultimately adjudicated before the Tax Court. If the individual is held to be an employee, the employer is liable for its contributions and the deductions it ought to have taken, as well as a 10% penalty on these amounts, increasing to 20% for a second offence, plus interest. Directors are jointly and severally liable with the corporation for these amounts. Prosecution, with penalties including fines up to $5,000, imprisonment for up to 6 months, or both, is also contemplated by the Act.
The Canada Pension Plan has two functions: the provision of retirement income and the provision of disability income to those who are disabled but younger than retirement age. Unlike Employment Insurance, all those who work have coverage. Independent contractors are responsible for contributing to CPP at the full rate, whereas employees are responsible for half only, paid by source deduction. The employer is responsible for the other half.
The employer is responsible for the entire amount it fails to withhold and remit, plus the aforesaid 10% or 20% penalty and interest. Directors are liable for premiums, penalties and interest but only where the company fails to pay. Failure to deduct and remit premiums is an offence punishable on summary conviction by a fine of up to $5,000 or imprisonment for up to 6 months, or both.
Employment Standards Act
Employment Standards legislation governs hours of work, overtime, minimum wages, holidays, vacations, various kinds of leaves, notice of termination and, in some cases, severance pay.
True independent contractors do not have the benefits of protection set out in Employment Standards legislation. However, if an independent contractor is held to be, in reality, an employee, and has not received vacation pay, termination/severance pay, or appropriate overtime pay, the employer is liable.
Contracting out of Employment Standards legislation is prohibited and consequently a provision which provides for less notice than an employee is entitled to under the legislation is void if the worker is found to be an employee. For the same reason, an independent contractor in name who is an employee in substance is fully entitled, despite the contract, to seek to enforce Employment Standards legislation against the employer in appropriate circumstances.
Creating an appropriate contract for an independent contractor is important. As noted previously, it is simply not sufficient if the parties state that it is their intention that the relationship be one of independence. The contract must be properly written and reflect an underlying relationship which contains the elements of independence. Moreover, compliance with the contract is required; Courts look to substance rather than form and a formal contract which is entirely ignored in practice will have little or no evidentiary weight.
If you make the decision that you want to attempt to create an independent contractor agreement, you should:
• Require the contractor to submit bills for services (as opposed to providing the contractor with a guaranteed sum or fixed retainer)
• Permit the contractor to hire employees and sub-contractors if necessary;
• Include an express termination provision in the agreement;
• Provide obvious and sufficient consideration for entering into an independent contractual relationship;
• Clearly sever a prior employment relationship before entering into a contractual relationship with that individual. If at all possible, allow a period of time to run between the end of the employment relationship and the beginning of the contractor relationship;
• Ensure that the contract is for a definite term or task. Bear in mind that indefinite term contracts are more common in employment relationships;
• Clearly state in the contract that it is an independent contractor relationship and not an employment relationship;
• Obtain an express acknowledgement from the contractor that the company will not be deducting or remitting any amounts for statutory obligations from the contractor’s fees;
• Obtain an indemnity from the contractor for any taxes the company is required to repay the CRA in connection with the contract;
• Clearly state that the contractor does not have the authority to enter into contracts on behalf of the company, or bind the company in any other way, without its express written authority;
• State that the contractor is free to provide his or her services to others. Any limitation in this area, including a requirement that the individual pre-screen potential clients with the company, will be evidence of an employment relationship or at the very least, of a dependent contractor arrangement – which doesn’t protect you;
• Require the contractor to obtain a G.S.T. number and to charge and remit G.S.T.
• Require the contractor to provide proof of Workers’ Compensation coverage or insurance in lieu of that coverage.
• Exert control over the contractor’s hours of work, vacation time or the manner of performing his or her duties;
• Allow the contractor to use company stationery or business cards;
• Supply the contractor with a permanent work station or office. If the individual must be provided with work space, consider charging the individual rent for this space;
• Allow the contractor to use company equipment or company employees as assistance. Telecommuters should pay their own computer and office equipment including software, fax machines and telephones;
• Require the contractor to comply with company policies and discipline procedures. The company can require all companies which it contracts to comply with its harassment policies as they relate to their interactions with the company’s employees and customers;
• Set quotas for the contractor or prohibit the contractor from soliciting his or her own clients;
• Provide the contractor with T-4 slips;
• Subject the contractor to company supervision or performance reviews;
• Refer to the contractor as an employee or member of the “team” to provide him or her with a title (either internally or externally);
• Set commission scales or salaries for contractors. Instead, an hourly, daily or project rate should be negotiated with the contractor;
• Label as an “independent contractor” a commissioned salesperson who receives the majority or all of his or her income from the sales of the company’s products, unless factors support such a designation;
• Insert a non-competition clause into the contract, unless absolutely necessary for the company’s protection. Non-solicitation and confidentiality clauses are less indicative of an employment relationship;
• Restrict the number and/or types of clients to whom the contractor may provide services or require pre-screening of the contractor’s clients; and
• If the contractor is with a company as opposed to a specific individual, stipulate which employee of that company must provide the services.
In my practice I strongly caution workers and human resource professionals to take a very close look at the situation with the above factors in mind and to obtain legal advice and expertise to draft the contract before entering into this type of relationship.
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