When you start working with a new organization, there can be advantages to being an independent contractor instead of an employee. However, be sure to follow all the rules carefully so that you stay on the good side of the Canada Revenue Agency.
If you are self-employed, you can also consider incorporating to reduce your liability and minimize taxes. Read on to learn more about being an independent contractor.
What is an independent contractor?
It’s not enough to simply say you are an independent contractor. You must follow the CRA rules so that you are classified as one, rather than as an employee.
Here are some of the key requirements:
- Level of control: You must be in charge of your own scheduling and activities. If your client says you must work from 9 AM to 5 PM, that would be classified as an employer-employee relationship.
- Equipment and tools: You must provide your own computers, phone, and other needed equipment. These cannot be paid for by your client.
- Hiring of staff: You can hire staff to work on the project. These people must be under your direction rather than that of your client.
- Financial risk: You must be taking some financial risk. If your pay is guaranteed, you may be classified as an employee. There should be opportunity for you to earn a profit and a risk of losing money if the project goes overtime.
To learn more about the CRA requirements, you can visit their website:
Employee or Self-employed? – Canada.ca
What are the key differences between a contractor and an employee?
The main differences relate to payroll taxes and how each party is treated if the relationship is terminated.
Employees are eligible to collect Employment Insurance if their employment ends. EI premiums must be deducted from their paycheque. Employers must pay their share of EI premiums as well. Similarly, both parties must contribute to the Canada Pension Plan.
On the other hand, independent contractors are not eligible for EI benefits in most cases. They and their clients do not have to contribute EI or CPP premiums.
Employees have some protection from being terminated. Under the Labour law, they are entitled to notice of termination or to receive termination pay. If an employer does not provide this, the employee can sue for wrongful dismissal.
An independent contractor receives no such protection. That’s why it’s important to have a written contract with your client. It should have a clause that explains what compensation you will receive, if any, if the client terminates the agreement.
In some cases, the courts have ruled that an independent contractor was actually an employee. When the organization terminated the agreement, the individual successfully sued for wrongful dismissal. Therefore, it’s essential to both follow the CRA rules and have a written contract detailing the independent contractor agreement.
Incorporation of independent contractors
If you are working as an independent contractor, you may wish to incorporate. While this does not guarantee that the CRA will view you as a contractor, it will strengthen the arms length relationship between you and your client.
Here are some of the advantages of incorporation:
- Liability: Corporations have less exposure to risk if you are sued or cannot pay your debts.
- Tax benefits: There can be tax advantages since you can hold income inside the corporation. If you are self-employed, you must declare all income directly on your personal tax return.
- Income-splitting: With a corporation, you can make your spouse a shareholder. When you pay a dividend, you can split it between yourself and your spouse.
- There are several other benefits available to a corporation such as IPP, RCA and Keyman insurance that are beyond the scope of this article
Disadvantages of incorporation
- Establishing the corporation: The primary disadvantage is that it adds a layer of expenses that you would not have if you were simply self-employed. To incorporate, you will need to pay a government fee and hire a lawyer to draft the articles of incorporation and corporate resolutions.
- Ongoing costs: As a corporation, you must file a corporate tax return in addition to your own personal tax return. You will need an accountant to help you with this filing, which will be an additional expense.
So, should you incorporate? If your revenues are small and you don’t expect them to grow significantly in the near future, it may make sense to simply be self-employed and report your income directly on your personal tax return. However, if you have net annual income of $60,000 or more, there can be significant advantages to incorporation.
Examples of an independent contractor vs. employee
Case study 1
Julia is hired as a sales representative for Canada by a software company based in California. Her earnings are purely based on commission – she receives no salary and is only paid if she makes a sale. She is required to cover her own costs, including telephone, internet, and travel expenses to visit potential clients. In addition, she must pay for advertising expenses to introduce the software to potential clients. During the first six months, she is not able to make any sales. She spends $5,000 on advertising and travel.
Independent contractor or employee? In this case, Julia is definitely an independent contractor. The organization is not paying her any salary and is not covering her expenses. She is taking on significant risk in paying marketing expenses when there is no guarantee that she will win any sales.
Case study 2
Kevin is hired by XYZ Corporation as an independent contractor. He serves remotely as an administrative assistant to the CEO. He must be available from 9 am to 6 pm to respond to the CEO’s demands. The company provides him with a phone and computer.
Independent contractor or employee: Kevin should be classified as an employee because he can’t set his own hours and the company provides his equipment.
Case study 3
Jean-Luc is a student who takes orders over the phone for a national pizza chain. He is required to work every Friday from 4 pm to midnight. He must also provide his own computer and phone. He is paid for each order taken rather than hourly – so if it’s a slow night he might only make $25.
Independent contractor or employee? The CRA could rule either way on this one! The employer sets his hours (like an employee) but he takes risk by being paid per order (like a contractor).
Independent contractors may have to collect and remit sales taxes
If you are an independent contractor, you have certain obligations that an employee does not have. When you invoice your client, you must charge and collect GST/ HST. You then must file an GST/ HST return and remit the taxes to the government on a regular basis. On the return, you can claim credits for GST/ HST paid on your expenses, including telephone, travel, and office supplies.
You may be exempt from the requirements of collecting and remitting GST/ HST if you are a small supplier with total revenue of less than $30,000 in a year. You may also be exempt if all your revenue is from exempt supplies such as financial services or precious metals. GST/ HST Rules are very complex. Please consult CRA or your tax accountant to determine whether you should charge GST on your sales.
Strengthening your claim to be an independent contractor
In order to avoid being classified as an employee, there are several steps you can take to build your status as an independent contractor:
- Hire staff: A part-time administrative assistant or a bookkeeper can leave you free to work with existing clients and find new ones. It also demonstrates to CRA that you are not simply an employee.
- Have more than one client: The CRA will look more favorably on your claim to be an independent contractor if you have several clients, even if some of them are quite small.
- Build an online presence: You should have your own website, business cards and invoicing system. Again, these demonstrate that you are a business rather than an employee.
Please contact us to learn more about the differences between independent contractors and employees. We’d be glad to help!