For many small businesses, hiring contractors over employees seems like a great idea—it’s cheaper and simpler. You can supplement the skills of your staff without incurring the financial overhead that would come with hiring a full-time employee, such as CPP & EI.
Unfortunately, the distinction between what qualifies as a contractors vs employees in the eyes of the Canada Revenue Agency (CRA) can be pretty grey. If you get it wrong, the mistake can cost your small business a lot of money in penalties and interest fees, so it’s important to get it right.
Start by asking yourself a simple question: “Is this person that I’m contracting genuinely trying to establish a business?” If so, they are a contractor. If not, they are an employee. Still not sure how to gauge this?
Let’s look at how the CRA distinguishes between contractors and employees.
Does the person you’ve hired have control over how, when, and where they complete the task you’ve given them? If so, they are a contractor. If you pay them by the hour and tell them what to do within these hours, they are an employee.
2. Tools and Equipment
Do you provide this person with equipment (e.g. computers, laptops, scanners, printers, paper, etc.) or do they supply their own? If they supply it themselves, they are a contractor. If you provide them with equipment, then they are an employee.
3. Subcontracting or Hiring Assistants
Is this person allowed to hire subcontractors and assistants? Can they do so without consulting you, and assign tasks to this person as they see fit? If so, they are a contractor. If not, they are an employee.
4. Financial Risk
Does this person stand to lose financially? In other words, do they have expenses or other overhead costs that are not reimbursed? If so, they are a contractor. If all expenses are reimbursed, they are an employee.
5. Opportunity for Profit
Is there an opportunity for this person to make a profit? For example, if they worked full time at the rate they are charging, would they earn more than if they were a full-time employee of your organization? If so, they are a contractor. If not, then they are an employee.
6. Responsibility for Investment and Management
Is this person responsible for investing in their assets, whether it be equipment, or education, or staff? Do they handle their own bookkeeping and administrating, including filing their own GST? Do they manage all of their own retirement and extended medical arrangements? If so, they are a contractor. If not, they are an employee.
As you can see, the CRA’s criteria can become a bit murky—perhaps you have contractually agreed to cover some of the contractor’s expenses, or to provide access to certain pieces of specialized equipment. How do you know where the line between contractor vs employee is? Well, the CRA weighs all of these factors, and whichever side comes out stronger is the side they go with.
It’s important to get this right because if you pay them as a contractor when they are actually an employee, you will be responsible for paying the employee AND employer portions of CPP & EI with penalties and interest. And at the end of your fiscal year, this can really add up.
Let’s say you paid a “contractor” $50,000. If the CRA deems they’re actually an employee, your penalties per year could amount to $7,500. Per year! If you’ve “contracted” this person for five years, and then you get assessed, the exposure could be as much as $38,000. If that happens, it will hardly have been cheaper and simpler to hire them as a contractor.
If you have any doubt as to whether members of your staff are contractors or employees, contact us.