The Trend
There are many circumstances where services to a payer are provided
through business contracts versus employment. We are not talking about obvious
situations such as operating an automotive service centre, or a hospital who
provides an operation; in this article we are talking about personal services
such as but not limited to: sales, purchasing, accounting, human resources,
domestic services, and even tradespersons working alongside others.
As intriguing as contractual arrangements may sound, it is not as simple
as you might think… for either party! For example, how do you handle payments
such as income tax and retirement/unemployment benefits? And what happens when
the authorities deem it an employment situation regardless of what the parties
agree to?
Why a contractual versus employment arrangement?
We start with the perceived advantage of contracts versus employment to
payer:
Only pay when services performed.
No overtime, holiday, stat, or sick pay.
No firing or lay-off rules.
No Pension, Unemployment, or Worksafe premiums.
Perceived advantage to payee:
More money.
Tax ‘write-offs.’
Sense of entrepreneurship.
What changes?
So, how does this differ administratively for the payee who was formerly
an employee? What do they have to do as certain payments formerly made by the
employer are now the payee’s responsibility?
First of all, you as the service provider do not receive the above
listed employee benefits… you might get a higher fee, but once you complete the
math, you can decide if you are ahead.
Next, we address income tax and CPP (Canada) / SS (USA):
You need to estimate your annual net income (income minus eligible
expenses*)
*Eligible means just that… eligible! In most jurisdictions driving to
work each day is personal, and your home ‘office’ is questionable. And taking
your buddies for drinks… not likely unless you can make a good case for it.
As for the famous term ‘write-off’… this does not mean you do not pay
for the item, it just means it is tax deduction if ‘eligible.’
A simplified example:
$100 revenue
$0 eligible expenses
25% tax rate
$25 tax ($100-0 = 100 X 25% = $25 tax)
$100 revenue
$50 eligible expenses
25% tax rate
$12.50 tax ($100 - 50 = 50 X 25% = $12.50 tax)
*Let us be clear… you still paid for the item out of your income, you
just paid less income tax if it was a legitimate eligible expense! For some
this is obvious, but many times I have heard employees use the phrase ‘it’s
just a write-off for you’ and not really know what this means.
Once you estimate your net income for the year you need to estimate your
income tax payable and set aside an estimated amount each pay period. In some
jurisdictions you need to remit these estimates as installments depending on
the dollar threshold.
Repeat the above exercise and set aside and/or remit your CPP/SS
payments. By the way, in most jurisdictions you will pay both what would have
been the employee and employer portion! Welcome to ‘Self employment!’
At year-end the fun begins:
First you prepare your financial statements including calculating your
net income (Revenue minus eligible expenses.)
Second, you calculate how much you owe in income tax less your
installments (assuming you were making them.)
Third, repeat this exercise for CPP/SS.
On to Unemployment Insurance. Most jurisdictions do not have a provision
for this if you are self employed; however, if there is a provision, you will
in most jurisdictions pay both the employer and employee portion. In regard to
collecting unemployment benefits, if you thought the fight was tough when you
were an employee, try it as an ‘independent contractor.’
In regard to Worksafe or Workers Compensation (WCB)… most jurisdiction
require the general contractor to pay this for sub contractors. Verify what applies
in your jurisdiction and situation.
As an independent contractor you may also be required to collect and
remit value added tax or VAT. Check what applies in your jurisdiction for your
industry, profession, and situation.
What can go wrong?
So, what happens if the authorities decide regardless of what the payer
and payee call it, they determine it as an employment relationship?
Well, in most jurisdictions the payer has to remit the income tax and
fees they would have had to remit if the payee were an employee, and the payee
loses the so-called eligible deductions or ‘write-offs.’ If the payee has
already made said income tax, CPP/SS/EI payments to the authorities, they may
receive them back as the employer has now been assessed for them.
To make matters worse for the payer, the payee may now be eligible for
unemployment insurance, overtime, statutory, sick, and vacation time… depending
on the jurisdiction.
So how does such a thing happen? Let me run a scenario for you:
General construction contractor hires sub contractors such as but not
limited to: excavator, concrete, framers, electricians, plumbers, cabinet
makers, drywallers etc. All are deemed sub-contractors, but the general has to
pay the WCB for everyone at this site (depending on jurisdiction.)
Ed’s Drywall Ltd (made up the name) is sub-contracted for drywall
installation and finishing; however, instead of hiring employees, he considers
each of his workers as ‘sub-contractors.’
Dave, who has worked for Ed for a long time is suddenly let go due to
lack of work. Not being able to find work as it is a small town, Dave makes his
way to the Unemployment Insurance office to apply for benefits.
During the meeting with the agent, Dave is asked for his separation slip
and record of employment; however, he does not have these as he was a
‘contractor.’ This is where he is informed benefits are for employees.
Not happy with the decision, Dave tells the agent he was more like an
employee, and a questionnaire is completed; here, the agent consults with an
income tax auditor, and assesses the situation as an ‘employment relationship.’
We will address how the agent determined this in a few minutes.
So, what happens next?
Dave receives unemployment insurance, and his income tax returns are
reassessed where he loses his ‘business expense’ deductions therefore owing
money to the income tax department. For Ed’s Drywall Ltd, all his
‘sub-contractors’ are deemed ‘employees’ where not only are they reassessed,
but Ed now must remit income tax, CPP, OAS (USA) and Unemployment Insurance
premiums for each of his workers.
Depending on the jurisdiction, Dave and his ‘co-workers’ may be eligible
to now claim for provincial/state employee benefits such as overtime, statutory
holiday, sick, and vacation pay.
Do I have everyone’s attention now?
How do authorities determine the relationship is actually employment?
So, what do the agents use to determine this was an employment versus
contractual relationship? The enclosed is an excerpt from our Forward Looking
Guide - Select for Success, which is found on our Amazon Kindle account:
Warning! Thin information applies to most jurisdictions, but it is
incumbent on the reader to consult a local lawyer, accountant, and/or official
to verify what applies in your situation and jurisdiction.*
In general, most jurisdictions consider the following factors when
assessing Contractor versus Employer-Employee Relationships:
• Control over the work included being instructed on what to do and how
to do it.
• Dictating the working hours such as providing the services between the
time of XX to XX.
• Providing the office, equipment, and tools.
• Integrating the individual into the organization including inviting to
functions and events.
• How similar tasks are performed within the organization.
• The length of time or permanence of the relationship.
• If the contract is the sole or main source or the payee’s income.
• How renumeration is determined such as piecework versus hourly.
• The payee hiring and controlling their own employees.
• The payee’s opportunity for profit and corresponding risk of financial
loss. (more on this later)
*Note - no one answer tips the scales as the assessment is determined
given the information in whole!*
So, let’s talk about ‘The payee’s opportunity for profit and
corresponding risk of financial loss!’ What does this mean?
When you are self employed you normally incur expenses as part of
setting up or managing your business regardless of if you earn income or not.
This can include minor expenses, or major investments such as buildings,
equipment, or machinery. With this, there is the potential for a financial loss
if you do not earn adequate income.
As well, as a business you engage in activities such as buying or making
and selling goods resulting in margins, and/or hire and charge higher rates
then you pay your workers; from this, you have the potential for profit. Of
course, if you pay more for labour then you charge out, or sell items for less
than you pay, you have the potential for financial loss.
The above are not factors for an individual who does not have an
investment, shows up for work, and receives pay for their efforts.
One last note: An employment relationship ruling does not necessarily
mean you now have a new employee in most jurisdictions… it means they were
deemed employees for the purpose of income tax, federal/state/provincial
benefits. If for example you are a unionized company with a defined benefit
pension plan, this may not mean the individual has been appointed to your
organization and enrolled in these plans. With this, you must verify what
applies in your jurisdiction.
For more information, I have included the following links as reference:
From the Government of Canada:
https://www.canada.ca/en/revenue-agency/services/forms-publications/publications/rc4110/employee-self-employed.html
From the Government of California:
https://www.dir.ca.gov/dlse/faq_independentcontractor.htm
Conclusion
So, there you have it!
As intriguing as contractual versus employment relationships sound, they
are not as simple as one might first believe… and they can go wrong!
I hope you find this information useful and remember to engage local
consult as to how your specific situation applies in your jurisdiction.
For information on the business support services we provide, remember to
visit us at: www.forwardlookingsolutions.ca.
Daniel
W. Elliot, CPA, CGA
Forward
Looking Solutions Corporation
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