What’s the Difference between an Employee and a Contractor?
Hiring in your business can be exciting, and also daunting. There seems to be a lot of confusion when it comes to understanding the difference between an independent contractor and an employee. While the nuances can be difficult to navigate, proper classification of a worker before hiring is important, as the consequences of getting this wrong can be steep.
While I understand the lure of wanting to hire a contractor over an employee (no payroll, less admin, more flexibility etc.), if you were a fly on the wall of my office, you would be tired of me advising my clients that:
‘Just because you call your worker a ‘contractor’ doesn’t, in law, automatically mean that they are.”
Similarly, just because you have your worker sign a ‘Contractor Agreement’ does not automatically mean that your relationship isn’t one of employee-employer. Instead, when making this determination, you need to consider the specifics of the relationship you have with that worker. There are various factors a third-party (likely a judge or the CRA) will consider when making that determination. It’s important you become familiar with these factors before hiring.
Let’s dive in:
Factors to Consider to Properly Classify your Worker
Degree of Control Exercised over the Worker
The first factor we’ll consider is the degree of control exercised by your business over your worker. ‘Control’ is the right to instruct how, when, and where work is performed, and who ultimately performs that work. The greater control exercised over a worker, the more likely that worker is an employee and not an independent contractor. For example, if you require your worker to show up from 9-5pm 4 days a week to perform their work, this looks a lot like an employee-employer relationship.
A key indicator of control is whether the worker is or will be permitted to hire their own subcontractors to help complete the work or assign it to their own employees. This is often how a contractor scales their own business. Alternatively, when an employee is hired to perform work, it is usually a requirement for personal performance of the work by the actual worker being hired. Consider an instance where you once showed up as an employee to a job…. I would venture to guess that your employer would have NOT been OK if instead one day you sent one of your subcontractors to fulfill your duties that day.
Ownership of Tools
A worker who owns and supplies the tools required to perform agreed upon work, like a computer or other office equipment, software etc., is more likely to be operating their own business, and is a point in favour of their being considered an independent contractor. A worker who is supplied with these necessities by an employer is more likely to be considered an employee. If you supply your worker with their computer, cell phone (or money towards their cell phone plan), software, and other tools necessary to carry out their work, this is looking more like an employment relationship.
Chance of Profit/Risk of Loss
Usually as a business owner themselves, an independent contractor may profit by completing work quickly and efficiently. Consequently, they may suffer a loss where expense in performing the work exceeds their income.
An employee is typically paid an agreed amount for time spent working and is not entitled to any increased profits achieved . An employee does not bear the expenses or liability risks of the business. They show up and do the work provided, without worry of it affecting their pay check.
Exclusivity
Someone who operates their own business is free to choose who they work for. A worker's freedom to work for any client indicates independent contractor status. Requiring a worker to dedicate working time to one company or requiring the worker to enter into a non-competition agreement to work exclusively for your business is more likely indicates employment status.
Dependance on the Organization
If you will be one of many clients of a worker in their own roster of clients, this is an indicator of a contractor relationship. However, you need to be careful with this, as I’ve seen relationships that started out with work being provided to a contractor sporadically, but as the relationship strengthened over time, the business gave them more and more work, and all of a sudden the contractor was only performing work for that one business. Overtime, the relationship shifted and they became completely dependent on the business for most of their income. Keeping on top of this is important, as these relationships can change over time.
Intentions of the Parties
The intentions of the parties when determining whether a worker is an employee or an independent contractor will also be a factor in making a classification. Such evidence includes the wording of their written agreement indicating one way or the other and also who was responsible for remittance of certain sales tax for their services and also reference to the other factors set out above. However, this evidence is not 100% conclusive, and the entirety of the working relationship will be examined to determine the true nature of it.
Each of these factors are taken into consideration on a case-by-case basis, which is why it's important to look at the relationship each contractor has to a company, and make the determination. If you have a hint of uncertainty, it’s a really good idea to get legal advice on this, as the consequences can be very expensive if you get this classification wrong.
When do Issues arise?
Issues can arise that would put a business owner at risk in a variety of ways. For example, if you end a relationship with a worker, they might think they are afforded certain period of notice, or worse, severance pay. Often, lawyers get involved and once the relationship is analyzed, it is found that although the worker was called a ‘contractor’ - after looking at the above factors, the relationship really fell into an employment classification. That means you are responsible for severance pay as set out under the Employment Standards Act in British Columbia or your province. In another situation, the relationship might be flagged by CRA when after a contractor files their taxes and the majority of their income comes from you, indicating the contractor doesn't have other clients and is solely dependent on your business for income. This means you may be responsible for EI and CPP that hasn’t been paid for the duration of your working relationship. In another situation, the relationship might get flagged when the contractor didn’t save for payment of their income taxes, because they thought these payments were being deducted at source by their employer.
Why Understanding This Difference Is Critical
With the upswing of the gig economy and more businesses placing their preferences on independent contractors over employees, the government is paying closer attention than ever to working relationships and examining these relationships closely.
If the government determines that a business owner has falsely classified a worker, even if it’s an honest mistake, it can lead to lofty penalties, payment of back taxes (like EI and CPP), severance pay in the event of termination of that worker. It’s likely you’ll also need to hire a lawyer to help you navigate these choppy waters which will result in legal fees.
This is why it is critical that you understand the difference in the relationship between employees and contractors before jumping into the hiring process. The two relationships and therefore the corresponding contracts are very different. I never recommend using a template for an employment agreement (or one you got from a friend). The laws of each province are different, and the laws are always changing!
If you have any question at all, it is always best to seek legal advice rather than risk an expensive mistake.
Wild Coast Law can assist you ensure you get this classification right in your business and ensure you correctly classify your worker, and have the right contractor agreement or employment agreement in place.
Feel free to book a call here to discuss here.
