Chapter 3: Employee vs. Independent Contractor

Question 1

What is the key distinction between an employee and an independent contractor?

Answer 1

The key distinction is whether the individual is in an employment relationship or carrying on a business for themselves.

Employees work for an employer under a contract of service, while independent contractors operate a business as a sole proprietor or as a member of a partnership.

Question 2

How does the ITA treat the term “self-employed”?

Answer 2

The term “self-employed” is not used in the ITA but is commonly used in the Canada Pension Plan Act and Employment Insurance Act.

In tax discussions, it refers to an independent contractor, implying someone carrying on a business on their own.

Question 3

Why is the distinction between employee and independent contractor important?

Answer 3

This distinction impacts the tax treatment for both the individual worker and the payer.

It determines how income is reported, whether deductions for Employment Insurance (EI) and Canada Pension Plan (CPP) contributions apply, and which expenses are deductible.

Question 4

What are the differences in expense deductions between employees and independent contractors?

Answer 4

Employees have limited deductions for employment expenses compared to independent contractors, who can deduct a wider range of business-related expenses under ITA 8(2).

Question 5

How does ITA 8(2) limit employment expense deductions for employees?

Answer 5

ITA 8(2) restricts employees from deducting expenses unless specifically permitted by the ITA.

Independent contractors have more freedom to deduct costs associated with their business activities.

Question 6

Can employees deduct travel expenses between their home and work location?

Answer 6

Generally, employees cannot deduct travel expenses between their home and their regular place of employment unless their home is also their primary place of business.

Question 7

What is the formula for calculating the Employee’s EI Premium for 2024?

Answer 7

Employee EI Premium = (Insurable Earnings up to $63,200) * 0.01661

For 2024, the maximum EI premium for employees is $1,049.

Question 8

What is the formula for calculating the Employer’s EI Premium for 2024?

Answer 8

Employer EI Premium = (Employee EI Premium) * 1.4

For 2024, the maximum EI premium for employers is $1,469.

Question 9

What is the Total Maximum EI Premium for both employee and employer in 2024?

Answer 9

Total EI Premium = Employee EI Premium + Employer EI Premium

The total maximum EI premium is $2,518.

Question 10

What is the formula for calculating CPP Contributions for employees in 2024 based on the first CPP ceiling?

Answer 10

First CPP Ceiling Contribution = (Pensionable Earnings - $3,500) * 0.0595

For 2024, the first CPP ceiling is $68,500, and the maximum contribution for the first ceiling is $3,868.

Question 11

What is the formula for calculating CPP Contributions for employees in 2024 based on the second CPP ceiling?

Answer 11

Second CPP Ceiling Contribution = (Pensionable Earnings over $68,500 up to $73,200) * 0.04

The maximum contribution for the second CPP ceiling is $188.

Question 12

What is the Total Maximum CPP Contribution for employees in 2024?

Answer 12

Total Employee CPP = First CPP Ceiling Contribution + Second CPP Ceiling Contribution

For 2024, the total maximum CPP contribution is $4,056.

Question 13

How is the Employer’s CPP Contribution calculated for 2024?

Answer 13

Employer CPP Contribution = Employee CPP Contribution

For 2024, the maximum CPP contribution for the employer is $4,056.

Question 14

What is the Total Maximum CPP Contribution for both employee and employer in 2024?

Answer 14

Total CPP Contribution = Employee CPP Contribution + Employer CPP Contribution

The total maximum CPP contribution for 2024 is $8,112.

Question 15

What is the Income Tax Treatment for EI Premiums paid by employers?

Answer 15

EI premiums paid by employers are treated as business expenses and are fully deductible.

Question 16

What is the Income Tax Treatment for CPP Contributions paid by employers?

Answer 16

CPP contributions paid by employers are treated as business expenses and are fully deductible.

Question 17

How are EI Premiums paid by employees treated for income tax purposes?

Answer 17

EI premiums paid by employees are treated as a personal tax credit.

Question 18

How are CPP Contributions paid by employees treated for income tax purposes?

Answer 18

CPP contributions are split as follows:

Personal Tax Credit: Contributions based on the first CPP ceiling

Other Deduction: Contributions based on the second CPP ceiling

Question 19

What is the Maximum Amount of EI premiums deductible for the employer in 2024?

Answer 19

The maximum amount is $1,469.

Question 20

What is the Maximum Amount of CPP contributions deductible for the employer in 2024?

Answer 20

The maximum amount is $4,056.

Question 21

What is the Maximum Amount of EI premiums eligible for personal tax credit for the employee in 2024?

Answer 21

The maximum amount is $1,049.

Question 22

What is the Maximum Amount of CPP contributions eligible for personal tax credit for the employee in 2024?

Answer 22

The maximum amount is $3,218.

Question 23

What is the Maximum Amount of CPP contributions eligible for other deductions for the employee in 2024?

Answer 23

The maximum amount is $838.

Question 24

How are CPP Contributions for self-employed individuals taxed?

Answer 24

Self-employed individuals must pay both the employee and employer portion of CPP contributions. The tax treatment is as follows:

Personal Tax Credit: For the employee portion

Other Deduction: For the employer portion

Question 25

What is the Total CPP Contribution for self-employed individuals in 2024?

Answer 25

Total CPP Contribution = $3,218 (Personal Tax Credit) + $4,894 (Other Deduction)

For 2024, the total CPP contribution is $8,112.

Question 26

Can self-employed individuals participate in EI?

Answer 26

Self-employed individuals are not required to participate in the EI program but can voluntarily choose to participate.

However, they are not entitled to regular benefits like employees but may be entitled to special benefits (e.g., maternity, paternity, sickness, etc.).

Question 27

What are the special benefits that self-employed individuals can access under the voluntary EI program?

Answer 27

Maternity benefits

Paternity benefits

Compassionate care benefits

Sickness benefits

Family caregiver benefits

Question 28

How does participation in the voluntary EI program for self-employed individuals work?

Answer 28

Self-employed individuals who choose to participate in the EI program must pay the same EI premiums as employees but do not pay the employer-equivalent amount.

They must wait 12 months before making a claim and remain committed for life unless they are no longer self-employed.

Question 29

How are CPP Contributions and EI Premiums paid by employees and employers?

Answer 29

Employees’ CPP and EI contributions are withheld from their pay by the employer and remitted to the CRA, along with the employer’s portion of these contributions.

Question 30

How are CPP Contributions and EI Premiums paid by self-employed individuals?

Answer 30

Self-employed individuals are required to make quarterly installment payments of CPP contributions and, if applicable, voluntary EI premiums to the CRA.

These form part of the quarterly income tax installments.

Question 31

How are CPP Contributions calculated for individuals who are both employed and self-employed in the same taxation year?

Answer 31

CPP contributions made through employment are considered first, and any difference between the annual maximum and the amount already contributed through employment is calculated against the self-employed income.

This ensures that total CPP contributions do not exceed the annual limit.

Question 32

What is the Total CPP Contribution for an individual who is both employed and self-employed in 2024?

Answer 32

Total CPP Contribution = Employee CPP + Employer CPP + Self-employed CPP

For 2024, the total maximum CPP contribution for individuals who are both employed and self-employed is $8,110.

Question 33

What are the Employment CPP Contributions for individuals who are both employed and self-employed in 2024?

Answer 33

Employment CPP = (Pensionable Employment Earnings - $3,500) * 0.0595
For the example provided:

Employee CPP: $2,469
Employer CPP: $2,469
Total Employment CPP: $4,938

Question 34

What are the Self-Employment CPP Contributions for individuals who are both employed and self-employed in 2024?

Answer 34

Self-Employment CPP = First CPP Ceiling + Second CPP Ceiling + Employer Equivalent Contribution
For the example provided:

First CPP ceiling: $1,398
Second CPP ceiling: $188
Employer Equivalent Contribution: $1,586
Total Self-Employed CPP: $3,172

Question 35

What is a significant disadvantage of being classified as an independent contractor rather than an employee?

Answer 35

Independent contractors lose access to employment benefits such as:

Dental and prescription drug plans
Membership in a registered pension plan

Vacation pay, sick pay

Life insurance coverage

These benefits can significantly add value to an employee’s remuneration, sometimes by as much as 20%.

Question 36

Why might independent contractors need significantly higher levels of remuneration compared to employees?

Answer 36

Independent contractors may need higher remuneration to cover the cost of benefits (e.g., extended medical coverage) that would otherwise be provided by an employer.

These benefits are often not available to contractors at a reasonable cost and can be a significant expense.

Question 37

How does the underground economy affect self-employed individuals?

Answer 37

The underground economy offers increased opportunities for income tax evasion for self-employed individuals, as it allows for income to be received without reporting to the CRA.

This is typically done by accepting payments in cash without issuing receipts or invoices.

Question 38

Why is conducting business in the underground economy risky?

Answer 38

Engaging in the underground economy, such as paying in cash to avoid GST/HST, can lead to several non-income tax concerns, including:

Warranty issues
Building code violations
Liability concerns for workers’ compensation

Question 39

What is the CRA’s stance on cash transactions that are not reported?

Answer 39

The CRA warns Canadians to avoid participating in cash transactions to evade taxes, such as hiring independent contractors to perform work for cash payments.

This type of transaction can lead to legal issues and the avoidance of taxes like GST/HST.

Question 40

What are the potential advantages of being classified as an independent contractor?

Answer 40

Advantages include:

The ability to deduct large amounts of expenses for tax purposes

Flexibility in work hours and the type of work accepted

Freedom to work for multiple clients

Question 41

What is a major disadvantage for individuals with limited deductible expenses who choose to be independent contractors?

Answer 41

For individuals with limited deductible expenses, being classified as an independent contractor may not be economically advantageous compared to being an employee, as they may not be able to deduct enough to offset the lack of employment benefits.

Question 42

Why is it difficult to change from employment to self-employment with the same employer?

Answer 42

The CRA often challenges individuals who switch from employment to self-employment with the same employer, especially when the relationship between the individual and employer remains unchanged.

Employers may also be reassessed for withholding CPP contributions and EI premiums.

Question 43

What are some non-tax advantages of being an independent contractor?

Answer 43

Non-tax advantages include:

Ability to set your own schedule

Freedom to choose the amount and type of work

Flexibility in accepting clients or contracts

Question 44

What is the GST/HST threshold for an independent contractor in Canada?

Answer 44

An independent contractor must register for GST/HST if they are not a small supplier.

A small supplier is defined as an individual who earns less than $30,000 in gross sales over a 12-month period.

Question 45

What are the advantages of using independent contractors from an employer’s perspective?

Answer 45

Employers benefit by avoiding the costs associated with:

CPP and EI contributions
Workers’ compensation
Provincial health care (where applicable)
Additionally, employers are not liable for legal claims related to negligence or other employee-related issues.

Question 46

How do CPP and EI obligations affect employer costs?

Answer 46

CPP and EI contributions add to wage costs, and employers must also account for provincial and territorial payroll taxes.

Employers avoid these costs when using independent contractors, which reduces the administrative burden of withholding and remitting taxes.

Question 47

What is a less measurable benefit of using independent contractors?

Answer 47

Employers avoid long-term commitments to independent contractors, as these individuals are typically hired on a contract basis.

This provides flexibility in staffing and labor costs.

Question 48

Why might a taxpayer want to treat an employee as an independent contractor?

Answer 48

Taxpayers may attempt to treat employees as independent contractors to reduce costs related to CPP, EI, and employment benefits.

This can also simplify tax reporting and reduce administrative burdens.

Question 49

What challenges arise when treating employees as independent contractors?

Answer 49

Reclassifying employees as independent contractors is challenging, particularly if the relationship and duties between the individual and employer have not changed.

Contracts alone cannot determine employment status, and legal tests will examine the nature of the work and relationship to determine if the individual is truly self-employed.

Question 50

What are Personal Service Businesses (PSBs) under ITA 18(1)(p) & 125(7)?

Answer 50

A PSB refers to a situation where an employee resigns, creates their own corporation, and enters into a contract with their former employer to provide services through the corporation.

The CRA closely monitors PSBs as they attempt to re-characterize employment income as business income, which may result in tax avoidance.

Question 51

What are the steps in creating a Personal Service Business (PSB)?

Answer 51

The individual resigns from their job.

The individual creates a new corporation controlled by themselves.

The individual enters into an employment agreement with their new corporation.

The individual’s corporation enters into a contract with their former employer to provide the same services.

Question 52

Why is the CRA concerned about the rise of PSBs?

Answer 52

PSBs are seen as a method of tax avoidance because they attempt to convert employment income to business income, reducing tax liability.

The CRA scrutinizes PSBs for improperly avoiding CPP and EI contributions, along with other employment-related taxes.

Question 53

What are the consequences of being classified as a Personal Service Business (PSB)?

Answer 53

When the PSB rules apply, they have punitive results, including:

The corporation cannot benefit from the small business tax rate (9%) and is taxed at the higher individual rate (around 33%).

Deductible corporate expenses are limited compared to what employees could have deducted, leading to restrictive tax outcomes.

Question 54

What is the general approach to distinguishing between an employee and an independent contractor?

Answer 54

The distinction is based on whether an employer/employee relationship exists, which is determined by intent, actions, and behavior.

This approach is guided by case law, such as the 2001 Supreme Court decision in Sagaz Industries and the CRA’s guidelines in RC4110.

Question 55

What role does the intent of the parties play in determining the existence of an employment relationship?

Answer 55

Both parties must explain their intent, whether it was to create an employment relationship (a contract of service) or an independent contractor relationship (a contract for service).

However, intent alone is not sufficient—actions and behavior must support this intent.

Question 56

Why is corroborative evidence required to support intent?

Answer 56

Intent may be self-serving, masking the true nature of the relationship.

Therefore, corroborative evidence (such as control, ownership of tools, and financial risk) is required to substantiate whether an employment relationship exists.

Question 57

What are the factors that courts and the CRA examine to determine the existence of an employment relationship?

Answer 57

Control: The employer’s control over how and when work is done.

Ownership of Tools: Whether the employer provides tools and equipment.

Ability to Subcontract: Whether the individual can hire others to do the work.

Financial Risk: Whether the individual bears financial risks, such as fixed costs.

Opportunity for Profit: Whether the individual has an opportunity for profit, as opposed to earning a fixed salary or wage.

Question 58

How does control factor into the existence of an employment relationship?

Answer 58

In an employment relationship, the employer typically controls the work and how it is done.

The level of control over tasks and work methods is a strong indicator of employment.

Independent contractors usually have greater autonomy in completing tasks.

Question 59

What is the significance of ownership of tools and equipment in determining an employment relationship?

Answer 59

Employees generally use tools provided by the employer, while independent contractors typically supply their own tools and cover related costs such as insurance and transport.

Question 60

How does the ability to subcontract or hire assistants affect the classification?

Answer 60

If an individual can subcontract work or hire assistants, this is generally indicative of an independent contractor relationship.

If the individual must personally perform the work, this points toward employment.

Question 61

What is the role of financial risk in determining an employment relationship?

Answer 61

Employees generally do not bear financial risk, while independent contractors assume the risk of losses and fixed costs related to their business, such as office space or equipment.

Question 62

How does the opportunity for profit distinguish an independent contractor from an employee?

Answer 62

In an employment relationship, the employer assumes the risk and reward of profit.

An employee typically receives a fixed wage or salary.

Independent contractors have the potential for profit based on the success of their business, with a corresponding risk of loss.