Your organization could wind up with a huge financial liability if you’ve mislabelled employees as contractors. Find out your legal obligations and the respective status of both groups.
Today’s changing workplace has made it more popular for individuals to work as independent contractors rather than employees. Aside from the legal distinctions between the two labels, companies can find benefits and drawbacks when using each, plus risks when applying the wrong label.
How do an employee and independent contractor differ in legal status?
An employee is employed via a contract of services whereas an independent contractor is engaged via a contract for services.
Section 1 of the B.C. Employment Standards Act (ESA) defines an employee. The Act applies to employees, but not to independent contractors, since the latter are considered self- employed.
Determining who is an “employee” vs. an “independent contractor” is based on tests developed by the courts and various tribunals, including the B.C. Employment Standards Branch. Thus, just because a person is labelled an independent contractor does not mean that he or she is one. The tests used by the B.C. Employment Standards Branch are as follows, quoted from their website:
Control — Is the person under the direction and control of another regarding the time, place, and way in which the work is done? Is the person hired, given instruction, supervised, controlled or subject to discipline? Did the person answer a help wanted ad, was told what to do, how to do it, and when to do it? Did the person have to do the work him or herself, or could that person give the work to another to do? Does the person perform work normally or previously performed by an employee?
The greater the degree of control, the greater the likelihood of the person being found to be an employee.
Ownership of tools — Does the person use tools, space, supplies, and equipment owned by someone else? If so, this would indicate an employment relationship. However, it is recognized that some employers require employees to provide their own tools or vehicles.
Chance of profit — Does the person have a chance of profit? If their income is always the difference between the cost of providing the service, and the price charged for the service, the worker may be someone other than an employee.
Risk of loss — Is the person at risk of losing money if the cost of doing a job is more than the price charged for it? If not, this would indicate an employment relationship.
Payment — Does the person receive payments of regular amounts at set intervals? Does the person receive payments regardless of customer satisfaction or customer payment? If so, this would indicate an employment relationship.
In general, the degree to which the party who pays for the service controls the supply of material and tools, and retains direction and control of the activities, increases the likelihood that the [d]irector [of Employment Standards] will find the relationship to be one of employer/employee.
In summary, the most important question is: “Whose business is it?”
As a common misunderstanding, some organizations believe that if any of the following situations apply, someone is a contractor: a company does not deduct income tax, employment insurance, Canada Pension Plan; the person has signed a written agreement stating he/she is an independent contractor; the person sets his or her own hours and is not actively supervised; the person also works for other companies; the person provides his or her own tools. This is not necessarily the case!
What are the employer’s obligations?
An employer must deduct from each employee’s paycheque for income tax, CPP and EI, and remit those monies to the government. In addition, an employer must remit their portion of CPP and EI premiums to the government. Some additional costs to employers for employees might include health benefits, sick leave, pension plans, and other fringe benefits (e.g. parking, gym membership, etc.). The B.C. Employment Standards Act also requires employers to pay employees vacation pay (at least four to six per cent of wages). Of course, an employer must also bear administrative costs, such as payroll and deduction remittances, plus human resources costs such as recruiting, training, and performance reviews.
Although it might cost more to hire an independent contractor than an employee, a company is not required to make any of the above deductions or remittances for contractors. Nor does a company have the same HR or administrative costs when using an independent contractor. Depending on the specific language of the contract for services, a company might not be required to pay severance pay to a contractor when services are no longer required.
Being an independent contractor has more tax benefits than being an employee. For example, from a tax perspective, an independent contractor can claim most reasonable business expenses and does not have statutory deductions taken from their pay (such as EI, CPP, and income tax).
Conversely, being an independent contractor deprives a person of the application of the ESA. Thus independent contractors are not subject to minimum wage, overtime, hours of work, vacation, and other protections afforded by the ESA.
What are the risks of using the wrong label?
An agreement between an employer and someone who labels the person as either an employee or an independent contractor is not binding on the government or any other legal forum. The tests discussed earlier provide some guidance with respect to whether an individual is an employee or a contractor, albeit one can rarely be absolutely certain.
Many companies appear casual when it comes to the distinction between an employee and an independent contractor. Companies should consider reviewing their existing contractor arrangements since there might be severe financial risks to both the individual and the company when using the wrong label.
A person might be considered an “employee” in one legal forum but an “independent contractor” in another. For example, the Income Tax Act is usually interpreted narrowly (to avoid imposing tax liability unless required by the Act) while the reverse is true for the Canada Labour Code or provincial employment standards (to provide minimum protections to employees).
If a company treats a person as an independent contractor and some legal forum determines otherwise, the company will be forced to remit to the government all the deductions it should have made from the employee’s pay (e.g. EI, CPP, income tax), possibly plus interest and penalties. In cases where a company has mischaracterized many employees as contractors, this could result in an enormous financial liability. The caveat to this is that the contract for services might require the “contractor” to indemnify the company for any legal determinations that require the company to deduct and remit monies for CPP, EI, or income tax (as a result of the “contractor” being deemed an employee).
Using the same example, if that person then successfully complained to the Employment Standards Tribunal that he or she is actually an employee and thus owed overtime, vacation pay, statutory holiday pay etc., the ESA allows a claim for up to six months of back wages owing, plus it institutes mandatory penalties.