WORKING WITH INDEPENDENT CONTRACTORS

Many sole proprietors get help from freelancers and subcontractors rather than hiring employees. Paying a genuine independent contractor avoids payroll deductions, but the relationship has to be set up and documented correctly, and a worker who is really an employee can expose the proprietor to years of unpaid CPP, EI and penalties. This page covers what to do before engaging a contractor, what the contract should say, how contractors are paid and reported, special cases such as construction and non-resident contractors, and the consequences of getting the status wrong. The legal test for employee or contractor status is set out on the Payroll page.

BEFORE ENGAGING A CONTRACTOR

• Apply the status test first: decide whether the work, as it will actually be done, fits an independent contractor. The title used in the agreement does not decide the question.

• When unsure, ask the CRA: either the business or the worker can request a ruling on employment status for CPP and EI purposes, using Form CPT1 or through My Business Account.

• Collect details: the contractor's legal name, business name, address, and GST/HST registration number if they charge tax. Ask for proof of liability insurance where the work carries risk.

• Workers' compensation: in some provinces and industries, such as construction in Ontario, a business can become liable for a contractor's workers' compensation premiums unless the contractor provides a clearance certificate.

WHAT THE CONTRACT SHOULD SAY

• Scope and deliverables: the result to be delivered, rather than hours to be worked under supervision.

• Fees and invoicing: a fixed price or rate, how and when the contractor invoices, and whether GST/HST is added.

• Tools and expenses: who supplies equipment and who bears expenses. Contractors normally use their own tools and cover their own costs.

• Freedom to work for others: no exclusivity, and the right to hire helpers or subcontract.

• Intellectual property: who owns work product such as designs, code or written material. Without a written assignment, a contractor generally keeps copyright in what they create.

• Confidentiality and termination: how either party can end the contract and what happens to work in progress.

PAYING CONTRACTORS

• No source deductions: no income tax, CPP or EI is withheld from payments to a resident independent contractor. The contractor reports the income and pays their own CPP.

• Pay against invoices: payments should be made on the contractor's invoices, not through the payroll system or on a regular salary schedule.

• GST/HST: a registered contractor adds GST/HST to the invoice, and a registered proprietor claims it back as an input tax credit. A contractor below the small supplier threshold may not charge tax.

• Deduction: fees paid to contractors are deducted on Form T2125, under subcontracts in cost of goods sold or as professional fees or other expenses, depending on the work.

REPORTING PAYMENTS

• Construction businesses: a business whose main activity is construction must report payments for construction services to subcontractors on the T5018 information return, due six months after the end of the reporting period.

• Other businesses: fees for services paid to self-employed individuals can be reported on a T4A slip in box 048. Check the CRA's current filing requirements in Guide RC4157 before year end.

• Keep records: the contract, invoices, proof of payment and any CRA ruling, for the full record-keeping period.

NON-RESIDENT CONTRACTORS

• Work done in Canada: a payment to a non-resident for services performed in Canada generally requires 15% to be withheld and remitted to the CRA, unless the CRA has granted a waiver.

• Work done outside Canada: fees for services performed entirely outside Canada are not subject to this withholding.

• GST/HST: imported services may be subject to self-assessed GST/HST if the business is not using them exclusively in commercial activities.

CONSEQUENCES OF MISCLASSIFICATION

• CPP and EI: if the CRA rules that a worker was an employee, the proprietor can be assessed for both the employer and the employee shares of CPP and EI that should have been deducted, generally for up to three years back, plus penalties and interest.

• Income tax: penalties can also apply for failing to withhold income tax and to issue T4 slips.

• Employment standards: a misclassified worker may be owed vacation pay, holiday pay, overtime and termination pay. Ontario's Employment Standards Act specifically prohibits treating an employee as if they were not one.

• Ongoing relationships: the risk is highest where one person works only for the business, for a long period, on a regular schedule, under close direction.

KEY POINTS

• Status depends on the facts: not on the contract's title. Ask for a CRA ruling if in doubt.

• Put it in writing: deliverables, fees, tools, freedom to work for others and ownership of work product.

• Pay on invoice: without deductions for resident contractors, claiming input tax credits on GST/HST charged.

• Watch special cases: T5018 for construction and 15% withholding for non-residents working in Canada.

SOURCES

• Canada Revenue Agency: Guide RC4110, Employee or Self-employed?, and Form CPT1.

• Canada Revenue Agency: Guide RC4157, Deducting Income Tax on Pension and Other Income, and Filing the T4A Slip and Summary; T5018 information return.

• Income Tax Regulations: section 105 (non-resident service providers).