by Leanne E. Standryk
This article was written by Leanne E. Standryk. The article is based on the premise that Employer’s are increasingly looking for a more flexible workforce to reduce the costs associated with carrying a permanent workforce. Individuals are forced to seek alternative means of employment and are more than ever establishing their own business and offering their services as independent contractors. This article reviews the elements of the employer/employee relationship and shifts to a focus on the legal rights and implications arising from self employment and independent contractor status.
The new economy has forced employers and employees alike to rethink the way in which they conduct business. Traditionally, organizations have maintained a set work force with a prescribed number of employees on a continuous basis to complete required work. However, increasingly, the workplace has become less “product” oriented, and more “project” oriented. Employers may not need a permanent work force.
Employers are more than ever seeking to obtain the services of individuals in a capacity other than as “employee” to reduce the costs associated with having a permanent work force. To answer this call, individuals are often willing to provide their services as an independent contractor. What does this shift mean and how do the legal rights differ that govern each relationship?
B. The Employer/Employee Relationship and the Employment Contract
Every Canadian employer has an employment contract with each of its employees. An employment contract is formed when an individual agrees to provide services to another party in exchange for remuneration.
An employee typically enters into a contract of service with an employer. Although the contract is almost always for an indefinite term, the parties may also contract for a “fixed” or “definite term”. If the parties do not specifically agree to a fixed term, it is generally assumed that employment will continue as long as the relationship is satisfactory, and will not end until either party gives reasonable notice in accordance with the applicable laws.
Parties may agree to employment for a fixed or definite term contract. A contract that sets out a fixed term and does not contain a mutual option to renew for an extended period expires at the end of the specified term. Under a fixed term contract, the employer is responsible for the same statutory deductions and benefits that apply to the indefinite or long term employer/employee relationship.
The substantial difference between the fixed termed contract and the definite term contract is that an individual hired under the terms of a fixed term contract cannot be dismissed before the end of their contractual term without cause. If they are dismissed without cause, they are entitled to damages for the entire unexpired portion of the term.
C. Elements of the Employer/Employee Relationship
Regardless of the type of contract agreed to, the elements characteristic of the employer/employee relationship are consistent. The following four factors often indicate that an employment relationship and therefore a contract of employment exists:
- the employer has the authority to select an individual for employment;
- the employer has the ability to determine the payment of wages or other remuneration;
- the employer has the right to control the employee with respect to the type, manner and timing of work; and
- the employer has the right to suspend or discipline the employee.
The employee generally agrees to perform whatever tasks the employer needs to have carried out. Subject to any express terms in the contract of service, employees cannot be dismissed from their positions without receiving reasonable notice or pay in lieu of notice unless employers have legal cause to terminate their employment.
Finally, certain obligations are owed to employers by all employees. These include obligations of confidentiality, good faith and loyalty.
The primary benefit to the employee arising from the employment contract is the protection provided by minimum standards or statutory rights and obligations imposed by law through employment standards legislation (ie. CPP and EI).
D. Self Employed Independent Contractors
Self employment is a term used to describe those people who are in business for themselves. Most often, self employed individuals earn a living by following their own trade, business or profession. These individuals are commonly referred to as an independent contractor, consultant, or entrepreneur.
In contrast with the employer/employee contract of service, the independent contractor or self employed individual enters into a contract for services. The contract is almost always for a definite period of time and the duties owed by the independent contractor are limited in nature. Subject to the particular contract, independent contractors generally owe no obligations of confidentiality or loyalty to those individuals receiving the services save and except a general duty of good faith.
E. Advantages and Disadvantages – Self-Employment and Independent Contractor Status
Hiring Firm/Company Advantages – For a company, there are a number of benefits and reasons for retaining an self employed independent contractor. The company is not compelled to make the employer’s contributions to CPP and EI and, it is unlikely that the company will provide group benefits and statutory entitlements such as vacation pay, overtime pay and notice/severance pay. This results in a financial saving to the company in terms of personnel and administrative time.
Hiring the self employed independent contractor also allows the company the opportunity to maintain a more flexible workforce. It provides the Employer with the opportunity to hire a highly specialized staff for short term projects. However, these individuals often come at a high price as the hourly fees are often much greater than that for the company’s regular full-time employees.
The company will owe no notice or severance obligations to the individual pursuant to employment standards legislation and, may terminate the relationship without cause or reasonable notice, subject to the specific terms of the agreement between the parties.
Advantages to the Self Employed Independent Contractor – The self employed independent contractor has the freedom to decide whom to work for, when to work and how to work. The most attractive ingredient is increased freedom to contract with all the risks and rewards. Generally speaking, the self employed independent contractor is free to contract with other entities during the course of their contract. They generally set their own hours of work and their work is not closely monitored by the employer.
Statistically, the self-employed independent contractor is usually paid 20% – 40% more per hour than employees performing the same work. This is in part due to the fact that the hiring party receives considerable savings by foregoing contributions to unemployment and worker safety insurances, health benefits as well as other mandatory tax deductions for the common employee. The self-employed independent contractor must pay for these things out of pocket and therefore needs to be paid more than employees to enable themselves to do so.
There are no salary tax deductions. This means the self employed individual can hold on to money longer without having to turn it over to Revenue Canada. This can result in improved cash flow.
A self employed independent contractor is entitled to business related tax deductions. All deductions must be viewed as reasonable in amount and must be an expense ordinarily incurred by the specific business being carried on. Common tax deductions include: office rent, travel, entertainment and meal expenses, marketing and promotional expenses and, equipment and insurance costs. In comparison, an employee’s work-related deductions are severely limited.
Hiring Firm/Company Disadvantages – The company will not have as much control over an self employed independent contractor and this may be perceived as a disadvantage to the company in certain situations. The company does not have the right to closely monitor the work or discipline the worker. In addition, the independent contractor does not owe the company any fiduciary responsibilities and company will not have the right to restrict the independent contractor’s ability to work for competitors.
Disadvantages to Self Employed Independent Contractor Status – There is little job security. Ingrained in the employer/employee relationship is the assurance that the employee is paid as long as employed, even if the employer’s business is slow. A self employed independent contractor must market and promote his/her business and generate the work to earn a living.
The independent contractor will not qualify for benefits and will not benefit from any statutory rights such as overtime, vacation and notice or severance pay. The independent contractor is also not eligible for employment insurance benefits should the need ever arise.
Finally, the independent contractor bears the risk of loss. Generally speaking, the independent contractor is personally responsible for all debts and liabilities that arise during the course of business.
F. Legal Formalities Involved in Establishing Self Employment and Independent Contractor Status
In some instances it may be necessary for the self employed independent contractor to obtain a license to carry on business. The license may have to be obtained from a municipality, the province of Ontario or from the Government of Canada. Generally speaking Municipal licenses may be required by electricians, plumbers, restaurants, tax cabs etc. An example of those activities requiring registration or a license under provincial law include employment agencies, motor vehicle dealers and real estate brokers.
Municipalities also have the legal right to establish rules about what types of activities can be carried out in particular areas. This is done pursuant to particular zoning by-laws such as residential, commercial and industrial designations. Generally speaking, the municipality will permit an individual to carry on a small business within their residence so long as any home containing a business is used primarily as a residence and the business does not negatively interfere with the neighbors right to privately use and quietly enjoy their own property.
Business name registration – If a self employed independent contractor decides to carry on business under a name or style other than his or her own name that name must be registered and filed with the Ministry of Consumer and Commercial Relations. Registration is generally for a period of five years and may be renewed. An amended registration is required to be filed whenever any change takes place in the information set out in a registration.
G. Determining Independent Contractor and Employee Status
The characterization of an individual as a self employed independent contract or an employee has various implications in terms of Income Tax liability; Canada Pension Plan and Unemployment Insurance eligibility; and individual protections pursuant to Employment Standards Legislation.
Although there a several tests that may be used to characterize the relationship as one of either employer/employee or self employed independent contractor, Revenue Canada and the Courts often use the Four Fold Test. The commonality between the tests is that each analyzes the substance of the relationship between the parties. The Four Fold Test consists of the following analysis;
- the extent to which the company controls the performance of the individual’s services;
- whether the individual owns the tools and equipment used in rendering the services;
- whether the individual has a chance at profit; and
- whether the individual has a risk of loss.
With this test, as with others, the factors must be viewed in the context of the whole of the various elements constituting the relationship. Generally speaking, the mere fact that a person provides his or her own tools and equipment does not make him/her a self employed independent contractor; the more the person is attached to and under the control of the employer, the more likely that he or she will be characterized as an employee.
H. Liabilities Arising form a Determination of Employee vs. Independent Contractor
Regardless of what the parties intended at the time that they entered into an agreement, if it is found that the relationship can be characterized as an employer/employee relationship as opposed to that of a self employed independent contractor, there can be considerable consequences to the hiring company. Various pieces of legislation including the Labour Relations Act, the Unemployment Insurance Act, Canada Pension Plan Act, Employment Standards Act, Workers’ Compensation Act, Income Tax Act, and Employer Health Tax Act make provision for the consequences and penalties to be applied where an employer has failed to meet its obligations.
Generally speaking, Revenue Canada will assess the company for unpaid Canada Pension Plan contributions and Employment Insurance premiums – both the employer’s and the employee’s shares, as well as income tax which should have been withheld going back up to 6 years, plus interest, plus penalities up to 20% of the amount that should have been withheld and remitted.
Practically speaking, for the individual worker, this situation may give rise to termination of employment because the company does not want to pay the additional expenses involved in the employer/employee relationship.
I. The Written Contract
Should a self employed independent contract use a written agreement? As always, a signed agreement between the parties may be of assistance in making the determination as between “contract employee” and “self employed independent contractor”. However, an agreement or contract in writing that defines the relationship is not determinative. Each administrative tribunal and court will apply its own criteria or tests to make the determination based on all the available facts.
The increased need for a more flexible workforce has caused many employee terminations and/or layoffs. This has forced many individuals to review seek alternatives to the traditional means of earning a living. As this paper has outlined, there are many advantages to both parties in establishing self employment and independent contractor status. In deciding which route to take it is well advised to canvass all of the advantages and disadvantages of each particular method of employment. You should seek the assistance of legal counsel and an accountant to determine what method is best suited to your objectives. Finally, when commencing new employment ensure that there is a common understanding between the parties as to all rights and obligations arising from the relationship – this will ensure that each party actually receives what they bargained for.