EMPLOYEE OR INDEPENDENT CONTRACTOR?

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EMPLOYEE OR INDEPENDENT CONTRACTOR?

SIGNIFICANT TAX & LEGAL CONSEQUENCES COME WITH MISCLASSIFICATION

One area of Indirect Tax that is often underemphasized and underappreciated by businesses and tax professionals alike is the proper classification of employees and independent contractors. Canada’s rules generally mirror those in the United States, and in both jurisdictions, misclassification of a worker (i.e., classifying the worker as an independent contractor instead of an employee) can give rise to significant tax and legal consequences.

In this Report, we review the Canadian and U.S. rules, and the challenges businesses face in navigating this classification process.

Canadian Legal Landscape

In Canadian law, the distinction between an employee and an independent contractor does not turn on any single factor. Canadian courts apply a multi-factor test, considering whether the worker is performing services as a person in business on their own account.

In making this determination, courts consider several factors, including the level of control the employer has over the worker, the worker’s investment in equipment and tools, whether the worker hires their own helpers, the degree of financial risk assumed, the worker’s opportunity for profit in performing the work, and more!

US Legal Landscape

In the US, based on a 2024 U.S. Department of Labor (“DOL”) final rule on independent contractor versus employee classification under the Fair Labor Standards Act (“FLSA”), a six-factor “economic reality” test applies. This test requires a review of the totality of the circumstances of the working relationship. As in Canada, no single factor is determinative:

1. Degree of Control: How much control the employer exercises over how and when the work is performed;
2. Opportunity for Profit or Loss: Whether the worker can earn profits or suffer losses based on their own business decisions;
3. Worker’s Investment: The extent of the worker’s investment in equipment, tools, or materials required for the work;
4. Skill and Initiative: Whether the work requires specialized skills and independent business initiative;
5. Permanence of the Relationship: Whether the working relationship is continuous or project-based or temporary;
6. Integral to the Business: Whether the work performed is a central part of the employer’s core business.

Misclassification Risks / Strategies

In both Canada and the US, there are some serious implications for worker misclassification, including tax and legal consequences.

Among the tax consequences would be federal CRA assessments for unremitted withholding taxes, including employer and employee CPP and EI contributions. Provincial employment standards requirements, such as minimum pay and holiday pay, would also apply, as would provincial worker’s compensation obligations.

Carefully drafted worker contracts, with proper classification and these indirect taxes in mind, can help minimize the risk.

Takeaways

In both Canada and the US, worker classification has become one of the most critical – and risky – compliance issues for employers today.  Getting worker classification wrong can trigger costly tax and legal liabilities.

Experienced Indirect Tax Counsel can help.

For help with Worker Classification and Indirect Tax, click here.

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