Wednesday, February 15, 2012

Differences between Employees and Contractors

Theoretically speaking, there's a world of difference between an employee and a contractor.

Why Does It Matter?

Let's start by looking at the legal consequences of the distinction, before we start looking at the legal differences between them.

An employee, unlike an independent contractor, gets protection of various statutes like the Employment Standards Act.  Minimum vacation entitlements, minimum wage, limitations on hours of work, mandatory breaks, etc.

An employment relationship also requires the employer to withhold and remit income taxes to the CRA on the employee's behalf, as well as EI and CPP contributions.  (Employers are also required to make EI and CPP contributions of their own in respect of employees.)  By contrast, an independent contractor has to make his own CPP contributions (in the full amount, including what would otherwise be the employer portion), doesn't get EI, and collects the full amount of his bill plus HST, with no obligation on the payor to withhold and/or remit taxes to the CRA.

The independent contractor, unlike the employee, is seen as a business owner, and is therefore able to write off  business expenses for tax purposes.  

Thus, all other things being equal, there are advantages and disadvantages to workers of being employees versus independent contractors.  (Contractors don't get protection of employment standards nor EI, and the framework on termination is often less favourable, and there's also more personal administrative responsibility for accounting and payment of taxes, etc.; on the other hand, there are often tax savings to being an independent contractor.)

For businesses, it's generally better to have contractors than employees.  Yes, I may pay 13% HST for the services I'm buying, but I get that back through credits based on the HST I'm collecting from my own customers.  In the mean time, I'm saving on EI, CPP, and potentially on other things like overtime costs, public holiday pay, vacation pay, etc.

So many payors want to structure their contracts as contracts for service (i.e. independent contractors) as opposed to contracts of service (i.e. employment contracts).  To do so, they put terms expressly saying that the worker is an independent contractor, not an employee, and will be responsible for their own CRA remittances, and will provide accounts to the payor for services rendered, with HST, etc.  (At least, the more elaborate ones go down that road.)

And workers will agree to this, partly because of an imbalance in bargaining power, but also partly because there's something attractive about being able to write off expenses as business expenses like a wealthy business-owner does.  Particularly on the termination of the relationship, though, a contractor may be in a much worse position than an employee.

The Legal Test

I know many experienced and sophisticated businesspeople, some of whom are extremely successful, and among them there seems to be a belief to the effect that the contract is God.  They are often quite surprised when I tell them otherwise.  (I recently had a dinner conversation with such an individual where he was quite surprised to learn that the minimum statutory notice cannot be contracted out of.  He doesn't like this reality, because of the prospect that a sophisticated employee could take advantage of an employer by negotiating terms he knows are unenforceable.  This is possible, but I would never recommend an employee do that for reasons of poor predictability, and it's certainly the minority case for employment contracts that a sophisticated employee is able to pull the wool over the eyes of a less sophisticated employer.)

The contractual terms aren't irrelevant.  How the parties have chosen to characterize the relationship is not completely devoid of legal meaning, but nor is it determinative - it is one among several factors that Courts will look at to determine whether an arrangement is a contract of service or a contract for service.

There are other factors, too:

(1)  Control:  To what extent is the worker directed by the payor?  Does the payor control the hours of work?  How and when the work will be performed?  Is the payor able to discipline the worker?

(2)  Ownership of tools:  Who actually owns the tools and other devices necessary for the work to be completed?  If I actually had to invest in my own business by purchasing the tools of my trade, then it's much more likely that I'm a bona fide business owner.  If I rely on my client to have the tools of my own trade for me to use, then...less so.

(3)  Chance of profit:  In general, most employees will have the bulk of their remuneration calculated by a pre-established formula based on a salary or hourly wage.  Contractors, on the other hand, tend to get paid by the job, and while hourly billing isn't unheard of, especially in certain industries, there's certainly a per value element to the calculation.

(4)  Risk of loss:  Most employees pay virtually nothing out of their own pockets.  If a job goes south, an employee loses income, but hasn't usually invested much more than time into it.  On the other hand, a contractor may have incurred out-of-pocket expenses, wages for other employees, and other overhead costs, meaning that if the job ends up taking longer or more resources to complete than anticipated, or the payor doesn't end up paying, the contractor has potentially suffered a loss of more than just time.

At its core, factors such as these are designed to flesh out the essential question, posed by Lord Wright in 1947:  Whose business is it?

Then What Happens?

There are a few contexts in which these disputes get fleshed out.  Sometimes, the CRA lifts up the rug on a 'contractor' relationship and reassesses the parties on that basis.

More often, the worker comes back at the payor after the end of the relationship wanting entitlements based on an employment relationship - EI remittances, pay in lieu of reasonable notice, unpaid overtime or holiday pay.

Even though the parties may have governed their relationship as a contract for service for an indefinite period of time, it remains open to the Courts - at the instance of the CRA or either party - to re-evaluate it.

One should note that, where termination of the relationship is involved, there's also what sometimes gets referred to as the intermediate category, or "dependent contractors", who are not employees yet still get employee-style rights such as reasonable notice of termination.


This blog is not intended to and does not provide legal advice to any person in respect of any particular legal issue, and does not create a solicitor-client relationship with any readers, but rather provides general legal information. If you have a legal issue or possible legal issue, contact a lawyer.

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