Are you an Employee or an Independent Contractor?

The determination as to whether a person is an employee or an independent contractor can be a difficult exercise and a source of uncertainty. The use of contractor / consultants within the IT professional services industry is commonplace.  Ensuring “onside” tax compliance is important as taxpayers have frequently been engaged in disputes with Canada Revenue Agency (CRA) as to the proper nature of a relationship.

The issue of whether an individual would be an employee or independent contractor is a question of fact. There is a “four-in-one” test which has generally been replicated by CRA in their policies. The four factors used in the test are:

• Control – how much control does the taxpayer have over their work?
• Chance of profit / risk of Loss – does the taxpayer have an ability to increase income and is there a risk that the taxpayer could have financial loss?
• Ownership of tools – does the taxpayer provide the tools to complete the contracts?
• Integration – is the taxpayer integrated into the payer corporation?

Based on the “four-in-one” test, the following checklist can assist you in determining if a person is an employee or independent contractor.

1)  Do you, as opposed to the payer, control when, where, and how you do your work? (Consider who determines the hours and place of work, whether the work performed was inspected and / or supervised, whether you report to someone, and whether you fill out a timesheet.)

2)  Are you able to work for other companies without the prior consent of the payer? If yes, do you provide similar services to other companies?

3)  Do you have the power to hire substitutes and assistants to perform the services you provide, without the payer’s knowledge or approval? Are you responsible for their remuneration?

4)  Are you responsible for any losses, expenses, or damages resulting from your activities?

5)  Have you worked for the company for a short period of time? Is there a foreseeable end to the project on which you are working, as opposed to there being a relationship that envisages an identified continuation of work?

6)  Do you provide your own supplies and equipment or reimburse the payer for the use of his or her equipment? Do you pay your own expenses?

7)  Do you use a separate office that is not on the payer’s premises?

8)  Are you ineligible for the rights, privileges, and benefits enjoyed by employees of the payer? (Consider such benefits as pension, disability and life insurance, health and dental insurance, employee stock option plans, and pay for vacation and statutory holidays.)

9)  Are your services supplementary to the payer’s business as opposed to being an integral part of the business?

10)  Do you issue invoices to the payer and receive cheques in payment of the invoices?

11)  When you invoice, do you calculate your fee on a basis consistent with that used by other independent contractors in your industry – for example, on the basis of production, flat fee, or time spent, whichever is the norm?

12)  Are you paid a fixed fee, or is there incentive compensation so that you can profit from sound management in the performance of your task?

13)  If a written contract exists, does it support an independent contractor relationship?

14)  Do you deal at arm’s length with the organization to which you provide services?

Setting up a proper structure and agreements that support the independent contractor status is key to avoiding potential audit / disallowed expenses / additional tax liability, penalties and interest. A review by your tax or legal professional can help you to ensure compliance.

- Jim McConnery, CA, TEP
Partner, Welch LLP

Split your Income – Save Tax!

Prescribed rate loans are a great tool for family income splitting. By virtue of our graduated tax rates, a family group will save tax if income is shifted from a high rate taxpayer to one or more family members that are in lower tax brackets. For example, a parent in Ontario that is in the top tax bracket and earns $10,000 of interest income will pay approximately $4,600 of tax on the income. If the income was instead earned by a child, without other income, he or she would pay no tax on the income. If the child had $20,000 of other income, then the $10,000 of interest income would attract approximately $2,300 of tax. The annual tax savings via the strategy will depend on the income shifted and the relative tax rates to the parent and child.

So far so good, except that if the parent gifts or loans the underlying investment funds to a child or spouse, then the income earned on the funds will attribute back to the parent. For this reason we must have a plan to avoid the application of the attribution rules. A prescribed rate loan is such a plan – attribution does not apply if the funds are loaned and interest is paid at a rate equal to or greater than the prescribed rate. The good news is that the current prescribed rate is 1%. Further good news is that the 1% will continue to apply in the future even if the prescribed rate increases in future periods.

Welch LLP assists clients in implementing prescribed rate loan arrangements. In many circumstances we use family trusts as part of the plan which leads to added flexibility. The link directs you to an article that provides more insight.

http://www.welchllp.com/publications/1f6f403e7423afbcc4f67a72611954be/Income_Splitting.pdf

- Jim McConnery, CA, TEP
Partner, Welch LLP