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Employing Contractors and Contracting Employees

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  • 1. Employing Contractors and Contracting Employees: Sorting Out Tax and Legal Issues Shane Onufrechuk, CA Richard Press, LL.B. November 10, 20115573299_1.pptDAVIS LLP and the DAVIS LLP logo are trade-marks of Davis LLP, © 2007 Davis LLP, all rights reserved. Unauthorized copying, distribution and transmission is strictly prohibited.
  • 2. Employee vs. Independent Contractor Leading Case – Wiebe Door Services Ltd. V. MNR • 4 tests (maybe 5)  Control  Ownership of tools  Chance of profit  Risk of loss  Maybe “integration” Latest Case – Long et al v. MNR • Tests too rigid • Integration test not relevant • Legal relationships matter – but not always followed in the courts where inconsistent Other cases
  • 3. Tax Implications of Employment - Individual Employee • Limitation on deductions  Tools  Musical instruments  Moving expenses etc. • Not responsible for CPP and EI • Not taxable supply for GST/HST • Income reported on a cash basis Employer • Obligation to withhold  EI  CPP  Income Tax • T4 Reporting
  • 4. Implications of Independent Contractor -Individual Contractor • Likely has instalment obligation relating to taxes payable • Expenses laid out to earn income deductible (subject to limitations in the Income Tax Act “ITA”) • Unless small supplier or exempt supply obligation to collect and remit GST/HST • Income reported on an accrual basis Service Recipient • No obligation to withhold tax • No obligation to report amount paid
  • 5. Implications of Employee-Like Relationship– Corporate Employees Personal Services Business • Defined at 125(7) of the ITA • Defined as  Corporation carrying on business of providing services where • Individual performs services on behalf of the corp • Individual or related person is a specified shareholder • Individual would “reasonably be regarded” as an officer or employee of the services recipient but for the corporation • Unless more than 5 full time employees or services are provided to an associated corp.
  • 6. Implications of Employee-Like Relationship– Corporate Employee cont’d Implication of being a Personal Service Corporation • Denied small business deduction • Limited deduction of expense in Corp. (same as employee) Purpose of legislation is to prevent the conversion of salary income into corporate business income taxed at a low rate Consider Criterion Capital Case for officers where services provided outside of employment duties
  • 7. Implications of Employee-Like Relationship– Corporate Employee cont’d Employer • No payroll costs i.e. EI and CPP • No withholding obligations • GST needs to be paid if not small supplier or exempt supply
  • 8. Personal Services BusinessTax Planning Opportunity? Income Tax Deferral • 25% corporate tax rate in 2011 • 19% deferral over to personal rate Absolute tax savings • Income splitting with family members • Pay out retained earnings when not a top marginal rate Reduced Payroll costs • No EI and CPP • No T4’s etc. Consider for high income salaried employees who have income in excess of personal needs, or a low income spouse or other adult dependants
  • 9. Personal Services BusinessDisadvantages Administrative costs and time Loss of “earned income” for RRSP purposes Dealing with stock options Change in law??
  • 10. Incorporated Contractors Similar benefits to Personal Services Business Enhanced deferral for Small Business Deduction income SBD rate in BC presently 13.5% on first $500,000 April 1, 2012 SBD rate will be 0% in BC for an 11% effective rate of the first $500,000 of active business income Creates a potential 32% tax deferral opportunity Creates liability protection
  • 11. Personal Services BusinessImplementation1. Create family trust (if necessary)2. Have trust or principal and related family members incorporate corporation with proportionate shareholding as desired3. Have principal terminate existing employment contract (subject to legal advice)4. Have incorporation entity and employer enter into a services contract with terms similar to previous employment agreement (see employment advice)5. Have principal enter into a contract with the incorporated entity to perform services on behalf of the entity.
  • 12. Stock Options Treatment different for employees and independent contractors Employees benefit from the stock options rules found in section 7 No 50% 110(1)(d) deduction for independent contractors No deferral for independent contractors on the issuance of stock options Treated as an in kind payment of fees for independent contractors
  • 13. Outside the tax regime: Legal tests Vary by tribunal Finding of one tribunal is influential, but not determinative, for second tribunal • e.g. may be a contractor for CRA purposes and an employee for human rights All test based on facts An agreement between the parties as to status is not determinative
  • 14. Legal test for contractor or employee status There is no bright line test Vary by tribunal Finding of one tribunal is influential, but not determinative, for second tribunal (e.g. may be a contractor for CRA purposes and an employee for human rights) All tests are fact specific
  • 15. Key Factors Control Integration (but not importance) Investment Diversity Legal relationship (but not intent)
  • 16. Control test Is there control over workers? • Selection – employers select specific employees • Dismissal and discipline – employers discipline and dismiss an employee • Method - employers control the method in which the job is carried out • Timing – employers set when the work must be performed • Remuneration - employers set and amend the payment scale
  • 17. Four-fold test Control (as per prior slide) Ownership of tools – investment in business Chance of gain – contractors have a chance of windfall profits if job performed successfully Risk of loss – contractors have chance of loss if services performed poorly
  • 18. Organizational or integration test Is work integral to the operation of the business? The more integrated the work is with the business, the more likely it is that the worker is an employee Considers control: can worker set own hours and methods
  • 19. Permanency test Based on duration of the relationship The longer and more continuous the relationship, the greater chance that it is an employment relationship Inapplicable for many common modern contractor relationships – e.g. distributorships
  • 20. Economic reality test Combines control test, four-fold test and permanency test Adds Diversity • Can worker perform similar services to other parties? • Can worker actively search out other work?
  • 21. Recent Cases (other than tax cases) 671122 Ontario Ltd. v. Sagaz Industries Canada Inc. • 2001 Supreme Court of Canada decision • Integration and Control Smith v. Centra Windows Ltd. • 2009 B.C. Supreme Court decision • Continuum of arrangements • No factor conclusive (i.e. no bright line)
  • 22. Recent Developments in Human Rights McCormick v Fasken Martineau Dumoulin 2011 BCSC 713 Pardy v. Earle & Zesty’s Restaurant 2011 BCHRT 101
  • 23. Human Rights test for employee status Utilization: is one party using the services of another for its own benefit Control: Does one party have the right to exercise control over the other Financial Burden/Remuneration: Who controls the amount of compensation received Remedial Purpose: Who has the practical ability to remedy the discrimination in question
  • 24. McCormick v. Fasken Law Firm: 650 equity partners worldwide; 60 in Vancouver (including McCormick) Partnership agreement required mandatory retirement at age 65 Found to be an employment relationship
  • 25. McCormick v. Fasken Firm utilizes partner to service clients and generate IP Partnership agreement and managing partner/executive committee control partner Remuneration of partner a judgment call of other partners, not strictly based on billings Forced retirement engages remedial purposes of Code
  • 26. Pardy v. Earle & Zesty Stand-up comedian hosted an open mic in exchange a $50 shared beer tab (all the comics had to share the tab) Restaurant did advertising for open mic Comedian gets into dispute with lesbian patrons Found to be an employment relationship Restaurant on hook for comedian’s damages
  • 27. Pardy v. Earle & Zesty Restaurant utilized comedian to attract patrons and to recruit some other comics Comedian needed restaurant’s permission to go on-stage and restaurant controlled comedian by preventing him from going on-stage again The shared $50 beer tab was sufficient remuneration Restaurant had power to remedy comedian’s wrong: could have stopped show; offered apology; offered compensation
  • 28. Why care? Tax and payroll liability Insurance liability (WCB and general) Employment standards Labour Code liability Human rights liability Privacy liability Civil liability (wrongful dismissal and vicarious liability) Intellectual property liability Post-relationship obligations
  • 29. How to protect yourself If retaining a contractor: • Contract with a company, not individual • Have a written contract. If hiring an employee: • Have a written contract.
  • 30. TaxationEmployer BusinessMust make income tax Contractor responsible forwithholdings own withholding and deductionsNot taxable supply of Contractor usually mustGST/HST charge GST/HSTLimited allowable Greater income tax benefits:deductions - more allowable deductions - income splitting
  • 31. PayrollEmployer BusinessHave payroll costs as must Minimal payroll costs forwithhold and contribute on contractor (likely paidCPP and EI through A/R)Issues T4 Contractor bears payroll costs for own payroll Contractor should render accounts
  • 32. Benefits and PerquisitesEmployer BusinessEmployers commonly Businesses should notprovide health and welfare provide health and welfarebenefits benefits to contractors Contractors lose “earned income” for RRSP purposesEmployers commonly Business may reimburseprovide perks (e.g. car contractors for expensesallowance, club dues, etc.) - Costs or costs plus
  • 33. Insurance and Health and SafetyEmployer BusinessMust establish WCB Contractor responsible foraccount WCBMust pay WCB premiums Should get clearance letterfor employeesEmployee negligence Not insured for actionsusually covered by general (Should ensure haveinsurance insurance)Indemnity uncommon Indemnity common
  • 34. Payment issuesEmployer BusinessMust usually pay wages at Can contract for any feeleast semi-monthly payment schemeDeductions from wages Can contract to set-offunlawful claims
  • 35. Hours of workEmployer BusinessNon-managerial employees Can establish flat rategenerally entitled toovertimeEmployees entitled to Contractors responsible forleaves (jury duty to providing servicematernity leave)
  • 36. Time offEmployer BusinessEmployees entitled to Contractor not entitled tovacation vacationNon-managerial employees Contractors not entitled toentitled to statutory statutory holidaysholidays
  • 37. Termination of relationshipEmployer BusinessSummary dismissal for just Summary termination for:cause - non-curable or non-cured material breach - bankruptcy - act of principalAbsent just cause, notice or Contracted term orpay in lieu “reasonable” noticeESA minimums
  • 38. Civil liabilityEmployer BusinessWrongful dismissal claim Wrongful termination claimexposure exposure- approx. 24 month - approx. 12 monthmaximum exposure maximum exposureVicarious liability issues Vicarious liability unlikely
  • 39. PrivacyEmployer BusinessObligation on employer to May be no obligation ofprotect employee personal business to protectinformation contractor informationMust implement privacy May need to obtain consentpolicy on collection, use to share personal info withand disclosure of employee contractor and ensureinformation contractor protects that info
  • 40. Human RightsEmployer BusinessMust comply with human May discriminate againstrights re. hiring and contractor.managing employmentrelationship Remedial legislation Broad scope of who is employee
  • 41. Confidentiality and Post RelationshipObligationsEmployer BusinessEmployee has duty of Contractor may not haveconfidence duty of confidenceConsider contracting for Can contract forpost-employment confidentiality; considerobligations (e.g. non- contracting for post-compete, non-solicit, etc) relationship obligations
  • 42. Fiduciary duty and loyaltyEmployer BusinessKey employees owes Absent professionalfiduciary duty relationship, fiduciary duty unlikelyAll employees owe duty of No duty of loyaltyloyalty - May provide services to- Conflict of interest usually competitor absentcause contractual prohibition
  • 43. Intellectual propertyEmployer BusinessEmployer automatically Business usually ownsowns most employee’s none of its contractor’sworks worksShould contract for Should contract for all IPunowned rights rights- e.g. moral rights
  • 44. Common contractual terms for employees Compensation Position, duties and reporting Termination Benefits and vacation
  • 45. Common contractual terms for contractors Fees and accounts Services Representation to public Termination Expenses and additional costs Insurance Authority Indemnity Set-off
  • 46. 5 common reasons why contractors arefound to be employees Have business cards (integration) Are part of corporate chart (integration and control) No financial investment in their own business (investment) Accept employee benefits, including vacation (integration) Have authority to bind the company (integration)
  • 47. 5 take away points A contractor is in business for itself, an employee works for you. Sort out the form of relationship at the beginning of the relationship. Have a good written contract for both employees and contractors. Try to stay away from close to the line. Get legal and accounting advice beforehand.
  • 48. Questions or Comments