An In-Depth Guide for Independent Contractors in Canada
By Daniel Kosir | October 3, 2011
Breaking Updates March 2020:
As Covid-19 has devestating impacts on small businesses and self-employed Canadians we are covering financial programs and supports as they become available. Here are the key resources that we currently have available:
- Covid-19 Grant and Loan Programs for Canadian Small Businesses: This article will list financial supports as they are announced.
- Covid-19 Small Business Survival Guide: This guide looks at four key business areas as small busineses grapple with the fallout from Covid-19: HR, legal, financial and technology.
Being a self-employed, independent contractor has many benefits and risks.
On the positive side, you can claim valid business expenses to reduce your taxable income, may be able to work at home and can have more freedom to control when and how you work.
However, there are also risks, as an independent contractor does not have the safety net that protects employees. Employment standards do not apply and if you find yourself without paying clients you will not be able to collect Employment Insurance (EI) benefits.
With at least 1.8 million Canadians in temporary and contract employment, we decided to create this in-depth primer, which explains what you need to know if you currently work as an independent contractor or are considering becoming one.
Understanding the basics of self-employment
You plan to be self-employed, but how is that different from a traditional employee relationship? Here are the essentials.
First, there are three main forms of business you can use:
- Sole proprietorships are businesses where the individual is the business – there is no legal distinction between the two. You can often operate under your own personal name without having to register a business (when you add something to the name, registration is required) and report your gross income, expenses and resulting net income as business or professional income at tax time.
- Partnerships are similar to sole proprietorships, except they have more than one owner, with taxable income and liability being shared amongst owners.
- Corporations are separate legal entities from the actual business owner. This form of business offers added legal protection, but in the early years a sole proprietorship or partnership will often offer more tax advantages.
(You can learn more about these forms of business in our Starting a Business article: What Form of Business Is Best for you?)
Second, when you are self-employed you are responsible for taking care of bookkeeping, tax filings, any required licensing and record-keeping. CanadaOne has put together a number of articles that can help you understand your obligations in these areas, which you will find in our Starting a Business Guide.
Finally, self-employment differs from full-time employment in a number of important ways.
You are not “hired” for jobs, but have contracts. You will want to build standard employment benefits like vacation pay, along with other costs like marketing and sales, into your pricing.
Nor can you “be fired” – instead you follow the terms of your contracts, whether they are written or verbal. Should things fall apart, whether you are accuse a client or are accused of breaching a contract, you will need to follow collection procedures and may end up in court.
An important point: No matter how well a relationship starts, when things fall apart understandings over what was agreed to can shift dramatically from the terms initially set. It is amazing how people can distort and change their understanding of a contract when money is on the table in a dispute.
The pros and cons of self-employment
Being an independent contractor comes with some great perks.
- Self-employed workers often charge more per hour than an employee in a similar position. If you can spend the majority of your time working, as opposed to doing business sales or admin, this can enable you to earn more money than you would as an employee.
- Self-employment allows you to claim any valid expense needed to operate your business. These may include any at-home business expenses (such as telephone, internet, and other utilities), business use of vehicle costs, meals, purchase of equipment, and even entertainment, in accordance with the Canada Revenue Agency’s (CRA) guidelines.
- All of these measures, not available to full-time employees, work to drop your base taxable income. (There are some tax differences for corporations.)
- Your clients will benefit as well. Since you will not be on payroll, they will not have to deduct taxes, make EI and CPP contributions, pay statutory holiday pay or follow employment standards legislation.
- Another is the ability to direct your own work, choosing when and how you work.
Though self-employment may free you from many frustrations that come with being a hired employee, it lacks many of the benefits.
- Job security: There is almost no job security in contract work. The temporary nature of a contract means that employment can be sporadic, scarce, and precarious. As an independent contractor, you can be terminated at any time by the company that contracted you, without any form of severance pay. If this happens, you cannot collect EI because you do not pay into it.
- Work conditions: The threat of such easy dismissal and lack of financial protection can leave self-employed workers hesitant to raise complaints that might be valid workplace grievances, as traditional employees would.
Some employers exploit the low level of protections that are afforded to these workers, hoping to avoid compliance with legal employment standards that full-time employees would have. This could result in poor working conditions.
- Benefits: Because the work is contracted, companies you work with do not have to provide the same assurances that full-time employees receive. As an independent contractor, you do not receive benefits, sick pay, or statutory pay, unless these have been negotiated (this is why independent contractor hourly rates are usually higher than employee rates).
- Liability: Independent contractors have very thin legal safeguards compared with traditional employees when it comes to issues of liability. As an independent contractor, you can be held personally liable for mistakes or accidents that occur while working. If something goes wrong, you may find yourself the target of a lawsuit, rather than the company you hold the contract with. It is possible to get insurance to protect against this, but it can be costly.
- Stress and Health: Though every type of employment can be stressful in its own right, contract work often means uncertain schedules, scattered demands, spans of unemployment, uneven cash flow, and very little in terms of social insurance such as pensions and benefits.
A recent Globe and Mail article looked at fatigue, work-related ailments, and family and relationship stresses, stating that over a long period, contract employment can become a health hazard to both workers and their families.
If you choose self-employment, it is your responsibility to understand your legal and tax obligations. Not knowing something is not a valid reason for failing to comply with Canadian laws.
When you are self-employed you need to:
- Submit an annual tax return that reports your gross income, gross expenses and net income using the government’s standard format.
- Collect and charge GST/HST if you earn more than $30,000 in either a taxation year, in any four consecutive quarters, or in any single quarter.
- Pay yourself properly, depending on whether you are a sole proprietorship, partnership or corporation. Either salary or drawings can be used in the first two instances, while only salary and dividends can be used for corporations.
- Remit installment payments when required by the CRA. As an independent contractor, you may not have to make payments until you file your taxes, but these will be larger sums of money.
- Keep proper records for the prescribed time (currently seven years).
- Properly maintain and pay employees in compliance with all applicable laws, which includes keeping records and making deductions properly.
There is no question that self-employment can have significant tax advantages. As a sole proprietorship or partnership you can reduce your taxable income using valid business expenses. (Corporations use expenses to reduce the net profit of the company, with the business owner either drawing a salary or taking dividends.)
If operating a home business, you can also deduct a percentage of corresponding costs from your home. For example, the CRA website states that if your home office takes up 10% of your total floor space, you can deduct 10% of your home maintenance costs, such as heating, electricity, and cleaning materials.
You can also claim depreciation expenses of fixed assets.
It takes a bit of time, but is very important for self-employed workers and independent contractors to gain an understanding of tax essentials. Otherwise, you could find yourself with unexpected costs at year end or worse, with charges against you for not filing a correct return or keeping correct records.
To better understand the ins and outs of business accounting principles, be sure to read the following articles:
- Help! What Taxes Must I Pay
- Accounting 101: Balance Sheet Basics
- Understanding Financial Statements
- A Guide to Expense Deductions in Your Canadian Business
- Self-Employed and Contract Earnings: How-To File Your Personal Tax Return
Did you know? Many self-employed workers are not aware that they need to pay both the employer and employee portions of CPP at tax time, which can result in an unexpected tax bill when they file their first return as a self-employed worker.
Independent Contractor or Employee?
Let’s say you land a contract and agree to work as an independent contractor. Both you and your employer think you are self-employed, but that does not mean that the Canada Revenue Agency (CRA) will agree.
To prevent tax fraud where people claim to be self-employed in order to take advantage of tax deductions, CRA has created a process it uses to investigate and determine if someone is an independent contractor or employee.
In Quebec, determination of status is made based on the Quebec Civil Code. In all provinces and territories except Quebec, Canada Revenue Agency notes that it will look at "... the total relationship between the worker and the payer, using a two step approach."
Understanding how CRA’s criteria can help you ensure that your contracts are set up, so that your work status as an independent contractor will be validated if challenged.
The language used when the relationship was formed is very important to the first step, where the CRA will assess the intent between the "worker" and the "payer".
For example, if the CRA determines that the two parties entered into a "contract of service": that signals an employer-employee relationship; while a "contract for services" signals a business relationship.
A written agreement can help create clarity of the intent of the relationship and is highly recommended. If the two parties have a different understanding of their work relationship, there is a chance that CRA will determine that there was an employer-employee relationship, which could be costly to both parties.
Once intent between the parties is established, the second step checks to see if the intent of the parties is reflected in the facts. In other words, the CRA wants to make sure that both parties are not using the independent contractor status incorrectly.
In this second step, the CRA will ask questions designed to see how much control the worker has. Important considerations include whether the worker:
- has control over where and how he or she works;
- can hire assistants or sub-contract work;
- provides equipment and tools;
- has taken a financial risk and has the opportunity to profit from his or her work;
- is responsible for investment and management; and
- has written business contracts with the client.
The more that the "client" controls the worker, the less likely it is that the independent contractor status will be upheld.
Exciting times, risky times
The amount of information you need to absorb when considering a shift to self-employment for the first time can be overwhelming.
If you find yourself accepting what really seems like a full-time job, presented as an independent contractor position you would be wise to approach the offer with caution. Some companies ask employees to work as independent contractors to reduce their overall costs and liability.
In these situations you may find yourself receiving few of the advantages of self-employment, while taking on the risk of having no safety net should your position be terminated. (In this situation there are opportunities to ask CRA to make a ruling on your employment status.)
At the same time, becoming an independent contractor or self-employed worker can be freeing and has the potential to enable you to earn more money than you could as an employee. This can work extremely well in industries where specific skills are in high demand.
Ultimately it is up to you to evaluate your options and make the choice that is best for you. Whatever you decide, understanding the essentials of self-employment is often the best place to start.