Big and small companies can benefit from hiring workers as independent contractors (IC) rather than employees. For example, you are only required to pay independent contractors for worked hours and not vacation or sick days. There is also less administrative work. You are not required to take deductions from an independent contractor’s pay for expenses such as Canada Pension Plan (CPP) and Employment Insurance (EI) contributions.
The independent contractor invests in their own tools and bears the expenses they need to incur to perform the task at hand. In addition, they provide work expertise and flexibility, as you can hire them on a project-by-project basis, which can help eliminate the need to provide notice or pay in lieu once their services are no longer needed. However, there is a correlative risk that a contractor may not complete the task by the deadline or leave the project midway. However, the benefits of hiring an independent contractor often outweigh the risks, making them attractive for many types of businesses.
But before you hire an independent contractor, it is important to know some of the basics involved. Below, we will outline some important considerations for any business owner considering hiring an independent contractor.
How to Pay an Independent Contractor and Report the Payment
The biggest reason why business owners love hiring independent contractors is they don’t have to undergo all the payroll procedures associated with regular employees. Instead, an IC will send you an invoice, and you can make the payment through various means, as you would pay any other account.
You need not deduct any CPP or EI or withhold tax for a contractor. But you must report the independent contractor’s payment to the Canada Revenue Agency (CRA) if the annual amount paid per contractor exceeds $500. You report this payment using a T4A slip, which summarizes all compensation a company pays to contractors or a non-employee worker.
It is the responsibility of independent contractors to file their year-end income tax returns. They must submit a T4A return to the CRA as a record of income. They can deduct business expenses or operating costs to reduce the taxable income on their annual return.
If you hire non-resident contractors living outside Canada, you must file a T4A-NR slip for each such contractor. The T4A-NR slip summarizes all amounts you paid to non-resident individuals, partnerships, and corporations for services they performed in Canada as independent contractors.
Make sure the person is truly an independent contractor.
But before your hire an independent contractor, be wary that the person or corporation that you hire must qualify as an IC in the eyes of the CRA. If the CRA identifies that you wrongly classified an employee as an independent contractor, you could face a hefty fine. The CRA has laid down parameters to differentiate an employee from an independent contractor:
- The contract – The payer and independent contractors should enter a contract for services (business relationship) and not a service contract (employer-employee).
- The degree of control – The payer should not control how the independent contractors perform the work and whether or not they hire additional help to complete the project.
- The tools – The payer should not provide or reimburse an independent contractor’s expenses for the tools and equipment needed to accomplish the work.
- The degree of exclusivity – The independent contractors should be free to take up work from other clients.
- The financial risk – The independent contractors do not incur a risk of loss or stand to gain a profit based on the company’s performance.
The Consequences of Misclassifying an Employee as an Independent Contractor
The CRA will determine the relationship based on the documents submitted by you and the IC. So ensure that you have proof that the person has an IC status. If the CRA determines that you misclassified an independent contractor when they should be an employee, the business’s financial consequences could be disastrous.
The CRA could ask you to pay all the CPP, EI, and withholding tax for the previous years; an employee was classified as an independent contractor. Moreover, it can impose a fine and penalty for misclassification. The independent contractors could also be required to repay all business expense deductions they claimed in previous years. Misclassification has the potential to create a huge tax bill for both parties.
Many business owners have a misconception that hiring an incorporated contractor (a contractor who has established their own corporation for performing and charging for work) is sufficient to prove the independent contractor’s status. But this is not necessarily the case. The CRA uses many parameters to determine the employee and IC status.
For instance, if the incorporated independent contractors work only for you and have no other clients, your case could come under scrutiny. In addition, if the CRA concludes that the organization is a personal services corporation, the independent contractors might have to repay the tax benefits and deductions the CRA offers small businesses.
Contact Edelkoort Smethurst CPAs LLP for Experienced Advice and Guidance on Hiring Independent Contractors
The CRA determines the status of a worker on a case-by-case basis. Therefore, it can be difficult to ensure you are in compliance with all regulations pertaining to hiring independent contractors. To avoid potential liability for CRA penalties, consult an accountant to help ensure you hire an independent contractor properly from the start. The tax and business advisors at Edelkoort Smethurst CPAs LLP can help. Contact us today by phone at 905-517-2297 or reach out online.