If you own a small business or startup, it’s always a question of when – or if – you hire people as employees or contractors. How do you know which is the right option for your organization?

Hiring employees means you’ll have to handle Canada Pension Plan (CPP) contributions, EI premiums, and generate income tax forms as part of your payroll. Plus, most employers offer extended health benefits in addition to paid vacation time, statutory holidays, and other perks. Then there’s also overtime pay, sick days, and — if things go wrong — termination pay.

Hiring contractors, in contrast, allows you to hire people as needed without having to worry about those things. In today’s market, there are many people who want to work freelance, so it can work really well. 

But it’s not as simple as just hiring either an employee or a contractor! There are certain conditions that the Canada Revenue Agency (CRA) and Employment Standards consider when determining how someone is classified as either an employee or a contractor. 

Sometimes, needs and roles change as businesses grow. It’s possible to have contractors when you start a business, and then hire them as employees once you’re more established.

Misclassifying someone you hire is risky and can have significant consequences:

  • If you, as the employer, fail to deduct the CPP contributions or EI premiums for someone who the CRA determines is actually an employee, you will have to pay both the share as the employer and on behalf of the employee — as well as penalties and interest. This would include unpaid wages (along with CPP contributions and EI premiums), as well as vacation pay (including statutory holidays) and overtime pay if applicable.
  • There are other consequences if you misclassify a worker. There are also fines for misclassifying employment status and the Ministry of Labour posts the names of offenders on its website. Penalties could also include prosecution, particularly for employers who have done this repeatedly.
  • There’s also provision for reasonable notice of termination and termination pay if an employee misclassified as an independent contractor is let go.
  • In recent years, class-action litigation by workers who challenge that they are not contractors but actually employees has become more and more common. There have been precedent-setting cases where workers hired as contractors have been found to be, in fact, employees who are entitled to the benefits outlined in and protected by Employment Standards. Some employers have settled out of court, but at great financial cost.
  • The onus is on the employer to prove that a worker classified as an independent contractor is not an employee. The way the CRA determines employee versus contractor is helpful to consider, but adjudicators with Employment Standards can have a more broad and generous interpretation of an employee relationship.

Generally, the difference in employer-worker relationships is intent:

An employer-employee relationship is a contract of service. Employees work for employers.

An employer-contractor relationship is a contract for services (a business relationship). Contractors are in business for their own accounts — they are self-employed.

Here are some of the differences between employees and contractors:

Can be hired for fixed or indefinite termsAre hired to provide specific services
Are usually required/expected to work for employer exclusively (no “moonlighting”); can be asked to provide “other duties as required”Run their own business and can have multiple clients; hired for limited duration or scope of services
Are provided with office space/workplace area, tools, equipment, and even uniforms to do their jobProvide their own tools and equipment; work in their own space; might work on site during contract (but don’t have dedicated office space)
Must complete their own work/duties as directed by employer/manager/supervisor; employer has supervisory responsibility and could take disciplinary actionsControl how and when they work and could hire their own employees or subcontractors; can refuse a project or assignment; set their own hours and terms
Are paid a salary or hourly wages with the 
employer handling payroll deductions for taxes, CPP, IE, etc.
Determine the fee paid for their services; invoice client(s) for services rendered; and are responsible to pay their own taxes, etc.
Does not take on the financial risk of the business, the employer doesIs responsible for performance and profiting from services provided; establishes rate of compensation but could risk profit/renewal of contract if performance is poor or services not rendered satisfactorily

If you have someone working for you as an independent contractor but you now feel that worker should be classified as an employee, it is possible to transition them from contractor to employee. Some workers will ask to be hired as independent contractors, but remember the onus to prove employment status falls to the employer (and workers can complain to Employment Standards if/when they feel misclassified). 

It’s wise to seek advice from your Accounting Team about related CRA forms and obligations and to seek legal advice for employment contracts.

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