Employee or independent contractor? The tax benefits of being an independent contractor are great, but make sure your position as an independent is well defined.

The changing nature of the workplace has opened up a lot of opportunities for more flexible employment arrangements. Given the chance, many people become independent contractors, selling their services to the highest bidder. Whether you are an employer or an independent contractor in such an arrangement, you have to make sure that the relationship is clear, so that the tax benefits of such an arrangement can be reaped. If you don't, it could mean a world of trouble.

From a tax perspective, the difference between an employee and an independent contractor is the number of deductions a person can claim, and payroll deductions for income tax, CPP and El (among a host of other considerations). Employees are severely restricted in the types of expenditures that they are entitled to deduct from employment income. Independent contractors, on the other hand, are generally entitled to deduct all reasonable business expenses, although numerous exceptions to the general rule do exist.

Employers are required to deduct and remit amounts for income tax, CPP and El. For CPP and El the employer also has to remit an employer premium. For businesses, this makes hiring an independent contractor rather more appealing.

How does one define an independent contractor? A number of cases have tackled this issue. In 671122 Ontario Ltd. v. Sagaz Industries Canada Inc. ("Sagaz") Mr. Justice Major of the Supreme Court of Canada stated: "The central question is whether the person who has been engaged to perform the services is performing them as a person in business on his own account." In making this determination, the Court noted that control is always a factor. But other factors to consider include:

1. Whether the worker provides his or her own equipment;

2. Whether the worker hires his or her own helpers;

3. The degree of financial risk taken by the worker;

4. The degree of responsibility for investment and management held by the worker; and

5. The worker's opportunity for profit in the performance of his or her tasks.

The Court went on to note that the above factors did not constitute an exhaustive list and that the relative weight given to each factor will depend on the particular facts and circumstances of the case.

Following the Sagaz, decision, a number of lower courts have had occasion to consider the employee versus independent contractor issue. Although the Sagaz. decision is still fundamentally important, an interesting trend has arisen which appears to have its origin in the Tax Court decision of Sara Consulting & Promotions Inc. v. MNR. In that case, Judge Bell stated that, "in the absence of clear and credible evidence that the description of a relationship is other than as agreed between arm's length parties, the description agreed upon by those parties must stand." So if parties say that it's an arm's-length arrangement, it should be considered as such.

In TSS-Technical Service Solutions Inc. v. MNR, Judge Teskey of the Tax Court noted that "a valid arrangement between arm's length parties should not be denied a tax or other advantage unless it is either a sham or the target of clear and unequivocal statutory language." In that ease, there was evidence that the parties intended the relationship to be that of an independent contractor and the Crown didn't argue that the characterization was a sham.

But the issue isn't always so clear-cut. The Federal Court of Appeal, for instance, joined the employee versus independent contractor debate in Wolf v. Canada. Although the three judges sitting for the Court concurred in the result, each provided separate reasons for judgement. Judge Desjardins considered the taxpayer's argument that, absent a scam, window-dressing or other such circumstances, his status is governed by his contract, which describes him as an independent contractor. Judge Desjardins rejected this argument by saying that the terms of the contract will only be given weight if they properly reflect the relationship between the parties. Judge Decary suggested that the final analysis involves looking into the terms of the relevant agreements and circumstances to find the true contractual reality of the parties.

But Judge Decary went on to say that courts, in their propensity to create artificial legal categories, have sometimes overlooked the very element that is the essence of a contractual relationship--the intention of the parties. "When a contract is genuinely entered into as [an independent contractor] and is performed as such, the common intention of the parties is clear and that should be the end of the search."

Judge Noel concluded the debate by saying that, when the facts suggest an employee /employer--independent contractor relationship in equal measure, the parties' contractual intent can't be disregarded.

Judge Porter probably best summarized the current state of the law when he said:

   [A] considerable degree of latitude seems now to have been allowed
   to creep into the jurisprudence enabling consultants to be engaged
   in a manner in which they are not deemed to be employees as they
   might formerly have been.

   Thus it seems to this Court that the pendulum has started to
   swing, so as to enable parties to govern their affairs more easily
   in relation to consulting work and so that they may more readily be
   able to categorize themselves, without interference by the Courts
   or the Minister, as independent contractors rather than employees
   working under contracts of service.

Although the recent trend in case law has been helpful by potentially providing greater flexibility to structure one's affairs in a tax-efficient manner, the determination is, and continues to be, necessarily uncertain. The consequences of being wrong after the fact can be costly as penalties, interest, CPP and El premiums may all need to be paid. Having a carefully crafted written agreement setting out the intentions of the parties may offer some protection if one of the parties subsequently changes his or her mind and argues that the relationship is not what it was purported to be. However, categorizing oneself as an employee or independent contractor is not simply a matter of inserting the proper clause in an agreement. All of the facts and circumstances must be considered in making that determination.

Anthony Strawson, CMA, LLB, BComm.

Although believed to be correct at the time of writing, this is an area in a continuous state of flux. The information contained herein is not a Legal opinion and should not be relied upon. Consult your professional advisor.

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