Canada: Is Your Contractor Really An Employee?

The issue of whether an individual is an employee or an independent contractor can have far-reaching effects on both the individual and the company for whom they provide services. However, companies often pay little attention to either the distinction between the two statuses or the possible effects of an incorrectly described relationship. Without giving much thought to the request, companies often agree to treat individuals as independent contractors at the request of the individuals who, for their part, are simply seeking to minimize their income taxes. Many do not realize that they cannot create and maintain an independent contractor relationship merely by calling it such in a written independent contractor agreement, withholding taxes or ensuring that the contractor is an incorporated entity. Rather, third parties such as Canada Revenue Agency (CRA), the Workplace Safety and Insurance Board (WSIB), the Ontario Minister of Labour (MOL) or the courts have the final say as to whether an individual is an employee or an independent contractor. More recently, in Ontario the Employment Standards Act, 2000 (ESA), now includes explicit criteria for individuals to satisfy in order to qualify as contractors as opposed to employees under the legislation.

The issue of whether an individual is an employee or an independent contractor has historically arisen most frequently in the Tax Court of Canada. This is because it is in the financial interests of the CRA for individuals to be employed by a company rather than to have an independent contractor relationship with that same company. Employees are subject to deductions from their pay for Employment Insurance (EI) and Canada Pension Plan (CPP) contributions. Independent contractors are not. Moreover, income tax deductions at source are not required, the calculation of income tax can differ between an employee and an independent contractor, and generally speaking, independent contractors are usually able to obtain better tax treatment than employees.

This insight explains the distinctions between employees and independent contractors and why it is important for companies to pay attention to those distinctions. As well, this insight overviews recent amendments to the ESA and also outlines the mid-ground category of "dependent contractors."

Consequences

A. Canada Revenue Agency

If a company has incorrectly treated an individual as an independent contractor, only to be told by CRA that the individual is deemed an employee, the financial consequences can include the requirement that the CRA be paid all outstanding EI and CPP contributions, with or without a fine. The change in designation will likely also affect income tax payments and may require additional amounts to be paid to CRA. Both employer and employee may be responsible for EI and CPP premiums, while the employee is ultimately responsible for additional taxes; however CRA may look to the employer for repayment of any required amounts, in which case the employer will then have to chase the employee for any required reimbursement.

B. Workplace safety and insurance

The WSIB and the Workplace Safety and Insurance Appeals Tribunal also apply similar legal tests in respect of premiums that must be paid by most Schedule "A" employers for workplace insurance for their employees. Where it is determined by the WSIB that independent operators are really employees under the Ontario Workplace Safety and Insurance Act (WSIA), it can render a company to be in breach of the WSIA for not remitting premiums for these workers. Breaches under the WSIA can lead to:

1. Investigation by the WSIB;
2. The charging of the outstanding amount due on the company's premiums, together with interest; and
3. A guilty finding in respect of a provincial offence and the levying of fines, under which directors and officers of a company can be fined up to CA$25,000 and companies can be fined up to CA$500,000.

C. Ontario Employment Standards Act, 2000

Similar tests are also applied when distinguishing an employee from an independent contractor for the purposes of looking at employee entitlements under the ESA. An individual who is deemed to be an independent contractor is ineligible for certain ESA benefits such as overtime pay, pregnancy and parental leave, vacation pay, statutory notice and, where applicable, statutory severance upon termination. The problem from the perspective of a company is that if an individual is a deemed employee but has not been provided with any of these statutory rights, the employer will be in breach of the ESA. The consequences of a breach of the ESA run the gamut from an order that the employee be compensated to a significant fine to imprisonment. Additionally, corporate directors can be found personally liable under the ESA for things such as unpaid vacation pay and unpaid overtime wages. Further, a failure to provide pregnancy or parental leave where required under the ESA can lead to a complaint of discrimination under the ESA or the Human Rights Code. Finally, employers are required to provide terminated employees with a Record of Employment within five days of termination, in order that the employee can apply for EI benefits from Service Canada.

D. Wrongful dismissal claims at common law

The distinction between employees and independent contractors can also arise upon a termination of the relationship by the company. Assume, for a moment, that you work for a company in the technology industry that has hired an individual as an independent contractor. Your company is diligent about properly documenting contractual relationships and accordingly, you have provided your contractor with a written independent contractor agreement. You want to ensure that the agreement looks like an independent contractor agreement rather than an employment agreement because you know that the terms of the agreement are one of the things that the courts take into account when determining whether someone is a contractor or an employee. Therefore, among other things, the agreement states that either party may terminate the agreement on 10 days' notice. This type of termination clause is one that is often found in independent contractor agreements. However, this sort of termination clause would not be found in a well-drafted employment agreement. Rather, an employment agreement in the technology industry might provide for minimum statutory notice and severance to be paid on termination pursuant to the provisions of the ESA, or amounts in excess of those minimums.

Now, let's assume that your company no longer requires the services of your independent contractor and you decide to terminate them six years after hire. You provide the 10 days' notice set out in the agreement. However, your contractor believes that for all intents and purposes they are really an employee, and they decide to commence a legal claim for wrongful dismissal. At trial, the judge looks not only at the terms and conditions of the written agreement but the way in which the individual was treated by the company, and determines that the individual was really an employee rather than a contractor. The notice that you provided, 10 days, does not equal the statutory minimum requirement of six weeks under the ESA. Moreover, your company may have had an obligation to pay statutory severance, which in this case would be a further six weeks. Because none of this has been provided for and is not even contemplated under the agreement, the court disregards the agreement and instead awards damages under the common law, which in this case equals several months of pay in lieu of notice. This is clearly not what either party contemplated when the arrangement was entered into but unfortunately, your company is left having to pay the price.

What to do?

Given the possible negative effects on a company when an employee is incorrectly described as an independent contractor, it is important that companies take a close look at those relationships when they are first entered into. There is a well-known saying: "If it walks like a duck and talks like a duck, it probably is a duck." This is likewise for employees. If, after looking at the individual who is going to enter into an independent contractor agreement, you come to the conclusion that they will appear to be in an employment relationship with your company, then they are likely an employee and no amount of contractual drafting is likely to remedy the situation. So what do the courts look at when determining whether an individual is an employee or an independent contractor and how can your company structure the relationship in order to assist in making it appear more firmly one way or the other?

How to Distinguish a Contractor from an Employee – Information Technology and Business Consultants under the ESA

Effective January 1, 2023, amendments to the ESA were introduced which provide that it will no longer apply to "business consultants" and "information technology consultants" when certain requirements are met. In other words, there are now explicit requirements which business and information technology consultants must satisfy in order to be considered contractors who fall outside of the purview of the ESA. If an individual purporting to be a contractor or consultant does not meet these requirements, at least for the purposes of the ESA, they will be found to be an employee.

Specifically, the ESA provides that if a person: (1) meets the definition of a "business consultant" or "information technology consultant" in the ESA; (2) provides services through a personal service corporation or a sole proprietorship as opposed to in their own name; and (3) receives a fee of CA$60/hour or greater, they will not be considered an employee within the purview of the ESA. In addition, there must be an agreement between the consultant and the company which sets out when the consultant will be paid and the amount the consultant will be paid (which, as stated above, must be equal to or greater than CA$60 per hour). Absent the satisfaction of all of those requirements, those individuals will be deemed employees as opposed to independent contractors.

The ESA defines "business consultant" as someone who provides advice or services to a business or organization on its performance, including advice or services in respect of operations, profitability, management, structure, processes, finances, accounting, procurements, human resources, environmental impacts, marketing, risk management, compliance or strategy of the business or organization. Similarly, "information technology consultant" is defined as someone who provides advice or services to a business or organization on its information technology systems, including planning, designing, analyzing, documenting, configuring, developing, testing and installing.

Even when a person satisfies these requirements and can be deemed a consultant under the ESA, the true nature of the relationship between the individual and the company may still be separately scrutinized by CRA or the courts to determine whether the relationship appears to be more like an employment relationship.

How to distinguish a contractor from an employee – The nature of the relationship

The Tax Court of Canada previously applied one or more of four tests in order to distinguish an employee from an independent contractor. Those tests have generally also been followed by the courts in deciding whether an individual is an employee or an independent contractor to determine notice entitlement with respect to a wrongful dismissal claim, and in deciding whether an individual is an employee or an independent contractor under both the WSIA and the ESA. The first test is the "control test," where the court looks at the degree of control exercised by the company over both the individual and the work to be performed. The second test is the "integration test," where the court looks at the degree to which the individual performing the work is an integral part of the company's business. The third test is the "economic reality test," where the court looks at:

1. The degree of control exercised by the company;
2. Whether the company or the individual owns the "tools" used by the individual;
3. Whether the individual has a chance to make a profit from the relationship; and
4. Whether the individual likewise has the chance to end up in a loss position from the relationship.

Finally, the fourth test is the "specified rule test," which asks whether the services performed by the individual are for a specified result.

The Supreme Court of Canada has since moved away from following one or more of these four strict tests. In the 2001 case of 671122 Ontario Ltd. v. Sagaz Industries Canada Inc. (Sagaz), which remains the standard-bearer for determinations of this issue, the court enunciated the test for distinguishing between an employee and an independent contractor as follows:

The test in Sagaz contains elements of the control test and the economic reality test, but not the integration test or the specified rule test. Moreover, it makes it clear that the test is free flowing, and likely to be greatly impacted by the particular facts of each case. What then, are some of the "facts" that the courts will look at in order to determine whether an individual is an employee or an independent contractor?

The court will often look to the written agreement between the parties as a starting point, because it may give some guidance as to the intention of the parties in framing their relationship. However, a written agreement is not determinative. If an individual with an independent contractor agreement is treated like an employee in most respects, the court is likely to find that they are an employee. Likewise, if an individual with an employment agreement is treated like an independent contractor in most respects, the court is likely to find that they are an independent contractor. What if the individual has incorporated as a company through which they perform services? Or what if the individual or their company has a GST number? If an individual appears to be an independent contractor for a number of reasons, this will be helpful in convincing the court as to the proper relationship between the parties. Once again however, these reasons are not determinative.

In addition to the explicit statutory requirements under the ESA for business and information technology consultants, the following is a non-comprehensive list of factors that the courts may look at when determining the status of the individual providing services to your company. It goes without saying that the more you are able to craft the relationship to meet the definition that you want, the more likely you are to get a court to agree with you if the relationship is ever called into question. Among the factors that the courts may look at are the following:

1. Statutory deductions – if you take statutory deductions from the pay of your service provider, the courts will make the finding that you intended them to be an employee.
2. Hours of work – if you want the individual to be classified as a contractor, you should not monitor their hours of work.
3. Exclusivity arrangements – if you want the individual to be classified as a contractor, you should not require them to enter into an exclusivity arrangement whereby they are not permitted to work for any other company or entity at the same time that they are providing services to your company.
4. Profit or loss – if you want your service provider to be a contractor, your arrangement with them should permit them to take the risk of profit or loss. In other words, if the contractor performs their work ahead of time and/or ahead of budget, they will be able to make a greater profit than if the work was merely performed on time and on budget. Likewise, if they perform their work behind time and/or behind budget, they will take a loss on the project. One way to ensure that your contractor assumes the risk of profit and loss, is to structure a commission arrangement. Another way is to agree to a fixed price for each portion of work to be delivered by your contractor.
5. Termination of the agreement – as discussed above, employees whose employment is being terminated in Ontario are entitled, at a minimum, to notice or pay in lieu of notice (and sometimes also statutory severance) in accordance with the ESA. Contractors do not have those entitlements and generally speaking, a contractor should have the same right to terminate their agreement with the company as does the company. In other words, the notice period for termination by either the contractor or the company should be the same, and none of the notice requirements that flow to employees under statute or common law should be extended to the contractor.
6. Job-site location – wherever possible, an individual who wishes to be treated as a contractor should work off-site. The exception will occur when it is absolutely necessary for the contractor to attend the site to perform tasks relating to the services purchased. Likewise, if a contractor needs to work out of the company's office, a service fee or rent should be charged to them for that office space.
7. Terms of service – whereas an employee will generally be given a job title and a vague framework of tasks and/or services to perform in relation to that job title, a contract for services should refer to the specific tasks or services to be provided.
8. Job titles – contractors are not employees and should not be given job titles within the company, nor should they be made an officer or director of the company. Generally speaking, contractors should not have business cards which identify them with your company. In addition, we sometimes see a member of the corporate executive team working under a contractor agreement. The higher an individual is within the corporate hierarchy, the more likely that they will be found to be an employee.
9. Integration – contractors work for themselves and generally have the freedom to perform services for more than one company or entity at a time. Therefore, contractors should not be made to integrate into the company through mandatory attendance at company social functions (e.g., holiday parties) or company meetings (unless those meetings relate specifically to the services which the contractor is performing). In a 2002 Tax Court of Canada decision², one of the factors which the court looked at in determining that a bicycle courier was a contractor, was the fact that the bicycle couriers had a different Christmas party than the office staff, and the couriers paid their way at their party unlike the office staff who did not have to pay.
10. Benefits – do not treat your contractors as you would your employees. Just because your employees may receive health, dental or other benefits does not mean that those benefits should be extended to your contractors. If your contractors desire the same benefits, they should be arranging for them and paying for them on their own. Likewise, vacation should not be provided to independent contractors.
11. Tools – contractors generally own and use their own tools, whether they be large items such as cars, computers or machinery, or smaller items such as stationary and supplies. Likewise, contractors are generally responsible for the maintenance, insurance and upkeep of those tools. If you require a contractor to use company tools in order to perform a specified task, consider a service fee or rental arrangement.
12. Authority – a contractor does not represent your company. Therefore, do not give them the ability to bind the company by signing contracts or cheques on the company's behalf.
13. Length of agreement – generally speaking, an employment arrangement will be for an indefinite period of time. If you are preparing an agreement for a contractor, try to narrow the length of the agreement to the specified time period or specified task for which you will require their services. While it is possible to permit for extensions of the agreement, remember that an independent contractor agreement that is perpetually extended will begin to resemble an agreement for an indefinite period of time and may ultimately be taken to indicate that the relationship between the parties has transformed from a contractor relationship to an employment relationship.
14. Business expenses – contractors' business expenses should be built into the fee for services to be performed and accordingly, should not be separately reimbursed in the same fashion that the business expenses of employees would ordinarily be reimbursed.
15. Insurance – contractors should be responsible for their own insurance coverage, including WSIA premiums and liability insurance. Subject to a specific exception under the WSIA which permits companies to extend coverage to contractors, companies should not do so.
16. Incorporation – wherever possible, have your independent contractor incorporate as a separate company and obtain separate Harmonized Sales Tax (or equivalent) registration. In addition, as noted earlier, contractors who intend to work as business consultants or information technology consultants must provide their services through a corporation or sole proprietorship with a business name registered under the Business Names Act, failing which they will be considered employees for ESA purposes.

Other legal developments – Dependent contractors

Not only are companies required to consider all of the foregoing when engaging workers, but there are a number of cases which have muddied the waters in this area even further. A third category of "dependent contractors" also exists in Canada. Put simply, a "dependent contractor" is an individual found to be a contractor but who is economically dependent on the company to which they provide services. As such, due to the contractor's reliance and economic dependence on the company, they are entitled to reasonable notice upon termination, as if they were an employee.

The Ontario Court of Appeal decision in McKee v. Reid's Heritage Homes Ltd³ (McKee) is one of the seminal decisions in Ontario confirming the existence of this intermediate category of "dependent contractors" in Ontario. In establishing such a category, the Court articulated a two-part test to employ when determining whether a worker is a dependent contractor:

1. First, determine whether the worker is an employee or a contractor (in accordance with the Sagaz analysis overviewed above); and
2. If the worker is not an employee, determine whether there is nevertheless near or complete exclusivity, and whether there has been a level of economic dependency on one customer.

More specifically, the Court said:

Therefore a contractor is dependent if two factors exist: (i) near or complete exclusivity; and (ii) a level of economic dependency.

Since the decision in McKee, other decisions have continued to shape the confines of the dependent contractor status. For example, in Keenan v. Canac Kitchens Ltd,⁴ the Ontario Court of Appeal held that a worker's exclusivity cannot be established by looking at a "snapshot" of their working history. Rather, one must consider the full history of the relationship between a worker and company and determine whether this full history demonstrates economic dependence nearing complete or near complete exclusivity. To put this principal into context, this case involved a married couple that worked exclusively for Canac Kitchens for approximately 25 and 30 years, respectively, until 2007, at which point they also worked for another company for two years until 2009. In 2009, Canac Kitchens was closing its operations and terminated their agreements with the plaintiffs without notice. Canac Kitchens attempted to cling onto the final two years of the plaintiffs' working relationship to demonstrate an independent contractor status. The court disagreed with this approach and held that the entire history of the working relationship demonstrated economic dependence and near or complete exclusivity. The court added that even when one considered the final two years in which the plaintiffs worked for another company, the work for they did for Canac Kitchens during that time still constituted a substantial majority of their work.

Most recently, in Thurston v. Ontario (Children's Lawyer),⁵ the Ontario Court of Appeal held that in order for a contractor to be considered dependent, that specific working arrangement must account for "substantially more than a majority" of the contractor's income.

What then does all of this mean for companies? As stated, dependent contractors have rights at termination akin to that of employees, and thus dependent contractors are entitled to common law reasonable notice upon termination. Accordingly, it is essential to take the time to carefully consider the nature of the relationship between a company and the person that the company is contracting with. If the assessment leads to the conclusion that the person fits or may fit the definition of dependent contractor, then it's best to insist on an employment relationship and employment agreement instead.

Conclusion

This is an area of the law which continues to develop over time. In the meantime, employers should take care to ensure careful drafting of independent contractor agreements and to ensure that the treatment of those individuals in the workplace mirrors the intent of the parties, the case-law and the legislation.

Footnotes

1. 671122 Ontario Ltd. v. Sagaz Industries Canada Inc., [2001] 2 S.C.R. 983 (S.C.C.)

2. Velocity Express Canada Ltd. v The Minister of National Revenue and Stephane Boileau, [2002] Docket Nos. 2001-2427(EI), 2001-3220 (EI), 2001-2428 (CPP), 2001-3221 (CPP) (Tax Court of Canada).

3. 2009 ONCA 916.

4. 2016 ONCA 79.

5. 2019 ONCA 640.

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