top of page

Contractor vs Employee: What Are the Tax Implications For My Business?

Updated: Jun 13





When you're ready to start expanding your team and hiring new people, you may encounter two different terms bouncing around: contractor vs. employee. While both are a form of worker that can support your business, the two terms have different meanings, tax implications, and legal implications. In this blog, we will delve into the definitions and distinctions between contractors and employees, explore the key differences for businesses employing contractors and employees, and provide strategies for effectively managing both types of employment status.


Key Highlights


  • Contractors work independently, set their own wage and schedule, and are compensated per project or at an agreed-upon rate. Contractors have more control and independence in their work arrangements.

  • Employees work for a company, receive regular paychecks, and have employer-dictated schedules.

  • Employers have legal and tax obligations for both contractors and employees, and misclassifying either one can result in penalties and legal consequences. The CRA provides information on how to tell the difference, even if there is no contract or an unclear agreement.


Understanding the Basics of Contractor And Employee Designations


Before delving into the tax implications, it is important to understand the basics of contractor and employee designations. What exactly does each term mean?


Definition of a Contractor


A contractor, also known as a contract worker, independent contractor, or freelancer, is an individual who is self-employed and works independently. Contractors generally do not have a boss to report to or be supervised by. They have the freedom to accept or decline work and typically have their own tools and equipment to perform their services. Contractors often work on a project basis and can work for multiple companies simultaneously, setting their own hours.


Definition of an Employee


On the other hand, employees work for a company and are under the direction and control of the employer. They receive recurring paychecks and often have benefits such as employment insurance, health, dental, and vision care. Employees typically have a set hourly wage or salary and may be entitled to overtime pay for working beyond regular working hours.


What's The Difference For The Employer?


For the worker, there are different pros and cons to both employee and contractor designations. But for the business employing them, there are also considerations and obligations to be evaluated before making a decision.


Let's dive into the differences on the employer's side of the relationship, and zoom in on the potential tax implications for your business.


Comparing Legal and Tax Obligations


Both contractors and employees have legal and tax obligations that businesses need to be aware of. The basic considerations include:


Payroll and Deductions


  • Employees: Employers must issue T4 slips to their employees, and are responsible to deduct income tax, CPP contributions, and EI premiums. They must remit these payments to the CRA accordingly.

  • Contractors: Businesses must issue T4A slips to contractors, reporting the amounts paid to them. However, unlike employees, businesses are not required to withhold income tax, CPP contributions, or EI premiums from contractors' payments.


Benefits


  • Employees: Employers may provide additional benefits to employees, such as health insurance, dental coverage, retirement plans, and paid time off.

  • Contractors: Benefits are typically not provided to contractors.


Control and Independence in Work Arrangements


The degree of control and independence is an important factor in determining whether a worker is a contractor or an employee. Contractors have a higher level of control and independence in their work arrangements. They have the freedom to choose their own projects, set their own schedule, and decide how tasks are to be completed. Contractors are not subject to the same level of direction and control as employees.


In contrast, employees have less control over their work arrangements. They are typically assigned specific projects or tasks by their employer and must adhere to the company's policies, procedures, and schedule. Employees may also be subject to supervision and performance evaluations by their employer. The level of control and independence in work arrangements can vary depending on the specific circumstances and the nature of the work relationship.


Depending on your needs as an employer, you may need more or less control and oversight over a specific project. This would be a key consideration when deciding between a contractor vs. employee.


Deciding Who To Hire: Contractor Vs Employee


Now that you understand the difference between contractors and employees, you may be wondering which type of worker is more beneficial for your business.


Contractors are generally cheaper to hire, since you will not have to pay for Canada Pension Plan contributions, Employment Insurance, Vacation, Overtime, or Severance Pay. Due to this, there is also less paperwork involved.


Employees may be slightly more expensive and time consuming to hire, but they may be a better fit for long-term work arrangements. Hiring employees also allows you to develop team loyalty, retain top talent, and provide more specific work rules and instructions.


Conclusion


In conclusion, the tax implications for hiring a contractor vs. an employee mainly comes down to your long-term goals. In the short-term, contractors are cheaper. But in the long-term, employees may offer valuable benefits to your company culture that go beyond the bottom line. Evaluating the need of the specific position or project you are hiring for is crucial to make the right decision.

No matter what choice you make, be sure that the designation is clear between you and the worker. Utilize clear language and written agreements to avoid misclassifying an employee as a contractor or vice versa. Not only will this help you avoid penalties from the CRA, it will also set your business relationship up for success!



Frequently Asked Questions


What Are the CRA Penalties for Misclassifying Employees as Contractors?


Misclassifying employees as contractors can have severe consequences. The penalties for misclassification can include fines, back payments of payroll taxes, and legal liabilities. Businesses may also face audits and investigations by the Canada Revenue Agency (CRA) and potential claims under employment standards legislation.


Is It Better To Be An Employee Or Contractor In Canada?


Both arrangements have their pros and cons for both the employer and the worker. Contractors have more freedom and flexibility, while employees have increased job security and stability. The best option depends on your overall career goals and intentions.


Can A Sole Proprietor Hire Employees In Canada?


Yes, a sole proprietor in Canada can hire employees. As a sole proprietor, you have the option to hire both contractors and employees depending on your business needs. 



Comments


bottom of page