In Canada, there are no hard and fast rules in the Tax Act that help an individual determine whether they are an employee or an independent contractor. There are three tests, which have evolved through court decisions, that are used to assess the relationship between an individual and his/her employer. They are:
- Economic reality or entrepreneur test
- Specific result test
- Organization or integration test
Why is this important? Well, if you’re a contractor, or self-employed, you can deduct any reasonable expense incurred to earn income. There is a distinction in the Tax Act between the type of income earned depending on whether you’re self-employed or not. If you’re self-employed, you earn business income as a sole proprietor. If you’re employed, you (of course) earn employment income and are restricted in the types of expenses you can deduct for tax purposes.
An employer is also required to withhold income tax, Canada Pension Plan contributions and Employment Insurance premiums from their employees’ pay. If you’re a contractor you’re likely required by the CRA to make tax installments since no one is withholding for you your contribution to the treasury on a regular basis. (The issue of installments will be covered in a future blog post.)
But back to the tests.
Economic reality or entrepreneur test
There are three aspects to this test: control, tool ownership, chance of profit/risk of loss. If someone is not only telling you what to do but how to do it, they have control over the work and a strong case is made that they are your employer. If you own the tools you need to do the job and they are not provided to you, this points to the likelihood that you are independent. Finally, if you are profiting from the work and bearing the risk of loss due to cost overruns, it is even more likely you are a contractor.
Specific result test
If there is a defined piece of work you’ve hired to do and you’ve been given the freedom to accomplish it however you see fit, the employer-employee relationship likely does not exist. As an employee you’re typically hired to perform tasks with no specific result and on an ongoing basis. If there is a defined beginning and end to the work required, that’s a pretty good indicator you’re self-employed.
Organization or integration test
This test concerns itself with the dependence of the individual on the organization. If benefits ordinarily conferred on employees are available to the individual, then from the outside (i.e. the CRA) it appears the individual is an employee. In certain cases the proportion of an individual’s total income which comes from a single organization has been taken into consideration as well, although personally I don’t think this is particularly convincing metric.
To sum up: There is no specific section of the Act that lays out all the rules to help a taxpayer determine if he/she can deduct expenses from their income. The law has evolved through court decisions and they have been based on the above three tests, which should all be taken into consideration along with the specific facts of the situation.
As with any general tax discussion, your personal situation is unique and could require the expertise of a Chartered Accountant. If you need a CA, please contact me and I will be happy to help you find one in your area!