Contracts and Self-Employment: A Workforce Perspective
by Leanne
E. Standryk
A. Introduction
The new economy has forced employers and employees alike to rethink the way
in which they conduct business. Traditionally, organizations have maintained
a set work force with a prescribed number of employees on a continuous basis
to complete required work. However, increasingly, the workplace has become less
"product" oriented, and more "project" oriented. Employers may not need a permanent
work force.
Employers are more than ever seeking to obtain the services of individuals
in a capacity other than as "employee" to reduce the costs associated with having
a permanent work force. To answer this call, individuals are often willing to
provide their services as an independent contractor. What does this shift mean
and how do the legal rights differ that govern each relationship?
B. The Employer/Employee Relationship and the Employment Contract
Every Canadian employer has an employment contract with each of its employees.
An employment contract is formed when an individual agrees to provide services
to another party in exchange for remuneration.
An employee typically enters into a contract of service with an employer.
Although the contract is almost always for an indefinite term, the parties may
also contract for a "fixed" or "definite term". If the parties do not specifically
agree to a fixed term, it is generally assumed that employment will continue
as long as the relationship is satisfactory, and will not end until either party
gives reasonable notice in accordance with the applicable laws.
Parties may agree to employment for a fixed or definite term contract. A contract
that sets out a fixed term and does not contain a mutual option to renew for
an extended period expires at the end of the specified term. Under a fixed term
contract, the employer is responsible for the same statutory deductions and
benefits that apply to the indefinite or long term employer/employee relationship.
The substantial difference between the fixed termed contract and the definite
term contract is that an individual hired under the terms of a fixed term contract
cannot be dismissed before the end of their contractual term without cause.
If they are dismissed without cause, they are entitled to damages for the entire
unexpired portion of the term.
C. Elements of the Employer/Employee Relationship
Regardless of the type of contract agreed to, the elements characteristic
of the employer/employee relationship are consistent. The following four factors
often indicate that an employment relationship and therefore a contract of employment
exists:
- the employer has the authority to select an individual for employment;
- the employer has the ability to determine the payment of wages or other
remuneration;
- the employer has the right to control the employee with respect to the type,
manner and timing of work; and
- the employer has the right to suspend or discipline the employee.
The employee generally agrees to perform whatever tasks the employer needs
to have carried out. Subject to any express terms in the contract of service,
employees cannot be dismissed from their positions without receiving reasonable
notice or pay in lieu of notice unless employers have legal cause to terminate
their employment.
Finally, certain obligations are owed to employers by all employees. These
include obligations of confidentiality, good faith and loyalty.
The primary benefit to the employee arising from the employment contract is
the protection provided by minimum standards or statutory rights and obligations
imposed by law through employment standards legislation (ie. CPP and EI).
D. Self Employed Independent Contractors
Self employment is a term used to describe those people who are in business
for themselves. Most often, self employed individuals earn a living by following
their own trade, business or profession. These individuals are commonly referred
to as an independent contractor, consultant, or entrepreneur.
In contrast with the employer/employee contract of service, the independent
contractor or self employed individual enters into a contract for services.
The contract is almost always for a definite period of time and the duties owed
by the independent contractor are limited in nature. Subject to the particular
contract, independent contractors generally owe no obligations of confidentiality
or loyalty to those individuals receiving the services save and except a general
duty of good faith.
E. Advantages and Disadvantages - Self-Employment and Independent Contractor
Status
Hiring Firm/Company Advantages - For a company, there are a number of benefits
and reasons for retaining an self employed independent contractor. The company
is not compelled to make the employer's contributions to CPP and EI and, it
is unlikely that the company will provide group benefits and statutory entitlements
such as vacation pay, overtime pay and notice/severance pay. This results in
a financial saving to the company in terms of personnel and administrative time.
Hiring the self employed independent contractor also allows the company the
opportunity to maintain a more flexible workforce. It provides the Employer
with the opportunity to hire a highly specialized staff for short term projects.
However, these individuals often come at a high price as the hourly fees are
often much greater than that for the company's regular full-time employees.
The company will owe no notice or severance obligations to the individual
pursuant to employment standards legislation and, may terminate the relationship
without cause or reasonable notice, subject to the specific terms of the agreement
between the parties.
Advantages to the Self Employed Independent Contractor - The self employed
independent contractor has the freedom to decide whom to work for, when to work
and how to work. The most attractive ingredient is increased freedom to contract
with all the risks and rewards. Generally speaking, the self employed independent
contractor is free to contract with other entities during the course of their
contract. They generally set their own hours of work and their work is not closely
monitored by the employer.
Statistically, the self-employed independent contractor is usually paid 20%
- 40% more per hour than employees performing the same work. This is in part
due to the fact that the hiring party receives considerable savings by foregoing
contributions to unemployment and worker safety insurances, health benefits
as well as other mandatory tax deductions for the common employee. The self-employed
independent contractor must pay for these things out of pocket and therefore
needs to be paid more than employees to enable themselves to do so.
There are no salary tax deductions. This means the self employed individual
can hold on to money longer without having to turn it over to Revenue Canada.
This can result in improved cash flow.
A self employed independent contractor is entitled to business related tax
deductions. All deductions must be viewed as reasonable in amount and must be
an expense ordinarily incurred by the specific business being carried on. Common
tax deductions include: office rent, travel, entertainment and meal expenses,
marketing and promotional expenses and, equipment and insurance costs. In comparison,
an employee's work-related deductions are severely limited.
Hiring Firm/Company Disadvantages - The company will not have as much control
over an self employed independent contractor and this may be perceived as a
disadvantage to the company in certain situations. The company does not have
the right to closely monitor the work or discipline the worker. In addition,
the independent contractor does not owe the company any fiduciary responsibilities
and company will not have the right to restrict the independent contractor's
ability to work for competitors.
Disadvantages to Self Employed Independent Contractor Status - There is little
job security. Ingrained in the employer/employee relationship is the assurance
that the employee is paid as long as employed, even if the employer's business
is slow. A self employed independent contractor must market and promote his/her
business and generate the work to earn a living.
The independent contractor will not qualify for benefits and will not benefit
from any statutory rights such as overtime, vacation and notice or severance
pay. The independent contractor is also not eligible for employment insurance
benefits should the need ever arise.
Finally, the independent contractor bears the risk of loss. Generally speaking,
the independent contractor is personally responsible for all debts and liabilities
that arise during the course of business.
F. Legal Formalities Involved in Establishing Self Employment and Independent
Contractor Status
In some instances it may be necessary for the self employed independent contractor
to obtain a license to carry on business. The license may have to be obtained
from a municipality, the province of Ontario or from the Government of Canada.
Generally speaking Municipal licenses may be required by electricians, plumbers,
restaurants, tax cabs etc. An example of those activities requiring registration
or a license under provincial law include employment agencies, motor vehicle
dealers and real estate brokers.
Municipalities also have the legal right to establish rules about what types
of activities can be carried out in particular areas. This is done pursuant
to particular zoning by-laws such as residential, commercial and industrial
designations. Generally speaking, the municipality will permit an individual
to carry on a small business within their residence so long as any home containing
a business is used primarily as a residence and the business does not negatively
interfere with the neighbors right to privately use and quietly enjoy their
own property.
Business name registration - If a self employed independent contractor decides
to carry on business under a name or style other than his or her own name that
name must be registered and filed with the Ministry of Consumer and Commercial
Relations. Registration is generally for a period of five years and may be renewed.
An amended registration is required to be filed whenever any change takes place
in the information set out in a registration.
G. Determining Independent Contractor and Employee Status
The characterization of an individual as a self employed independent contract
or an employee has various implications in terms of Income Tax liability; Canada
Pension Plan and Unemployment Insurance eligibility; and individual protections
pursuant to Employment Standards Legislation.
Although there a several tests that may be used to characterize the relationship
as one of either employer/employee or self employed independent contractor,
Revenue Canada and the Courts often use the Four Fold Test. The commonality
between the tests is that each analyzes the substance of the relationship between
the parties. The Four Fold Test consists of the following analysis;
- the extent to which the company controls the performance of the individual's
services;
- whether the individual owns the tools and equipment used in rendering the
services;
- whether the individual has a chance at profit; and
- whether the individual has a risk of loss.
With this test, as with others, the factors must be viewed in the context
of the whole of the various elements constituting the relationship. Generally
speaking, the mere fact that a person provides his or her own tools and equipment
does not make him/her a self employed independent contractor; the more the person
is attached to and under the control of the employer, the more likely that he
or she will be characterized as an employee.
H. Liabilities Arising form a Determination of Employee vs. Independent
Contractor
Regardless of what the parties intended at the time that they entered into
an agreement, if it is found that the relationship can be characterized as an
employer/employee relationship as opposed to that of a self employed independent
contractor, there can be considerable consequences to the hiring company. Various
pieces of legislation including the Labour Relations Act, the Unemployment Insurance
Act, Canada Pension Plan Act, Employment Standards Act, Workers' Compensation
Act, Income Tax Act, and Employer Health Tax Act make provision for the consequences
and penalties to be applied where an employer has failed to meet its obligations.
Generally speaking, Revenue Canada will assess the company for unpaid Canada
Pension Plan contributions and Employment Insurance premiums - both the employer's
and the employee's shares, as well as income tax which should have been withheld
going back up to 6 years, plus interest, plus penalities up to 20% of the amount
that should have been withheld and remitted.
Practically speaking, for the individual worker, this situation may give rise
to termination of employment because the company does not want to pay the additional
expenses involved in the employer/employee relationship.
I. The Written Contract
Should a self employed independent contract use a written agreement? As always,
a signed agreement between the parties may be of assistance in making the determination
as between "contract employee" and "self employed independent contractor". However,
an agreement or contract in writing that defines the relationship is not determinative.
Each administrative tribunal and court will apply its own criteria or tests
to make the determination based on all the available facts.
J. Conclusion
The increased need for a more flexible workforce has caused many employee
terminations and/or layoffs. This has forced many individuals to review seek
alternatives to the traditional means of earning a living. As this paper has
outlined, there are many advantages to both parties in establishing self employment
and independent contractor status. In deciding which route to take it is well
advised to canvass all of the advantages and disadvantages of each particular
method of employment. You should seek the assistance of legal counsel and an
accountant to determine what method is best suited to your objectives. Finally,
when commencing new employment ensure that there is a common understanding between
the parties as to all rights and obligations arising from the relationship -
this will ensure that each party actually receives what they bargained for.
