Know before you Hire: The difference between Contractors and Employees
Have you decided it's time to get some help in your business?
But not so fast! Before you do you need to make sure you know the differences between hiring an independent contractor and employee.
As a business owner, making the leap to hire support in your business is an exciting (yet sometimes scary!) decision. You may breathe a sigh of relief knowing that you no longer have to do all the things on your own.
At the same time, you might have some feelings of nervousness around hiring and understanding the difference between independent contractors and employees. That's totally OK.
The differences between employees and independent contractors can be hard to navigate, but it is so important to ensure you have properly classified workers before they are hired to join your team. The legal consequences of getting this wrong can be a stressful and expensive nightmare for your business. Read on to learn more about the differences between a Canadian employee vs contractor.
Should I Hire a Contractor or an Employee?
I get this question a lot!
Answer: It totally depends on your needs as a business owner. If you don't need someone on part-time or full time hours, are happy to assign work to them without much oversight or direction, or just need someone for a certain project or that has a certain skillset that is totally outside the scope of the nature of your business. A contractor might just be the right fit!
But, if you're looking to build and fill out a certain role in your business, want to have oversight over their duties and schedule, long term (and possibly their exclusive) commitment, and you are going to provide them with all the things they need to do their duties, you're likely talking about an employee.
This is obviously not a thorough overview, but I wanted to lay some groundwork for basic differences.
There are definitely several advantages to hiring independent contractors vs employees in your business. There’s no payroll, less administrative work, more flexibility and ability to hire when you need them. However, just because you call your worker a “contractor” doesn’t by law, automatically mean that they actually are. Trust me, if you were a fly on the wall in my office, you’d hear me say that a lot to my clients.
At the same time, just because you have a worker sign a “Contractor Agreement” doesn’t automatically mean that it’s not technically an employee-employer relationship. To make this determination you need to look at the expected relationship you expect before you hire, and then reassess it from time to time as it progresses.
Ready? Let’s dive in.
Factors to Consider When Classifying Independent Contractors vs Employees
When determining whether a worker is an independent contractor or an employee, there are several specifics of the relationship that you need to consider and get right in order to classify them properly. It’s essential that you become familiar with these factors before hiring, that way you don’t have to worry about a third-party (such as a judge or CRA) stepping in.
Degree of Control
The first factor to consider when classifying a worker is the degree of control that your business has over the worker. In this case, “control” refers to the right of your business to instruct the worker on how, when, and where their work is performed, and who performs that work. The greater the control is exercised over a worker, the more likely it is that the worker is classified as an employee and not an independent contractor.
For example, if you require a worker to be online from 9-5, 4 days a week to perform their work, this likely looks more like an employee-employer relationship.
On the other hand, if you don’t require your worker to clock in during a set time or log a certain number of hours, giving them the freedom to complete their work in their own time, the worker would more likely to swing towards being classified as an independent contractor.
Whether or not the worker is allowed to hire their own subcontractors to help complete the work or assign it to their own employees is also a key indicator of control and helps determine what the worker should be classified as. Hiring subcontractors or other employees is often how an independent contractor scales their own business.
Alternatively, a true employee is hired to perform work and it is typically required that they perform the work on their own, without delegating or hiring it out further. For example, if you were an employee and were expected to show up to a job, your employer would likely NOT be okay with you sending one of your subcontractors to work to fulfill your duties (although TBH back in my employee days, there sure would have been a lot of things I would have loved to outsource!).
Ownership of Tools
Another key factor to consider when determining the difference between independent contractors vs employees is who owns and supplies the tools required to complete the work and get the job done.
A worker who owns and supplies their own tools, such as a computer, office equipment, software, etc., is most likely operating their own business as a classified independent contractor.
If a worker is supplied these necessities, such as a computer, software, cell phone, or money towards their phone plan or internet bill, by an employer, they are most likely considered to be in an employee-employer relationship.
The waters can be muddied because most business owners have their own subscriptions to software (like Canva, Quickbooks, Later, and others!) that various contractors might log into and utilize to carry out their duties. This is totally fine! However if you send them a laptop, outfit their home office and give them a car to use for their duties, you’re likely leaning more towards an employee relationship.
Chance of Profit/Risk of Loss
Chance of profit/risk of loss also helps determine what is an independent contractor vs employee. Most often, as a business owner themselves, an independent contractor may profit by completing work quickly and efficiently. Consequently, they may be at risk of losing profits if their expenses in performing the work exceeds their income.
An employee is typically paid an agreed upon amount, whether an hourly rate or salary, for time spent working. They are not entitled to any increased profits achieved, no matter how quickly and efficiently they work or how high the quality of their work is. This is a huge reason why so many people are turning to starting their own business!
The expenses and liability risks of the business do not fall on an employee like they do an independent contractor. Employees simply show up, do the work assigned to them, and collect a paycheck, without worrying about the risks or expenses affecting it.
An independent contractor who runs their own business is free to choose who they work for. This freedom to work for any client indicates an independent contractor classification.
On the other hand, requiring a worker to dedicate working time to one company only or requiring the worker to enter into a non-competition agreement to work exclusively for one business is more likely to indicate an employment classification.
Dependance on the Organization
If a business is going to be one of many clients that a worker has in their own roster of clients, this is another factor that indicates a contractor relationship. An independent contractor is not dependent on one organization as they may have multiple organizations that they work for and count on for their income.
You need to be careful with this though. If a contractor relationship starts out with you hiring the contractor sporadically on a project basis, but as the relationship grows and strengthens over time, the business is assigning more work and the contractor is only performing work for that business, this relationship could be seen as shifting towards employee-employer relationship as the contractor becomes fully dependent on that organization for income. It’s important to stay on top of these relationships, as they can change over time.
While it’s not within your control whether or not a contractor has other clients, if you are providing them work on what could be considered a full-time basis, precluding them from having time to (or needing to!) seek out other clients, you might be treading a fine contractor/employee line.
Intentions of the Parties
When determining whether a worker is an employee or an independent contractor, the intentions of both parties is also a factor in making a classification. Evidence of these intentions includes the wording of their written agreement indicating one way or the other.
Another piece of evidence is who is responsible for the remittance of certain sales tax for their services, and also reference to the other factors set out above. This evidence is not 100% conclusive, and in the case that it goes to court, the entirety of the working relationship between the business and worker will be examined to determine the true nature of it.
OK, But What Determining Factor is Most Important?
Well, all of them! There is no clear cut answer here. If a judge or CRA were making a determination, they’d carefully consider all of the above factors, and judge based on reasonableness and taking into consideration the facts of the case.
Each of these factors in classifying an independent contractor vs an employee are taken into consideration on a case-by-case basis, as each situation may look different. That’s why it's important to look at each specific relationship that every contractor has to a company and make the determination from there.
If you even have a hint of uncertainty, it’s a good idea to seek legal advice. It’s better to be safe than to subject yourself to the consequences of getting the classification wrong, as this can be very costly. It can also impact your credibility and ability to hire quality workers in the future.
When Do Legal Issues Arise Over Hiring Independent Contractors vs Employees?
When hiring independent contractors vs employees, legal issues can arise that put a business owner at risk in a variety of ways.
One example is, if you end a relationship with a worker, they might think they are afforded a certain period of notice (even that included in a contract) before ending the relationship, or worse, severance pay. When lawyers get involved in this type of situation and analyze the relationship, it might be determined that even though the person was called a “contractor,” after assessing the factors above, the relationship actually looked a lot more like an employee/employer relationship.
If this is the case, it might mean the business owner is responsible for remittance of any upaid taxes, employment insurance premiums, and even severance pay.
Sound expensive? Ya. It sure can be.
In another example, the relationship might be flagged by the CRA after a contractor files their taxes and it is found that the majority of their income comes from you, indicating the contractor doesn't have other clients and is solely dependent on your business for income. This means you may be responsible for EI and CPP that hasn’t been paid for the duration of your working relationship.
Lastly, consider the example of a relationship being flagged when the contractor doesn’t save money for the payment of their income taxes because they thought these payments were being deducted at the source by their employer. A classified independent contractor must pay their own income taxes, whereas a classified employee has their taxes deducted from their paycheques.
Why It's SO Important to Understand the Difference Between Independent Contractors and Employees
As more and more businesses are opting to hire independent contractors over employees due to time and money-saving benefits, the governments in both Canada and the United States are catching on. They are paying closer attention to these working relationships and examining them and the factors stated above closely.
If the government determines that a business owner has falsely classified a worker, regardless of if it’s an honest mistake, the business owner can face big penalties, hefty back tax payments (like EI and CPP), severance pay in the event of termination of that worker, and expensive legal fees in hiring a lawyer to try to remedy the situation.
That’s why it is so critical that you take matters into your own hands and understand the difference in the relationship between independent contractors vs employees before you even begin the hiring process.
All of this is NOT to deter you from hiring, because there is so much power in outsourcing in your business. This is simply to guide you and protect you along the way, because the two relationships and corresponding contracts that you’ll need to have in place to protect yourself and your business are very different.
If you’re looking for a contract to use for an employee-employer relationship, I do not recommend using a template, as the laws of each province are different and the laws are always changing. In this case, it’s best to seek legal advice and have a lawyer help you draft your contract.
However, if you are looking for a contract to use with an independent contractor, whether you're located in Canada or the United States you can check out our lawyer-drafted, peer-reviewed customizable contract template here in the shop.
Looking for an independent contractor and non-disclosure agreement template? You can grab both in our hiring bundle here.
Happy growing, scaling and delegating!