Banka: When a subcontractor has employee tax status

Small businesses are constantly trying to cut costs. One way they tend to try is by cutting back on staff or only using subcontractors.

Small businesses are constantly trying to cut costs. One way they tend to try is by cutting back on staff or only using subcontractors.

Periodically, the Canada Revenue Agency has targeted their payroll audits to those kinds of industries who abuse the use of subcontractors.

There are rules that the CRA uses to determine if a self-employed contractor should actually be considered an employee.

The booklet that explains this issue is RC4110—Employee or Self-employed and can be downloaded from the CRA web site.

First, let’s try to determine if hiring a subcontractor really saves you any money. In a simple example, we will assume an employee that earns $2,000 a month on salary and gets paid on the 15th and the 31st.

So if we use the CRA on-line payroll deduction calculator, this type of pay period is called semi-monthly.

We enter an amount of $1,000 into the income line on the salary calculation page. We also need to ignore any special payments that may be included with the regular pay so we choose ‘Next’ to continue. We also ignore any balance forward amounts for CPP and EI for this example.

When we choose ‘Calculate,’ we see that the total tax to be withheld from this employee’s pay cheque is $84.98 plus $42.28 for CPP and $17.80 for EI, giving the employee a net pay of $854.94.

As an employer, you would need to calculate on a monthly basis the amount that you need to remit to CRA.

So for this employee, we would double the amounts above and add the employer expense portion of CPP and EI giving us a total of $424.52. So looking at this transaction from a cash flow perspective, on the 15th we pay the employee a net of $854.94; on the 30/31st a net of $854.94; on the 15th of the following month we remit the payroll taxes of $424.52.

The total cash flow is then $2,134.40. We are paying the employee $2,000 per month and it is costing the employer $134.40 for the transaction.

So now if we pay the subcontractor $2,000 a month and tell them that they need to remit their own taxes, all we are really saving is the $134.40 and perhaps a little less administration for only needing to write the cheque or electronically submit at the end of the month, instead of three times a month.

If CRA happens to audit your payroll files and determines that your subcontractor is actually an employee, you may be fined $10,000 per occurrence. Why would someone take that risk to save an approximate $1,660.80 ($134.20 x 12) a year?

So how does the CRA determine if the person is actually an employee or a subcontractor?

They consider four factors—control, ownership of tools, chance of profit or risk of loss and integration.

As explained in the CRA guide, usually the employer assigns the tasks, how the work is done and the methods used. If the employer doesn’t really control how the work is done, but has the right to do so, then they are considered to have control over that employee.

Some things to consider—who determines the hours of work, when and how the work is to be done, and the location.

The next area to consider is the ownership of tools. Are they provided by the employer, or is the subcontractor required to use and maintain their own tools?

There are exceptions to this rule because in some industries such as construction the carpenter would be required to provide his own hammer even though he/she may be an employee.

An important consideration is the chance of profit or risk of loss. Does the worker receive a guaranteed pay every pay period regardless of the results achieved, or is the income based on the satisfaction of the purchaser?

Finally, there is the integration factor which is based on whether or not the worker is dependent on the payer for income.

A subcontractor would have more than one employer so would not be dependent on payment from only one source.

This can be a very subjective area of payroll audits, so if you are considering a subcontract relationship, you may want to contact the CRA directly and ask for a ruling of the working relationship before it starts.

One other thing to mention is that an employee’s income is reported to the CRA on a T4 slip. If you employ a subcontractor, you are required to issue them a T4A slip. If you are in the construction industry, the slip is a T5018. All are due to the CRA by Feb. 28 of the following year.

Gabriele Banka is a Certified General Accountant and the owner of Banka & Company Inc .


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