Small Business & Start-ups: Part Three: Employees and Contractors
Updated: Feb 6
In the first part of this article we addressed some basic legal issues concerned with management (directors and officers) and advisers. This second part will continue with the “growth of people and expertise within an organisation” concept but seek to address some basic legal issues concerned with employees (which can include officers) and contractors.
Employees vs. Contractors
Perhaps a starting point should be distinguishing between who is an employee and who is a contractor. It is not uncommon for entrepreneurs to think that an organisation can avoid much of the administrative, tax and legal burden attached to the concept of employment by designating (usually in a written agreement) those who provide services to an organisation as “consultants” or “independent contractors”. While certainly outlining the intended relationship in a written agreement is prudent and, in characterizing the actual relationship, sometimes helpful – the law tests any characterization of a relationship against certain generally accepted factors and, in doing so, may come to a different characterization than that which was intended or, at the very least, described in the written agreements. Why be concerned? Organisations have certain obligations with respect to such things as tax, employment standards or notice attached to the different characterizations (particularly employment) for which they may be held liable for in the future and after the fact.
When there is a mutual understanding that a relationship is that of an employer-employee (supervised, exclusive, scheduled working environment; paid salaries, wages (including advances), bonuses, vacation pay, or tips; provision of certain taxable benefits or allowances, such as board and lodging; reporting and tax withholding) there is seldom a legal dispute regarding actual relationship. The dispute arises more often when an organisation (often referred as the payer) seeks to retain those providing services (workers) as contractors so as to avoid the perceived hassle and substantive costs and liabilities of managing employees. Depending on whether the issue is to be determined by a Court in an employment law case or by the Canada Revenue Agency in a tax matter, the discussion of the relevant facts can be described somewhat differently but generally the discussion does revolve around the following concepts:
Intent – determining, usually by the terms of a written agreement and the actual interaction of those involved, whether both parties intended to enter into a contract of service (employer-employee relationship) or whether they intended to enter into a contract for services (business relationship).
Control – considering the ability, authority, or right of a payer to exercise control over a worker concerning the manner in which the work is done; what and where work will be done and when any work is to be done.
Ownership – considering if a worker owns and provides tools and equipment (thereby accepting the significant investment in the tools and equipment along with the cost of replacement, repair, and insurance) to accomplish the work to be done . A worker who has made a significant investment is likely to retain a right over the use of these assets, diminishing the payer’s control over how the work is carried out. In addition, such a significant investment may place the worker at a risk of a financial loss.
Subcontracting – considering if a worker can subcontract work or hire assistants because subcontracting work or hiring assistants is a factor of control and can affect their chance of profit and risk of loss.
Financial Risk – considering the degree of financial risk taken by the worker and/or if there are any fixed ongoing costs incurred by the worker or any expenses that are not reimbursed. Usually, employees will not have any financial risk as their expenses will be reimbursed, and they will not have fixed ongoing costs. Self-employed individuals, on the other hand, can have financial risk and incur losses because they usually pay fixed monthly costs even if work is not currently being done.
Opportunity for Profit – considering whether the worker can realize a profit or incur a loss (based on the proceeds of their work exceeding non-reimbursed expenses), as this indicates that a worker controls the business aspects of services rendered and that a business relationship likely exists. Employees normally do not have the chance of a profit and risk of a loss even though their remuneration can vary depending on the terms of their employment contracts. For example, employees working on a commission or piece-rate basis, or employees with a productivity bonus clause in their contract can increase their earnings based on their productivity. This increase in income is not normally viewed as a profit, as it is not the excess of proceeds over expenses. Self-employed individuals normally have the chance of profit or risk of loss, because they have the ability to pursue and accept contracts as they see fit. They can negotiate the price (or unilaterally set their prices) for their services and have the right to offer those services to more than one payer. Self-employed individuals will normally incur expenses to carry out the terms and conditions of their contracts, and to manage those expenses to maximize net earnings. Self-employed individuals can increase their proceeds and/or decrease their expenses in an effort to increase profit.
It is important that any relationship based on either or both the actions of the parties or the written agreement between the parties reflect accurately both the intended relationship from the perspective of both parties as well as the actual relationship as tested against the factors above. This is important since the final, proper characterization of a payer/worker relationship can have implications on many legal obligations including:
Income Tax – if employed the Canada Income Tax Act will apply, which means the organisation has (and had) an obligation to withhold income tax from the pay and may be liable to pay the taxes it ought to have paid in addition to paying penalties, fines and interest. An organisation is not responsible for withholding and subsequently paying neither a contractor’s income taxes nor any other payments required by the Income Tax Act. The Employment Insurance Act and Canada Pension Plan Act will also likely apply in which case the organisation can be liable to pay further unpaid contributions, penalties and fines.
Goods & Services Tax – if contracted for services, the Canada Excise Tax Act will apply which means generally that contractors should submit invoices to an organisation to receive payment for the work done and, after reaching the prescribed annual threshold, contractors must register with the Canada Revenue Agency (CRA), obtain a GST/HST number and begin charging GST/HST and provide such organisation with this number when invoicing. Provincial sales tax may apply in certain circumstances as well.
Provincial Employment Standards – if employed then a number of provincial legislation will apply like the British Columbia Employment Standards Act which has a with a number of possible implications like unpaid vacation pay, overtime, leave benefits and notice periods for termination.
Common Law – the common law throughout Canada has implied certain obligations and liabilities into an employer-employee relationship the most important of which is often, in the absence of a contract, the need to provide notice of any termination of employment without cause, which can amount to a significant notice period.
Independent Contractors vs. Dependent Contractors
Having taken the time to consider the nuances of the employee vs. contractor relationship to an organisation, the analysis does not stop there. Several cases across Canada have further distinguished, almost always in the context of determining a fair notice period to any end of a relationship, between an independent contractor and a dependent contractor. Generally, Canadian courts have concluded that many workers perform services for others in arrangements that are structured neither strictly as employment relationships nor properly characterized as independent contractor relationships and have therefore created a sub-category of the “dependent” contractor. Status as a dependent contractor is determined on a review of the facts of each case but is generally a conclusion based on “exclusivity” – often determined by restrictive agreements or provisions which do not permit the contractor to provide similar services to other organisations. If there is an element of exclusivity of a contractor providing services on a long-term and regular basis, the contractor will be seen as entirely dependent on that one company for income and, as some courts have characterized it, not be technically an employee but is in a position of economic vulnerability which then requires the court to protect that worker by deeming him or her to be a “dependent” contractor and therefore entitled to reasonable notice of termination where services are terminated without cause – similar to employment relationships.
Paperwork, Payroll, Record Keeping and Reporting
Entrepreneurs adding employees must be mindful, and prepare to meet the requirements of, provincial and federal laws regarding obtaining information from employees, payroll, deductions, contributions and remittances, record-keeping and timely reporting to both the employee, and provincial/ federal agencies. There are numerous software packages available to small enterprises but nothing will entirely replace an experienced accountant or book-keeper knowledgeable in such matters.
In British Columbia almost all parties to any workplace – whether an owner, employer, supervisor, prime contractor or worker – has a role and responsibility when it comes to health and safety in the workplace. Further, provincial worker safety laws and regulations often provide further refinements on responsibility for an employee and a contractor. It is important that entrepreneurs take the time to review applicable work safety laws and regulations and make any filings necessary prior to or concurrent with any engagement of employees or contractors.
Legal Entitlement to Work
Entrepreneurs need to ensure that any individual they are hiring as an employee or contractor is legally entitled to work in Canada. Under Canada’s Immigration Act, generally only Canadian citizens; permanent residents; or persons who have a valid employment authorization are authorized to work in Canada (and there are technical requirements related to this last category that should be understood and carefully attended to). Understanding the circumstances of any proposed employee or contractor before entering into a services agreement is important. Resident business owners must also understand that individuals entering Canada from the United States for work or business may have obligations in terms of obtaining a work permit or Temporary Resident Visa (TRV). Which many Canada-U.S. agreements may mitigate or facilitate these arrangements, care should be taken to understand and attend to any processes before a U.S. employee or contractor is speaking to a Canada Border Agent.
Protection of Intellectual Property and Confidential Information
Entrepreneurs, regardless of the size or specific industry, should but their mind to implementing a concise, consistent, and effective process for determining the ownership of, and protecting, intellectual property and, more basically, addressing concerns related to confidential information and privacy concerns.
Intellectual property concerns can vary with the type of business undertaken - from significant concern for tech start-ups to almost an entire indifference in industrial, retail and hospitality undertakings. Any business can have, develop, own, use or transfer intellectual property and in many circumstances in today's economy this intellectual property can underwrite the profitability of, or eventual value attributable to, almost any business. There are differences between, for example, Canadian and U.S. law in this regard (such as morality rights in copyright) and, within Canada, differences between the legislated and common assumptions and protections afforded to any of patents, copyright and industrial designs (such as deemed ownership of patents, copyrights or industrial designs). You may think your organisation has no need to address intellectual property issues – however this assumption is typically based on too narrow a perspective on what exactly is, or what could be, a potential patent, copyright or industrial design issue.
Regardless, almost any business undertaking has or will have confidential, proprietary or private information. Having all employees and contractors understand what is, or may be, confidential, proprietary or private information; who owns that information; what can and cannot be done with that information and what the implications of any violation of the foregoing is a fundamental element of good business. Whether using a Confidentiality Agreement or a confidentiality clause in an Employment or Contractor Agreement that outline what information is secret and is to be held in strict confidence; or whether using a Restrictive Covenant Agreement or restrictive covenants in an Employment or Contractor Agreement that prevent the use of confidential information or trade secrets and ensure that a departing employee or contractor will not solicit other employees or contractors or seek to compete with the organisation during and for some reasonable period after the end of the engagement – it is important that entrepreneurs consider addressing these issues early, effectively and consistently as their business grows and expands.
Again – similar to adding directors or officers to your original enterprise, founding group or family – growth through adding personnel as employees or contractors is often a necessary and most often good thing. However, again, unique legal and administrative issues arise and the best course of action is to obtain advice from experienced accounting and legal professionals to ensure your organisation can attend to any new formalities or obligations; mitigate any legal risk or liability; and ensure as best possible an unimpeded pathway to further growth, prosperity and value. Endeavor Law would be pleased to assist any founder, founder group or family business understand and attend to employment and contractor matters that may arise as your business starts to grow.
Does not constitute legal or other advice and must not be used as a substitute for legal advice from a qualified legal professional in your jurisdiction who has been fully informed of your specific circumstances. Information may not be up-dated subsequent to its initial publication and may therefore be out of date at the time it is read or viewed. Always consult a qualified legal professional in your jurisdiction.