Small Business & Start-ups: Part Three: Employees and Contractors
Updated: Feb 20, 2021
We recently addressed some basic legal issues concerned with management (directors and officers) and advisers (see here). This second part will continue with the “growth of people and expertise within an organization” concept but seek to address some basic legal issues concerned with hiring employees (which can include officers who are not just appointed by directors, but employed by the business) 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 organization 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 organization 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 that determine what the legal relationship is 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?
Organizations have legal obligations that arise by virtue of the legal relationship they create with service providers - whether employees, dependent contractors or regular contractors. Payroll withholding obligations, Canada Pension Plan and Employment Insurance contributions, goods & services taxes, provincial services taxes, harmonized services taxes, WorkSafe BC matters, employment standards obligations and even assessment of issues like vicarious liability all are impacted by the legal relationship, not necessarily the stated relationship, which means an organization may be held responsible for obligations not properly attended to today well into 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 organization (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 generally 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 extra profit o r shoulder the 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 can increase their earnings based on their productivity but 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 and take the risk of loss because they have the ability to pursue and accept contracts as they see fit; negotiate the price (or unilaterally set their prices) for their services; and have the right to offer those services to more than one payer while concurrently incurring expenses to carry out the terms and conditions of their contracts. Self-employed individuals generally have the ability to increase their revenues 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 particularly 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 organization 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 organization 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 organization 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 organization 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 organization 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 organization, 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 "ndependent 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.
A service provider's status as a dependent contractor is determined on a review of the facts of each case but generally is determined on the basis of “exclusivity” which itself is often determined by the existence of restrictive agreements or provisions which do not permit the contractor to provide similar services to other organizations. 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 organization for income. In turn courts reason that while not technically an employee protected by employment law or employment standards, the worker remains in a position of economic vulnerability justifying that the court protect that worker by deeming him or her to be a “dependent” contractor and entitling that lawyer 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 payroll administration service providers and numerous software packages available to enterprises of all sizes but an experienced accountant or book-keeper knowledgeable in such matters is an invaluable addition to any business.
Work Safety and Worker Compensation
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. Worker safety laws and regulations outline responsibilities and impose obligations on business owners, employers, management, primary contractors and even workers whether they are employees or contractors. It is important that entrepreneurs take the time to review applicable work safety laws and regulations; register their business with provincial work safety agencies and make any filings and payments 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 status in this regard of any proposed employee or contractor before entering into a services agreement is important and there are material consequences for both employer and employee if problems are identified and enforcement is taken.
Resident business owners must also understand that individuals entering Canada from the United States for work or business - a somewhat common arrangement with many businesses - may have obligations in terms of obtaining a work permit or Temporary Resident Visa (TRV). There are exemptions, and Canada-U.S. agreements may mitigate or facilitate these arrangements; however 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 at a point-of-entry for the first time.
Protection of Intellectual Property and Confidential Information
Entrepreneurs, regardless of the size or specific industry, should put their mind to implementing a concise, consistent, and effective process for determining the ownership of, as well as protecting, intellectual property and confidential information.
Intellectual property concerns can vary with the type of business undertaken - from significant concern for tech start-ups to almost an entire indifference in 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.
Entrepreneurs need to be aware of differences between, for example, Canadian and U.S. patent and copyright law (such as morality rights in copyright) as well as, within Canada, differences between the legislated and common law 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 organization 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 worthy of some degree of protection and 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 (and best included in some form of agreement or contractual covenant) and it is important that entrepreneurs identify these issues from the inception of their business and consider addressing these issues early, effectively and consistently as their business grows and expands.
Protection of Personal Information
Personal information is any recorded information about an identifiable individual other than their business contact information and includes information that can be used to identify an individual through association or inference. Organizations will no doubt collect personal information in the workplace and all organizations are legally obligated to protect any personal information they collect, use or disclose - whether the information is about that organization's customers, employees or others. Further, issues of workplace privacy in particular can be very complicated to address. Common disputes include the collection, use or disclosure of employee medical information by employers; employer monitoring of employees’ use of the internet or personal e-mail accounts at the workplace; and employer surveillance over employees at the workplace. Again, it is important that entrepreneurs identify and address these issues early, effectively and consistently both at inception and as their business grows and expands.
Growth through adding personnel (whether directors, officers, advisers, employees or contractors) is often a necessary, and most often good, thing. However business owners and management must appreciate that unique legal and administrative issues may arise in this regard and that the best course of action is to obtain advice from experienced accounting and legal professionals to ensure your organization 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 and offers legal advice and services on terms and at rates structured for new and growing British Columbia businesses (see here).
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.