The Legal Quandary of Contract Workers and Taxes
Thousands of workers provide services as contractor workers in Ontario. They span professions like hair dressers, naturopaths, sales representatives and software developers, to name a few. They are employed by small and mid-sized businesses, like beauty parlours and wellness clinics, as well as large institutions, like national banks. Until recently, their status remained ambiguous in Ontario. Were they employees, depenent contractors performing work like employees or self-employed independent contractors? Are they entitled to vacation pay and overtime? And who is responsible for federal source deductions, like Income Tax EI and CPP? Matters concerning contract workers and taxes remain a legal quandary.
In January this year, the Ontario government attempted to clean some of this up. Bill 148 brought sweeping reforms to the Employment Standards Act (ESA). Employers must now clearly classify their workers as employees, dependent contractors or independent contractors. Provincial laws protect dependent contractors just like employees. They are entitled to the same benefits, including vacation pay, overtime, health and disability benefits, etc.
However, the ESA remains in provincial jurisdiction. Your federal deductions and entitlements are governed by the Income Tax Act. Unlike the ESA, it does not yet recognize your dependent contractor status.
Federal Income Tax Act
The Income Tax Act stipulates the requirements for insurable and pensionable earnings. For standard employment relationships, the law holds your employer responsible for deducting taxes and source deductions, like EI and CPP, from your income. They must remit these in a timely manner to the Canada Revenue Agency (CRA). These contributions determine your benefit entitlements to Employment Insurance and the Canada Pension Plan.
If you work as an independent contractor, the law views your working relationship just like a business transaction. Accordingly, you invoice your clients for your services and collect/remit GST/HST, as applicable. The CRA allows you to claim deductions for business purposes, like rent, internet and mileage. The earnings of the business are not insurable or pensionable and you may opt out of the Employment Insurance Plan. However, as a self-employed individual, the CRA holds you responsible for source deductions like income tax & CPP for money you draw to pay yourself.
Dependent contractors fall somewhere in-between. In fact, many dependent contractors only become aware of the tax quagmire when their employment ends. Although Ontario laws deem your status no different from employees, you may not be eligible for Employment Insurance. The CRA may incorrectly consider you a self-employed independent contractor, holding you responsible for source deductions and penalizing you with interest for not remitting your payroll taxes on time. Presently, dependent contractors must jump through a few hoops first, to shift this burden onto their employers.
Contract Workers and Taxes: Lyon Vs. Her Majesty the Queen
In 2016, we won a precedent setting case, Keenan v. Canac Kitchens, for dependent contractor clients. Our team of lawyers played a significant role in drawing the line that delineated dependent contractors from independent contractors. These standards formed the basis for provincial reforms enacted in Bill 148.
Recently, we embarked on a similar exercise with the Federal Income Tax Act through our case, Kearsten M. Lyon v. Her Majesty the Queen. It offers a classic example of the challenges many dependent contractors face. Ms. Lyon began working as a contractor with Kinetica Health Group in 2008. She performed clerical work as a receptionist and office administrator. Two years later, she upgraded her skills and assumed additional responsibilities as a Chiropractic and Physiotherapy Assistant and Certified Pilates Instructor.
From the onset, Lyon did not bill Kinetica any GST/HST. The owner of Kinetica, Peter Tzakas, was a licenced chiropractor, exempted from collecting and remitting these taxes. He advised Lyon that, since her services to clients were performed under his licence, she was GST/HST exempt as well. This notion turned out to be false as Ms. Lyon discovered in 2016. She eventually learned that she should have collected GST/HST all along. Consequently, Ms. Lyon advised Mr. Tzakas that she would bill him for taxes, retroactively.
Employment Status Change
Soon after, Mr. Tzakas changed the employment relationship with Ms. Lyon, as well as other staff at the clinic. They mutually agreed to become employees of Kinetica, retroactive to January 1st, 2016. Mr. Tzakas made source deductions, including EI and CPP, and remitted them to the CRA. But this arrangement did not last long for Ms. Lyon. On June 18th, 2016, Mr. Tzakas terminated her employment. On paper, Ms. Lyon had only been an employee of Kinetica for a few months. She was ineligible for Employment Insurance and the CRA considered her an independent contractor, responsible for back taxes.
She therefore applied to the CRA to prove her status as an employee of Kinetica for the entire duration of her employment relationship. They agreed to assess her status from 2015 and 2016 and advised they would assess 2011 to 2014 only after the first decision was rendered. Initially, Ms. Lyon successfully established that she was an employee for 2015 and 2016. However, Mr. Tzakas appealed the decision and the CRA reversed it’s own ruling. Ms. Lyon’s case escalated to the Tax Court of Canada.
Tax Court of Canada (TCC)
The Income Tax Act is quite different from the ESA. It has no provision for recognizing employment status. Rather, Tax Courts examine the intent and nature of the working relationship to determine who carries responsibility for deducting and remitting taxes and source deductions to the CRA.
The process involves two steps. First, the court examines the subjective intent of each party in the work relationship. And secondly, they ascertain whether the terms of the relationship remain consistent with the intention. Through the trial, they review factors like degree of control, ownership of the tools, chance of profit and risk of loss, etc.
After a thorough examination of the facts, the TCC concluded that Ms. Lyon was indeed, an employee of Kinetica. They disregarded the expressed intentions of an independent contractor relationship because the objective factors did not support those intentions. In other words, the historical independent contractor relationship was irrelevant because all the facts pointed to a traditional employment relationship. The ruling held Kinetica responsible for the back taxes
The TCC ruling was influenced by the extent of control Mr. Tzakas held in this work relationship. For starters, he held full economic control. Ms. Lyon was neither a shareholder at Kinetica nor did she stand to earn a profit or risk a loss. She earned an hourly rate for her administrative and clerical tasks as well as Pilates, chiropractic and physiotherapy duties. The clinic provided almost all of Ms. Lyon’s clients, compensating her for the Pilates services with a percentage of the fees they charged the clients. The Court determined that this was akin to an employee earning income through commissions. It was not indicative of an independent contractor relationship.
Mr. Tzakas also maintained a large degree of control over her activities. For example, while Ms. Lyon set fees for her sessions, he insisted on being consulted and had final say in the changes she made to packages or rates. Mr. Tzakas required her to see his clients on Kinetica premises using his equipment and prevented her from seeing them elsewhere. Kinetica handled all client bookings for her Pilates sessions through their on-line scheduling system. They billed clients for her services using invoices with their logo. Mr. Tzakas expected Ms. Lyon to operate under the Kinetica brand, providing her with business cards that suggested she was a staff member. He also required her to fill out time sheets each week on forms that listed her as “staff”.
In the words of the Court, “to the outside world, Lyon would have been perceived as being an employee of Kinetica.” They determined that Ms. Lyon was not a contractor for 2015 and 2016 and held Kinetica responsible for the back taxes. The CRA will now use this ruling to assess her taxes for 2011 to 2014.
Signalling Dependent Contractors
This decision is important for many workers. If you have traditionally worked under contract, then your employer must classify you as either dependent or independent. The matter of contract workers and taxes remains complicated and federal laws have yet to catch up with dependent contractor status. If you are facing tax problems with the CRA and they have incorrectly classified you as an independent contractor, then give us a call. Our lawyers are not afraid to wade into this uncharted territory. We can examine your circumstances and advise you better than most.
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