Employee or Contractor or Both: Finding the Right Mix for Your Small Business

No business can grow with just one person running the show. While you may have started alone, you are bound to feel the need for different talent and skill sets to grow your business. Some tasks require consistent, regular, and repetitive work each day, such as cleaning the store and arranging shelves. Other tasks require specialized skills that might be used occasionally but are equally important, such as rebranding the store or developing a new marketing campaign. It all depends on the nature and unique requirements of your business – and hiring a full-time employee may not always be the most cost-effective answer.

Of course, employees and contractors have their own advantages and disadvantages, but what you choose makes a big impact on your budget, internal management, and legal and tax obligations.

Key Considerations When Choosing Between Employee and Contractor

Startups usually opt for contractors on a project basis to cut costs, while large companies prefer full-time employees to ensure consistency. But saving money at the cost of consistency, or focusing only on consistency while ignoring creativity, can be costly in the long run.

So, how does a small business owner decide what works best for their business? Here are the main points you should take into consideration before deciding:

Payments and Benefits

For a business owner, the main difference between employees and contractors is the pay structure. Employees are paid regular salaries, alongside benefits such as health insurance coverage and paid time off. What is termed a benefit for the employee, however, is a cost for the employer. Apart from regular paychecks, the employer has to contribute towards employees’ retirement plans and manage compulsory payroll deductions, including Employment Insurance (EI), Canada Pension Plan (CPP), and income tax.

Contractors, on the other hand, are not entitled to such benefits. They are paid as per the terms specified in the contract, with no hidden costs or extra perks.

An accountant helps you with all the documentation, payroll, and vendor payments with necessary deductions to help you stay compliant with CRA requirements and contractual obligations. They analyze your cash flow and the cost of hiring employees/contractors to help you optimize workforce mix.

Tax Responsibilities

When it comes to tax obligations, employers handle employees’ income tax through withholding tax, remitting it to the CRA, and issuing T4 slips. This is not the case with contractors who come under the “Self-Employed” category and handle their tax obligations themselves.

Legal Obligations

When you hire employees, there are several mandatory labour laws you must follow, such as minimum wage, overtime pay, paid vacation, and rules governing severance pay. In addition to these, there are other regulations and employee rights, such as protection against discrimination based on gender and skin colour. Not adhering to these rules leaves the employer vulnerable to lawsuits.

While the laws regarding contractors aren’t as stringent, there are other things an employer must be cautious about.

The Risk of Misclassification

There have been instances of employers incorrectly classifying employees as contractors to save on expenses. This is a major offence that can have serious legal implications, including a hefty fine and unpaid employer contributions, including CPP and EI, accumulated over the years the employee worked under the pretense of a contractor. So be careful when classifying employees and contractors under federal and provincial laws.

How Does the CRA Differentiate an Employee from a Contractor

While an employer chooses between hiring an employee or a contractor based on business need and budget, the CRA looks at it through a different lens.

The CRA takes into consideration three main factors for classification:

• Control: Who is responsible for controlling when, where, and how the work is done?
• Tools/Equipment: Who provides the tools required for the work?
• Financial Risk: Does the hired individual experience any direct impact if the company makes a profit or suffers a loss?

If the answer to any of the questions is the company, the person hired could be an employee and not an independent contractor. While a contractor may do the work that an employee does, he/she is responsible for making all decisions on how to get the work done. The company only assigns the work. The contractor is responsible for the procurement of tools and equipment, and is financially invested in the work and bears the risk of losses for the project going over budget, non-payment, or payment delays.

Having said that, it is necessary to understand that these are not the only factors that are used for classification. The CRA does a careful assessment of the working relationship before classification. You might want to get your contractual relationship reviewed by a professional accountant for correct classification as per CRA requirements.

Fixing Misclassification Issues

If you end up misclassifying your employees as contractors, the best solution is to disclose your mistake upfront and take measures to address it before things get out of hand. That’s why engaging a professional accountant to help clean up your books and do an internal audit to identify any such errors is a good idea. Such voluntary disclosure might also help reduce any penalties or save you from severe action.

Contact DNTW Toronto LLP in North York to Help You with Accounting and Compliance

Talk to a professional accountant to help you meet all CRA requirements with the right documentation and timely remittance. At DNTW Toronto LLP, our accountants and bookkeepers provide services including payroll, tax filing, and financial statement preparation. To learn more about how DNTW Toronto LLP can provide you with the best accounting and bookkeeping services, reach out to us here.