Who to hire? Independent contractor vs. employee
HR Insights

Do you know if your worker is an independent contractor or employee? With provincial governments cracking down on employee misclassification, we asked Toronto-based corporate lawyer Darielle Teitelbaum why it matters and how to avoid costly compliance violations.

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You’ve just hired an IT worker who provides their own laptop and works from home during odd hours. Are they a contractor or an employee?

How about an experienced sales director who agrees to a one-year assignment to build out your sales team? That’s a contractor, right?

In both cases, the answer depends. As an employer, it’s your responsibility to properly identify the nature of the work relationship and to treat the individual accordingly. If you don’t, employee misclassification fines could hit you and your business hard.

What is employee misclassification?

“Determining independent contractor vs. employee status is one of the most common issues in employment law,” explains Darielle, who specializes in legal counsel for athletes, wellness, and entrepreneurs.

“In most casesand where penalties are most likely to occuremployee misclassification is when employers wrongfully identify certain workers as ‘independent contractors’ when they should, in fact, be employees.”

This matters because employees are entitled to certain rights and protections (including minimum wage, paid vacation, and group benefits) that ICs don’t generally have access to. Failure to classify them correctly could mean having to pay out what they are owed plus significant legal fees.

Why hire independent contractors?

For small businesses and startups, contractors can be a great way to fill talent gaps without committing to a full-time employeeand the paperwork that that entails.

Temporary workers also offer greater flexibility. Employers can hire them based on rising and falling business needs or hire highly-specialized talent on a per-project basis.

With remote work technology and the rise of the gig economy, more people and businesses are taking advantage of non-traditional work arrangements than ever.

Studies have found that independent contractors (also known as flexible workers, contingent workers, or giggers) already make up 30% of the workforce, and could exceed 40% in the next few years.

There’s also a distinct financial incentive for hiring contractors instead of employees.

Using contract workers allows business owners to cut labour costs, such as employment insurance, training and development, and severance pay. ICs are not entitled to paid vacation or group benefits, and employers don’t have to withhold their income tax. (In some cases, the worker will actually request to be classified as an IC to claim significant tax deductions). According to StatsCan, temporary work also pays less than permanent work across every industry.

On the whole, independent contractors can seem to be far less expensive and offer reduced risk.

While this may appear to be an obvious advantage for employers, it is also where the danger of misclassification comes into play. As David Weil, former advisor to President Obama puts it:

“Though its form varies, the impacts of misclassification are almost always the same: the underpayment of wages, absence of benefits, and increased exposure to a variety of risks. And when misclassification is adopted as a business strategy by some companies, it quickly undermines other, more responsible employers who face cost disadvantages arising from compliance with labor standards and responsibilities.”

Whether accidental or intentional, small businesses can be hugely impacted by the costs and consequences of misclassifying their employees.

What are the consequences of employee misclassification?

The penalties for misclassification can come from the CRA, workers’ safety boards (i.e. WSIB), or federal or provincial law.
In the case of a dispute, employers may be obligated to pay outstanding payroll deductions, including unpaid overtime, severance, work-related injury fees, and vacation pay, in addition to penalties and legal fees.

Another area of liability is group benefits. For example, if an employee has been wrongfully denied health benefits because of their ‘contractor’ status, the employer may have to repay damages and may even be prosecuted.

“In the event of a dispute, it is the employer’s responsibility to prove that the individual is not an employee,” says Darielle. “As an employer, you absolutely must understand employee classification before you hire a new worker.”

So: Independent Contractor or Employee?

As Darielle explains, this is the heart of the issue: how to tell the difference between an employee and an independent contractor. Unfortunately, the categories aren’t cut and dried.

“The CRA has created a long and detailed guide on the subject, however, individual cases are still subject to interpretation. A government decision can also override any intent or contractual agreements made between you and the worker,” she explains.

To help separate the two, here are the general definitions and distinctions for determining individual contractor vs employee status.

independent contractor vs employee

Who is an independent contractor?

Independent contractors are hired for a specific service. They pay their own taxes and are not entitled to any employer-sponsored benefit or pensions.

Who is an employee?

Employees are subordinate to their employers. The conditions of their work are generally more controlled, as is their frequency and method of pay. Employee status directly affects entitlement to government benefits and implies statutory rules surrounding employment. An employer must do payroll and deduct Canada Pension Plan Contributions, Employment Insurance Premiums, and income tax for all employees.

Common misconceptions

So far, it may seem straightforward who is a contractor and who is an employee. However, there are blurred lines. For example, Both contractors and employees can work remotely or in-office. They can work part-time or full-time in a variety of roles and industries.

The Government of Ontario further specifies that an individual may still be considered an employee even if they:

  • Agree (verbally or in writing) to be an independent contractor
  • Charge HST
  • Submit invoices
  • Use their own vehicle for work purposes
  • Don’t have statutory deductions taken from their pay (eg. tax, CPP, EI).

Ontario’s Ministry of Labour has recently promised to make employee misclassification a priority enforcement issue.

It bears repeating that no single factor in this table will identify a contractor or employee. For example, an individual may provide their own laptop or have a ‘side gig’ with another employer on weekends and still be considered an employee by their primary employer.

The bottom line, Darielle stresses, is that if you are growing your team and are in any way uncertain about your workers’ status, do a thorough assessment before you hire. It could save you significant cost, liability, and your reputation as an employer.

Useful templates:

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The above information represents general legal concepts and should not be taken to be legal advice in any way. If in doubt, you should always consult with a lawyer and an accountant when making employment decisions.