Issue of the week: Employee or a Contractor

As part of the M. Saini CPA Inc. blogging experience, I will be writing/communicating, an "issue of the week" segment. Based on feedback, this segment may discontinue over the busy tax season months, but shall resume shortly thereafter. Please note that all issues are real world, with a real business, affecting real tax payers. However, for obvious confidentiality obligations, names/businesses/scenarios have been altered to protect those parties involved.

Background

Tax payer was sent a letter from the Canada Revenue Agency (CRA) regarding her 2015 Income Tax Return. Essentially, CRA questioned the income reported/to be reported on line 104 (other employment income) or line 130 (other income) or line 135 (self-employment income) of her income tax and benefit return.

The tax payer was issued a series of cash payments starting the fall of 2015 through to the end of the year, totaling an amount just less than $10,000. The company, whom paid these cash payments, was invoiced by the tax payer and recorded the applicable payments as an expense on its income statement. The company, not being in the construction industry, did not issue a T5018 - Statement of Contract Payments. Furthermore, the company did not issue a T4A - Other income (box 28 other income or box 48 fees for services). Nor were any payroll source deductions (income taxes, CPP, EI) deducted from the payments and remitted to CRA - no T4 was issued for the 2015 tax year to the tax payer.

Issue

Should the payments made to the tax payer be considered employment income (line 101 or line 104)? Or should the payments be considered self-employed independent contractor payments (line 130 or line 135)?

Company - if the payments were to be concluded as employment income, the employer would be responsible for ALL missed source deduction, both employee and employer portion. Also a 10% penalty for late filing of the T4 slip and interest charges.

Tax payer - regardless of whether the payments are employment income or self-employment income, the amount would still need to be reported on the income tax return and thus added to taxable net income.

Generally accepted accounting principals

The question of whether a person is in a business relationship (self-employed independent contractor) or in an employee-employer relationship is not one that is always easy to answer. There have been many court cases on this subject. Generally, the following criteria are explored in order to reach a reasonable conclusion:

intent - did both parties sign a contractual agreement prior to the commencement of activities? Was the agreement specified over a period of time? Or was it an indefinite period? Were both parties able to end the relationship at any time?
control - more control is generally exercised by an employer over an employee than by a client over a self-employed person
chance of profit/risk of loss - self-employed persons usually have some degree of financial risk, and more opportunity for profit than employees
integration - an employee's job will be an integral part of an employer's business, where the tasks performed by a self-employed person will likely be less integrated with the client's business
tools and equipment - self-employed persons are more likely to be supplying their own tools and equipment, as well as being responsible for their maintenance

These topics are further explained in the CRA publication RC4110 Employee or self-employed. (A comprehensive checklist is available at http://www.taxtips.ca).

Bias

For the company, whom paid cash, the bias would be to consider the tax payer an independent contractor and thus not incur any extra costs, such as, employer portion of CPP and EI.

For the tax payer, the cash payments, were just that - so the bias would be not to report anything. Which would be intentionally misrepresentation on the income tax return, fraudulent and may be consider tax evasion. Not an alternative that ever should be taken, however, a true bias taken by many tax payers. (M. Saini CPA Inc. does not condone this type of action, rather only presents this bias for discussion purposes).

Conclusion and Recommendation

Applying the tests noted above:

intent - a contractual agreement was signed prior to commencement, which outlined specific terms and requirements. The tax payer was to invoice the company on a regular basis for the work performed for that period. The intent of both parties was for the tax payer to satisfy tasks within her own availability and the contract was terminable by any party, at any time.
control - the company had control over what tasks were assigned to the tax payer, however, did not exercise control on the scheduling or supervision of activities
profit/loss - the financial risk was on the tax paper, as she was only paid for work performed. Moreover, if she did not work on tasks, she was not able to bill the company. The chance for profit/risk of loss was on the tax payer.
integration - although specific task could be performed independently, in aggregate the completion of all tasks was integral part of the company's business
tools and equipment - fully provided by the company

Based on the totality of the tests above, in my professional opinion, I would conclude the relationship to be a company and self-employed independent contractor. Thus, the tax payer should be reporting the ~$10k on schedule T2125 and line 135 of her 2015 income tax and benefit return. Furthermore, the company would record the payment under subcontract payments and report on its income statement.

For any questions or concerns, errors or misinterpretations, please feel free to leave a comment and or contact me at mike@sainicpa.com.

*with reference of:

Source: http://www.taxtips.ca