Business owners often talk about growing their businesses by hiring contractors rather than employees. The argument is compelling: the paperwork is simpler, and you can be more nimble. However, like everything in business, it is not always that clear-cut. There are a few factors to consider before deciding whether to hire contractors or employees.
The Canada Revenue Agency (CRA) sees employees and contractors differently, and it’s important to ensure that you treat employees appropriately to avoid adverse tax consequences down the road. In addition to tax reasons, there are other more subtle business reasons why the nature of the relationship matters. Sometimes, the tax reason and the business reasons are at odds!
4-Point Test to Determine Employment Status
Here are the four things you’ll need to consider when understanding your working relationships with contractors or employees.
Degree of Control
Control can be hard to define, but generally, an employer has greater control over an employee than an independent contractor. Core questions to ask oneself include the following. Does the individual control how the work is done? Do they have flexibility in the design and scope of the product or service that they deliver? If the individual has significant control over the provision of the work and its design, they are likely a contractor. If the details of how and when the work is delivered are set by the employer, the individual is likely an employee.
Contractors provide services to several clients simultaneously, while employees spend most of their working time with a single employer. For the contractor, the "employer" is usually one of several clients, and clients have less control over service providers than employers have over employees. In short, the key questions to ask are as follows:
- Who decides how the work is performed?
- Can the worker accept or refuse additional work?
- Who sets the working hours?
Chance of Profit and Risk of Loss
An independent contractor usually has some degree of financial risk and opportunity for profit, whereas the employer/employee relationship does not. What this means is that a contractor enjoys much less certainty over their future revenues, just like any business. Employees have some certainty about their income as their salary or wages are set at the beginning of the employment relationship.
Contractors may be paid on an hourly or fixed fee basis. Neither form of payment is specific to the contractor status, just as employees may be paid on an hourly or a salary basis.
The main difference between contractors and employees in terms of renumeration is the ease with which the relationship with employer/client can end. A contractor provides a service like any other business and the employer can choose another provider or choose to not purchase the service without notice and without obligation. An employer that ends a relationship with an employee usually has to provide notice and or compensation.
Integration of the Role
An employee’s tasks are an integral part of an employer’s business, but the tasks of a self-employed contractor are generally not as integrated into the business. Are you in the software space and hiring a contractor to do some painting around the office? The painter’s role is likely not an integral part of your business. A contractor may provide core services to a business but do so at arm's length. They may not be physically present at the client's business, and they may not be integrated into the business' day-to-day workings the way employees are. More importantly, they may provide these services to several clients in the same period. Questions to ask are as follows:
- Is the work performed a core part of the business?
- Does the worker perform tasks for multiple clients?
Tools and Equipment
Self-employed contractors usually supply the tools and equipment needed for the role. Employees usually use equipment provided by the employer.
There are benefits and disadvantages for business owners with both kinds of relationships. Depending on the type of worker your small business needs, you may need to decide between hiring an employee or a contractor.
Why Employment Status Matters to Businesses
- Tax Obligations: Employers must withhold income tax, Canada Pension Plan (CPP) contributions, and Employment Insurance (EI) premiums for employees but not for contractors.
- Employment Standards: Employees are entitled to benefits like minimum wage, overtime pay, and statutory holidays. Contractors do not receive these benefits or any other benefits.
- Legal and Financial Risks: Misclassification can result in penalties, back payments, and legal action from government agencies or the worker.
Benefits of Hiring Contractor vs Employee
Benefits of Hiring Employees
If you’re looking for longer term working relationships, employees are frequently your best bet. If you are hiring for full-time positions, you will find that employees can be more devoted to your company and its growth because their salary depends on it. You can expect employees to have a greater presence at your office or place of business, and with that, you can better get their buy-in on culture and vision.
If your business has employees, you generally have much control over the working relationship. You have the flexibility to decide on wages and hours, and how your employees work.
Benefits of Hiring Contractors
If you’re a small, growing business but aren’t financially ready to hire long-term employees, contractors can be an effective option to get a job done without the commitment. While contractors may not have the same devotion to your business as your employees, they are heavily incentivized to provide better services than their competitors. Contractors may outperform employees because of competition with other service providers and because employers can easily end the relationship.
Despite the perception that contractors can disappear quickly, many freelance workers will be happy to commit to working with you and your business on a longer-term basis. If your business ebbs and flows, you may want a reliable roster of contractors that can take on extra work during the busy season, but that you won’t need to pay during quieter months.
Working with contractors can be appealing because of the simplicity of tax reporting and administrative paperwork. You will not have to pay for their Canada Pension Plan (CPP/QPP) contributions or remit their payroll taxes to the CRA. You’ll also be off the hook for paying for employee benefits like health care, maternity/paternity leave, and vacation time.
Disadvantages of Hiring Contractor vs. Employee
Disadvantages of Hiring Employees
When you hire employees, you run payroll and remit payroll taxes. Outsourcing your payroll functions is always an option to reduce headaches associated with employees.
Employment regulations can be tricky. For instance, ending a relationship with an employee can be challenging and comes with some uncertainty and liability.
As an employer, you are required to withhold income tax from your employees’ paycheques and remit them to the government at a specified frequency. In addition, you must make contributions to the Canada Pension Plan and Employment Insurance (EI) premiums for your employees.
Staff contributes heavily to overhead, which can be a burden in prolonged, slow business periods. In addition, downsizing is costly as separation packages can often cover months of employees' wages after they depart the company's employ.
Disadvantages of Hiring Contractors
Since contractors are responsible for managing their own taxes and fees, plus generally provide their own tools and equipment, their rates will be higher than if you were to hire an employee.
As self-employed individuals, contractors may not feel the same level of commitment to your company as employees. On the other hand, solid contractors will have a high level of commitment to providing quality services, which compensates for being a step away from the company. However, if you find a contractor you really like working with, putting in the effort to pay them on time and respect the work they do goes a long way. Many freelance workers value long-term relationships with clients and will forego other client work if they enjoy working for you.
Are you a small business owner that is managing payroll for your employees? Consider outsourcing your payroll or bookkeeping tasks. Let’s talk about the time and money your business can save with a fully customized outsourced payroll concierge.
