• Staffing – Employees vs. Independent Contractors

    I’m often asked whether it’s better for the company to work with people as employees or as independent contractors (also called contractors or consultants – the differences are of style, not meaning). Consulting is common in the technology business in Canada, particularly during any recession, and as businesses staff up it’s an important question to ask.

    Like most everything else, the answer is “it depends”. If you need occasional help, or a discrete task performed, using the services of an independent contractor can make a lot of sense – there’s no fussing with payroll, there are no employment benefits, existing teams are not disrupted, and there is often very little overhead involved. But the employment relationship is generally better suited for situations involving more permanence, and the law reflects this in a variety of ways. Here’s a summary, then, of legal considerations you should take into account when making this decision.

    1. Employers are required to make certain source deductions – like income taxes, Canada pension plan contributions and employment insurance premiums – from salary and wage payments to employees, but not from payments to contractors, who are responsible for paying their own. Companies that in this regard treat personnel as independent contractors when they are in substance employees face the risk of being challenged on that determination, with a possible outcome being assessed for unpaid amounts, plus penalties and interest. Independent contractor agreements typically include indemnities under which the contractor agrees to make the client whole if this happens – but good luck collecting on the indemnity, which typically only becomes relevant because the contractor is having trouble paying its taxes and therefore is probably unable to satisfy a demand under an indemnity.

    2. The employer’s obligation at common law to give reasonable notice on termination can be involved as well. This is because a staff member who was originally brought on as a contractor might in substance be an employee instead, or might over time in substance become an employee, in the eyes of the law.

    An example of a scenario in which this could become an issue would be a staff member arguing after termination that on termination they were actually in substance an employee and not an independent contractor (even though they were described as an independent contractor in company records, in their agreement, and even though source deductions were not made) and therefore entitled to more notice of termination than agreed to in the independent contractor agreement. This claim is typically only worth making for longer-term staff members – people for whom the difference between termination notice for employees at common law and contractual termination notice under an independent contractor agreement can be significant.

    How do you know who is an employee? The law generally looks at the person’s substantive relationship to the business (after all, if it were as easy as just picking the right job description, it would be easy for employers to avoid a whole host of legal obligations to employees.) The cases take a variety of approaches, but in substance if a person has only one client, works in the client’s office, works full-time, uses the client’s computers and other tools, works when and on projects directed by the client, and with the client’s employees, there is a pretty strong case to be made that the person is in substance an employee and not a contractor. And team members who start out as contractors can certainly see their relationship to the company evolve over time in this direction.

    3. If a person who is in substance an employee is compensated as an independent contractor instead, certain amounts such as overtime, vacation pay, statutory notice and severance payments can be due to the person, and if not paid can result in substantial fines against the company and its directors.

    4. The rules are somewhat complex but the result is that in Canada, employees receive preferential income tax treatment of the gains from a stock option grant. The differences between this treatment and the approach taken with contractors can be significant.

    5. The default rules in Canada concerning who owns the intellectual property created for the company treat employees and contractors differently. Under the Copyright Act, for example, the employer generally owns copyrights created in the course of an employee’s employment. Under patent and other forms of intellectual property law the rules are somewhat different, but the essential point is that the result one gets can differ depending on the status of the team member.

    For most companies, however, this is not an issue because they require each new team member to agree to a form of agreement that gives to the company ownership of intellectual property created in the course of employment.

    6. Finally, the rules on SRED tax credits treat employees and consultants differently. Mark MacLeod has the details.

    For a variety of reasons, the choice between treating team members as employees and independent contractors can mean very different results. And treating people who are in substance employees as independent contractors instead can have unexpected and adverse results. It’s a distinction you should take seriously, and consider early.

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