Tax implications for Self-Employed
For tax purposes the distinction between an employee and an independent contractor is important for the following reasons:
1. The deductibility of expenses is considerably more restricted for employees. Self employed individuals may be in a position to claim more deductions.
2. Employers must remit income tax, EI and CPP payments to the CRA (Canada Revenue Agency) for employees only.
The deductibility of expenses
An employee can only deduct those expenses that are specifically allowed under ITA (Income Tax Act) Part I, Division B, Subdivision a, Section 8, whereas a self-employed individual may deduct all expenses incurred to earn business and property income as permitted by ITA, Part I, Division B, Subdivision b.
The deductibility of expenses for sales/negotiation employees
Expenses incurred for the purpose of earning income from employment for employees who sell property or negotiate contracts may be deductible only if the following five conditions are met:
a. he/she must be employed in the year in connection with the selling of property or negotiating of contracts for his/ her employer;
b. under the terms of his/her contract of employment he/she must be required to pay his or her own expenses;
c. he/she must be ordinarily required to carry on his duties away from his/her employer’s place of business;
d. he/she is remunerated in whole or in part by commissions or other similar amounts fixed by reference to the volume of the sales made or the contracts negotiated.
e. he/she was not in receipt of a reasonable allowance for traveling expenses in respect of the taxation year that was not included in computing his or her income.
An allowance is a fixed amount which is paid to an employee in excess of his or her salary without the requirement that the employee be accountable for the amount expended. An unreasonable allowance is one that is less than a reasonable amount, greater than a reasonable amount, or deemed not to be reasonable. A reasonable allowance is not taxable, thus any expense deductions are not allowed if a reasonable allowance is received. An unreasonable allowance has to be added to the taxable income and only then the expenses incurred for the purpose of earning income are allowed.
Non-Tax implications for Self-Employed
The noon-tax implications for a self-employed person include:
1. they are ineligible for general EI benefits, holidays and employer-paid or other non-cash benefits;
2. they have a potential liability issue for the service they perform;
3. they cannot collect severance pay;
4. they lack job security, and thereby assume increased economic risk
The difference between being employed versus self-employed is important because self -employed individuals are treated as businesses and are allowed to deduct all reasonable expenses incurred for the purpose of producing income from business. Employees, on the other hand are strictly limited to those deductions specifically listed in section 8.
It is interesting to note that for labour law purposes, individuals usually prefer to be employees to gain protection for their severance, pension and injury compensation rights, but prefer to be self-employed for tax purposes. With regret this option is not available.
The courts have applied the following tests in order to determine whether an individual is an employee or self-employed:
* The economic reality of entrepreneur test – examines several economic factors such as control, ownership of the tools and chance of profit/risk of loss. In cases where the taxpayer doing the work supplies neither funds nor equipment needed to do the work, takes no financial risks or managerial responsibility and has no liability, the courts have applied the economic reality test and held that the taxpayer is an employee.
* Integration or organization test – examines whether the individual doing the work is economically dependent on the organization. The more dependent the individual is on the organization, the more he or she will appear to be an employee.
* Specific result test – examines whether the individual doing the work and payer agree that certain specified work will be done and possibly with the use of assistants provided by the worker. In this situation it may be inferred that an independent contractor relationship exists. In the CRA’s view, this test is satisfied where the facts suggest that a person is engaged to achieve a defined objective and is given all the freedom to obtain the desired result.
It has to be noted that no one test can be used to determine whether someone is an employee or is self-employed and all tests should be considered together before a conclusion is reached.
Income Tax Act;
Federal Income Taxation: Fundamentals, 5th Edition- published by CCH Canadian Limited