Contractor vs Employee – Know your employment status – Tax implications

For the majority of individuals who successfully apply for a job, it is evident that you are taking on a role as an employee. As an employee you receive a pay cheque at the end of each pay period which identifies the amount of income tax, Canadian Pension Plan and EI withheld and ultimately your net pay (net of tax pay). 

However, it is not always that simple. Over the past few years we have seen an increasing trend of tax payers who have been paid on a contractor basis (no tax withheld by employer) without being informed by the employer. The majority of these tax payers have been newcomers to Vancouver, Canada who are not familiar with the Canadian tax system and the vast majority believed they were being paid as an employee with tax being withheld by the employer. 

Tax implications to tax payer?

So, what does this mean for the tax payer when they find out they have been paid as a contractor? In short, they will owe tax to CRA. Where the tax payer believed they were paying tax with each pay cheque, this was not the case, which presents the unfortunate reality that tax will likely be owed to CRA by the tax payer.

Why would an employer prefer to have contractors?

From some examples we have seen, it appears the employer ‘tricked’ the tax payer into believing they were an employee, but why would an employer prefer to pay tax payers on a contractor basis. In short, they will save money. When hiring employees and employer is required to pay employer contributions for EI and Canadian Pension Plan, they will also be required to incur additional payroll related costs for running payroll each pay period, and producing T4s to employees at year end. When paying an individual as a contractor, the employer avoids all these additional costs. 

Cons to tax payer of being a contractor

When a tax payer is surprised to find out they are a contractor, there is the initial shock that tax is ultimately required to be paid on their net income. There are also additional cons to the tax payer:

  • More technical tax filing when compared to filing a T4 tax return. A contractor is required to fill out a T2125 declaring their income and expenses on their tax return. If filing themselves, this would require the tax payer to carry out research on the allowable deductions and other tax compliancy issues. 
  • When recording deductions on a T2125 this increases the record keeping requirements of the individual who will be required to retain copies of receipts for several years.
  • A contractor is required to pay a higher rate of CPP on their income, usually resulting in a higher amount of CPP being paid when compared to being an employee
  • Access to EI is more difficult when operating as a contractor

Pros of being a contractor

It is not all doom and gloom, and naturally some tax payers prefer operating as a contractor to an employee. There are many pros to being a contractor when operating in a correct manner:

  • There are far more allowable deductions against contractor income when compared to employment income. This can result in a lower tax payable when operating as a contractor (this depends on the nature of the business and level of eligible deductions). The most common allowable deductions are home office expenses as well as vehicle usage expenses. 
  • There is no required EI contribution on contractor income. 
  • Usually a contractor will have more freedom to decide the time and place of their work activities and will usually be able to carry out work for more than one company, whereas some employees are required to sign contracts which reduce the flexibility of their work and ability to work for more than one company.

Questions/Tax advice

If you are unsure of your employment status, or require a consultation related to any of the information provided above, or a tax question in general, please do not hesitate to contact the Jackstaxback team at . At this time (January 2023) our physical office in Vancouver is not open as we have switched to satellite office operations since the start of COVID. We are currently carrying out tax consultations over the phone, and are fully operational as usual over email.