One of the most litigated personal tax issues in Canada concerns whether an individual who provides services to a corporation is acting in his or her capacity as an “employee” or is an “independent contractor.”
Individuals often attempt, where possible, to structure their services as an independent contractor since the types of expenses that can be deducted to earn self-employment (business) income are far greater than the limited employment expenses permitted to be deducted by an employee.
Furthermore, the independent contractor is often tempted to incorporate and to provide his or her services through the corporation which has access to the favourable low small business tax rates on its first $500,000 of active business income. Any amount not needed to fund the owner’s current lifestyle can then be left inside the corporation and invested, permitting a deferral of personal tax on the corporate earnings until they are ultimately paid out as a dividend, perhaps many years later.
The Income Tax Act, however, contains a special anti-avoidance rule to prevent individuals, who might otherwise be properly regarded as employees, from incorporating their own company which in turns provides services to what otherwise would have been their employer.
Under the Act, the “incorporated employee” is said to be operating a “personal services business” (“PSB”) and the consequences of this are severe. Income from a PSB is not eligible for the low small business tax rate and the corporation is restricted in the types of expenses it can write off for tax purposes, limited only to the expenses an employee can deduct.
Traditionally, the Courts have looked to a number of tests to determine whether an individual is an employee or independent contractor. These tests include: the intent of the parties, the level of control exercised over the work being done and the chance of profit or risk of loss.
A recent case (609309 Alberta Ltd.., Stan Nance v. the Queen, 2010 TCC 166) involved Mr. Stan Nance who was an experienced Alberta ironworker and was employed by Spantec Constructors Ltd. (“Spantec”) in 1993 and 1994 until Spantec decided to close its Calgary office and end Mr. Nance’s full-time employment.
Spantec said, however, that it would like to have Mr. Nance continue working for it on an hourly basis.
Mr. Nance decided it would make sense for him to incorporate and, together with his then common-law spouse, incorporated 609309 Alberta Ltd.
Mr. Nance provided all of the revenue generating services to 609309’s clients. His then common-law spouse did the books, payroll, banking, liaising with accountants, etc.
In November 1997, Spantec and 609309 entered into a personal services contract which provided that 609309 would provide the personal services of Mr. Nance as a steel superintendent to Spantec.
The contract provided that 609309 would receive forty-four dollars per hour worked by Mr. Nance. The contract included an express agreement by Spantec and 609309 that they were independent contractors and required that Mr. Nance be an employee of 609309.
In November 1998, a second contract was drawn up which provided that 609309 would provide Mr. Nance's supervisory services on the same project at the same hourly rates. This document provided that the billed hours were to match Spantec’s crew’s hours, Monday to Thursday, ten hours per day and that additional hours to complete paperwork etc. could not be billed.
It also provided that any expenses would be paid to Mr. Nance personally and not to 609309 and would be claimed using Spantec's employee expense claim forms.
609309 appeared to have no other clients other than Spantec during the years in question.
The main issue in the case, therefore, was whether, but for the existence of 609309, Mr. Nance would reasonably be regarded as an employee of Spantec.
Mr. Nance relied strongly upon the intention of the parties as evidenced by the terms of the personal services contract.
The Judge, however, concluded that in the context of a PSB case, the intention of the parties is irrelevant since the “sought-after reduced (small business) rate and tax deferral could not be achieved to begin with unless the parties intended an independent contractor relationship.”
Secondly, the Judge observed that the opportunity for profit was limited to forty-four dollars per hour worked and all related expenses, including insurance, were borne by Spantec.
Finally, when it came to the control test, it was the opinion of the Judge that the extent of control that Spantec had and needed over the work done by Mr. Nance was such that a proper characterization of his services would have been one of employment.
As the Judge concluded: “(o)verall, it is simply hard to see how a worker on these contracted financial terms with Spantec could be said to be truly in business for himself.”
The Judge ruled that a PSB did indeed exist and as a result, the negative consequences outlined above were indeed applicable to 609309.