Employee VS Contractor – CRA Penalties for incorrect worker classification

File:US Navy 080823-N-1328S-003 Steel Worker 3rd Class Michael Featherston and Constructionman Steven Cline, both assigned to Navy Mobile Construction Battalion (NMCB) 133 embarked about the Military Sealift Command hospital ship US.jpg

Over the past month we have been exploring the topic of hiring new staff and how to determine if you should hire your new worker as an employee or as a contractor.

Last weeks post explored, in more detail, the CRA checklist that you need to refer to when determining how your new staff should be classified. Following on from last week, today’s post will outline the CRA penalties that you will incur if you do not abide by this checklist as well as provide you with insight into what might cause the CRA to investigate you.

What you need to know about the CRA

The first thing you need to consider when classifying your workers is that when you are paying them as contractors the CRA is not receiving payroll taxes from your business.

Avoiding payroll taxes may feel like a small WIN. However, you need to remember that the CRA, much like your business, does not like to experience a loss.

The unfortunate difference between the CRA and most small businesses is that when the CRA feels like they may be owed money, they have the power to come after you and make your life very uncomfortable.

Red Flags

The CRA may chose to review your business at anytime however there are some common factors  that usually  trigger an investigation.

  1. When your contractor files their tax return, the CRA may choose to audit them to ensure they have listed the correct income. This will lead to them investigating and interviewing all of the contractors clients which will include you.

  2. The top two expenses for most businesses are rent and payroll. If your return shows that one of your top expenses is contractors then the CRA will more than likely view that as a red flag and investigate you.

  3. Your worker may try to apply for EI and discover they are not eligible due to the fact that you were paying them as a contractor. This could lead to them asking the CRA for a ruling.

  4. Your worker at any point can request a ruling if they feel that you are paying them incorrectly.

  5. Come tax time when you worker discovers they owe money to the CRA for unpaid taxes they may become disgruntled and  request a ruling.

If you are investigated the CRA will interview you and your contractors face-to-face and make a ruling that is based on your answers to the checklist questions that we discussed last week.

Consequences

If the CRA investigates your business and determines that you have incorrectly categorized and paid a worker as a contractor when they should have been paid as an employee, you will experience the following penalties:

  1. You will need to back pay (to the start date of your agreement with the worker) all outstanding payroll taxes INCLUDING  the employee’s portion.

  2. You will also need to pay penalties and interest on the amount that was overdue.

All expenses will be incurred by your business and cannot be passed on to the worker in any circumstances.

The cost associated with the CRA ruling that your contractor should have been an employee can be crippling to your small business. That is why we recommend that you thoroughly read through the checklist and if at any point you are uncertain you contact the CRA and get a ruling.

In addition to affecting your business, the investigation can affect your contractors. If they have claimed a different amount on their return to what your records show, they too will experience penalties.

Lessons

Make sure you encourage your contractors to declare their income correctly. Inform them that you will be declaring the full amount they are going to charge and that you don’t want to see them incur any penalties.

Study the CRA checklist and make sure you are confident that you have categorized your worker correctly. If you are unsure contact the CRA and ask for a ruling, the short term pain will result in long term gain.

Use your common sense, if it walks like a duck and it talks like a duck, chances are it is a duck!!!. So if you hire someone who resembles a standard employee within your industry chances are the CRA will rule that you should be paying them as one.

If you don’t need a full time worker yet the job requires you to hire an employee, hire an on call employee or use a temp agency. Temp agencies include payroll in their fees so you are covered.

We cannot reiterate enough how important it is that you make sure you categorize your workers correctly and that when in doubt you contact the CRA.