Credit: Wix Media
Finding work as an independent contractor has become increasingly common in many industries. It is particularly popular in technology and entertainment, such as the video game industry where various elements requiring different skillsets are involved in designing a game.
Hiring employees for specific projects doesn’t always make financial sense for the parties involved, hence the industry benefits from the flexibility offered by independent contractors.
While you may be considering work as an independent contractor, it’s not always as straightforward as signing a contractor agreement and getting to work. If you want to maximize your business potential, you have some important things to consider.
Independent Contractor – Pros and Cons
Being an independent contractor is a great way to engage in business. It offers flexibility and control over one’s work that isn’t traditionally associated with employment. Independent contractors are their own boss, they decide their working hours and can choose to take a day off.
Independent contractors also have the freedom to contract out their services to multiple clients, and in doing so they can create a business identity and brand.
On the other hand, independent contractors don’t have the same job security and benefit packages as employees. There may be times when you are busy with projects, but that doesn’t always last and you’ll have to spend time looking for work. Consequently, you’ll have to make sure you plan your next month or year out so you can make sure you have enough savings for bills and personal costs.
• You are your own boss
• The potential to create your own brand and build a business
• Work with multiple clients and projects
• Decide how you work
• Tax benefits
• No guaranteed income
• Job stability
• No traditional benefit plans
• Find your own work
• Greater investment and upfront cost
You may find that some clients require you to be incorporated to engage in a working relationship with them. This is usually required for long-term contracts or projects with an indefinite timeline, as an alternative to permanent employment, because it reduces their overall hiring costs and eases the administrative burden of dealing with employees.
Incorporating also makes sense as you build your business and reach a higher tax bracket. By incorporating you may qualify as a Canadian Controlled Private Corporation (CCPC), allowing you to benefit from the Small Business Deduction (SBD) tax incentive.
Incorporating as an Independent Contractor
If you’re committed to starting a long-term business as an independent contractor, then you may want to consider incorporating to maximize your business potential and reap the tax benefits available to you. Through a corporation you can claim tax benefits as a CCPC as long as you meet the qualifications.
Some of the relevant qualifications include:
• You are a private corporation
• You are a Canadian resident
CCPCs can take advantage of the SBD, a tax benefit that is applied to the first $500,000 of active business income, which qualifies them to pay less taxes than a regular corporation and, in many cases, a sole proprietor. In 2019 for example, the average CCPC in Ontario was taxed at 12.5%, which was 14% less than the regular corporate tax rate of 26.5%.*
*Please note that these tax rates may be inaccurate and change from year to year and vary province to province. Make sure you have the latest SBD figures and the relevant CCPC tax rates at the time of your reading.
It is important to understand that the SBD only applies to active business income, which does not include passive income or income from a personal services business (PSB). Independent contractors need to be careful they aren’t labeled as a PSB, since doing so will not only disqualify them from receiving SBD, but from other tax benefits as well.
Independent contractors are exempt from PSB tax treatment, so long as the contractor performing the services does not fit the description of an incorporated employee.
What is a Personal Services Business?
A PSB is defined under subsection 125(7) of the Income Tax Act as a business where an individual performs services on behalf of the corporation. In other words, it is a corporation which is set up solely for providing services to another corporation.
As mentioned above, this scenario usually occurs when clients and hirers require independent contractors to be incorporated to reduce their costs. In consideration of this trend, the CRA has made changes to the tax legislation to counter this.
By declaring your corporation as a PSB, the CRA has made an assessment that you aren’t an independent contractor but an incorporated employee that is subject to personal income tax rates instead of corporate rates.
Furthermore, as an incorporated employee you are not considered self-employed and cannot claim many of the standard business deductions available to corporations and sole proprietors. So, it is essential that you take the necessary steps to ensure you qualify as an independent contractor and not an incorporated employee.
Credit: Wix Media
Are you an Independent Contractor or an Incorporated Employee?
Even if you’re an independent contractor on paper, you may appear as an employee to an independent observer if you have the same working conditions and benefits afforded to employees.
Such conditions and benefits include:
• Single client or employer
• Designated or shared workspace provided by client or employer
• Working hours defined by client or employer
• Equipment provided by client or employer
• Coverage or reimbursement of expenses by client or employer
• Fringe benefits
The above benefits are certainly convenient, but they effectively treat independent contractors as employees, and can lead to you being declared an incorporated employee.
Ensuring your status as an independent contractor isn’t straightforward and there isn’t a tried and tested template to avoid the incorporated employee label. In the 2015 case C. J. McCarty Inc. v. The Queen the Tax Court introduced a set of tests to determine the qualifications for a PSB, but the test must be applied on a case-by-case basis in consideration of unique work scenarios.
Some of the tests they considered were:
1. Control Test
• Does your client control how and when you must perform your duties?
2. Integration Test
• Do you perform your duties independently or are you performing them alongside your client’s employees?
3. Economic Reality Test
• Does your client provide you with the tools and equipment to perform your services, or do you?
• Can you negotiate the price of your services and can you offer your services to more than one client?
4. Specific Results Test
• Are you hired for a specific purpose or project, or are you hired indefinitely?
5. Intention Test
• Have you received a contract of services from your client or are you offering a contract to your client?
If you apply the tests to your scenario and find that your client has significant control in how you operate, then the CRA might consider you a PSB and consequently an incorporated employee.
Steps you can take to ensure you are an Independent Contractor
Now that you are aware of how easily an independent contractor could be considered an incorporated employee, it is important to know some of the steps that you can take to cement your status as an independent contractor.
The most important part is emphasizing the intention that you are indeed an independent contractor and that you are not being hired under the guise of a contractor so your client or hirer can save on costs.
You should also show that the intention of your business is to provide a service to multiple clients. Structure your business and contract with the client in a way that improves your status as an independent contractor.
There are many traditional and creative ways to strengthen your case, such as:
1. Document your work scenario in a contract
• Make sure that you are the party offering a contract of services on your terms, and in doing so specify the intention of the working arrangement and the work to be done. An easy way is to include a clause in the contract that explicitly states that you are an independent contractor. 2. Use your own equipment
• If you have your own workspace and equipment that you use for your services, then its better to use that if you can. Of course, this isn’t necessarily a dealbreaker if your client has specialized tools that will improve your performance of services. Some of the ways you can use your client’s equipment or workspace is by adding a clause in the contract that indicates you are renting the space or tools from your client in order to better perform the task. 3. Invoice the client for your services
• Make sure you are not receiving a salary. Generate and provide invoices to your client which sets out the services you have provided or are providing. You can choose to invoice at various stages of your service, just ensure you include a clause in your contract. Any type of payment should be received through your invoices. 4. Do not accept fringe benefits
• These can include insurance coverage, fitness memberships, meal plans, or employee discounts. Such benefits are usually an important factor in choosing employment over contracting and is a signature trait of employment. An independent contractor should be responsible for their own benefit plans.
5. If you can, provide your services to more than one client or company
• A standout quality of being an independent contractor is the ability to contract work out to more than one client. If you don’t have many clients at the time, ensure that your contracts do not include any clauses that would prohibit you from working with other clients, such as non-compete clauses. Non-disclosure agreements (NDAs) on the other hand are standard procedure and should not affect your status. 6. Establish yourself as a business
• If possible, have a business plan. Think about the skills you offer your client and how you can provide those skills as a service to multiple clients.
Whether you’re looking for a job or want to offer your skills as a service to multiple clients, you might consider becoming an independent contractor instead of traditional employment. This avenue offers a different opportunity to employment but should be considered and planned carefully. As you have learned, there are many benefits to being an independent contractor, including significant tax benefits that allow you to maximize your business potential. At the same time, it can be tricky, and you could end up being labeled a PSB, incurring more taxes and losing out on traditional deductions available to self-employed workers. If you are considering work as an independent contractor, please plan carefully. If possible, seek out legal and business advice from a business lawyer, or tax advice from a tax lawyer or an accountant. At Amar-VR Law we have advised many clients on this matter and have provided them with business reports tailored to their specific scenarios. Though we cannot guarantee our clients won’t be considered PSBs, we work with them to devise strategies they can implement to safeguard their status as independent contractors and prepare for any potential surprises. If you have any questions or concerns about any of the subject matter discussed in the article, please feel free to get in touch and click the contact button below.