Articles & Media

Direct Service Providers: A Caution


by Hugh McPhail, Q.C.

We continue to see a common use of “direct service providers” and other similar contractor arrangements. They all assert that the individuals are “contractors” and not “employees”. Some of these situations involve individuals who are controlled and directed like employees, work exclusively for the employer for a long time, and have little independence in an entrepreneurial sense. We have been concerned for some time that many of these individuals, if the issue is tested, will be determined to be employees. So what? Why should employers care?

Most people only seem to focus on the income tax ramifications of the classification. As long as the direct service provider used an incorporated company, the Canada Revenue Agency did not seem to be concerned about these relationships. Some employers have even been sloppy about that (e.g., a trade name is not a corporation). However, there has been an important new development on the tax side that we will discuss further below, which may soon make most of these arrangements undesirable for individuals.

Our concern from an employer perspective has been amplified by recent cases which have highlighted concerns beyond those related to income tax. The Federal Court of Appeal recently decided that subcontractors with typical contracts were nevertheless “employees” for the purposes of employment insurance and Canada pension plan contributions and eligibility. The New Brunswick Court of Appeal recently decided that certain "assistants" working for Canada Post Corporation were employees for the purposes of WCB coverage even though the collective agreement with the affected union stated that they were not employees. The definition of “employee” for human rights purposes has always been much broader than under other legislation. Now a British Columbia case has recently decided that a partner in a law firm is an “employee” who cannot be subject to mandatory retirement. The Alberta Labour Relations Board recently decided, in a series of surprising cases, that many cabdrivers are “employees”, even if they own their own cabs and work when they want.

What are some of the other consequences to employers when “contractors” are found to be employees? One consequence is that employers could face considerable liability under employment standards legislation for entitlements such as overtime, vacation pay, holiday pay, or termination pay. Another is that you may be directly liable for the contractor's activities or disabilities. Wrongful dismissal claims could also be expensive if “subcontractors” are actually classed as “employees,” though a carefully worded termination provision can assist you in either event.

It is important to understand that an agreement stating that someone is not an employee is not sufficient to avoid obligations if the true relationship meets the definition of “employee” (and that definition often varies somewhat depending on the legislation involved). This is an area requiring careful attention. Well-crafted contracts can help lower the risk to employers.

There is one recent development that could mean an end to employees wanting to be paid as direct service providers. The Federal Minister of Finance has announced an intention to tax incorporated employees at a higher rate. When these changes become law, there will actually be a tax disadvantage to working employee pay through an employee’s personal corporation. That could spell the end of the drive to use direct service provider arrangements. It is impossible to say when these changes will be effective, but they appear to be on their way. For more information, click here to see a related article written by our Estates, Trusts & Taxation group


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