You’re about to hire an employee. But he has his own business and wants to be an independent contractor. That way, he’ll pay less tax. And it’s easy for you too — you will just have to pay his invoices and won’t have to include him in your employee headcount.
But wait. There can be significant consequences from incorrectly characterizing an employee as an independent contractor. Not only can the individual, at the end of the relationship, claim he was really an employee and entitled to significant severance benefits, the tax authorities can also come knocking, as was the case recently in Quebec.
Richard Darveau is the principal director and executive officer of four companies. Through a trust, he owns 100 percent of a holding company (Groupe Bermex Inc.), which has full control over three subsidiaries operating in the furniture industry (Bermex International Inc., Finition Chez Soi Inc., and Confortec 2000 Inc.).
After the Department of Revenue completed its tax audit and the companies answered a questionnaire, all four companies received notices of assessment for 2003, 2004, and 2005 totaling $177,653.69, on the grounds that the amounts paid to Darveau as management fees for the years in question should have been considered employment income and subject to the deductions at source.
Although the companies challenged them, the assessments were maintained.
The issue before the Court of Québec and the Québec Court of Appeal was this: Is Darveau a self-employed worker bound by a service contract or an employee who is a party to a contract of employment?
According to the Court of Québec, although the control he exerts over the companies gives him a freedom similar to that of a self-employed worker, he nonetheless is a salaried employee.
The Court of Appeal confirmed this decision, indicating that the relationship of subordination and control is the main criterion used to distinguish a contract of employment from a service contract. To determine that relationship, the Court of Appeal examined the extent to which the worker was integrated into the business’ activities. It found that this criterion, although developed in common law in provinces outside Quebec, was equally applicable under Québec civil law.
The following elements were indications that Darveau is highly integrated into the companies’ activities and thus is a salaried employee:
- The nature of the services rendered to the companies, namely the development of policies, procedures, and resolution of short-term problems;
- The considerable income drawn from the companies and the absence of any need to develop a clientele;
- The absence of any written agreement;
- The fact that no consulting services were rendered to other clients;
- The fact that there were no replacements in the event of his absence;
- The absence of any report to the companies of the activities engaged in and evaluation criteria for the services rendered; and
- The active role in determining his own duties.
Furthermore, the following factors were inconsistent with Darveau being an independent contractor:
- Absence of any risk of losses or chance of profits;
- The monthly remuneration was received as constantly as a salary;
- Fees were invoiced in advance, without any subsequent adjustment to reflect time actually worked;
- The work was performed in the companies’ offices;
- No tools or equipment were provided by Darveau; and
- Darveau brought no particular expertise.
Lessons to employers
This Québec Court of Appeal decision confirms that improperly identifying the contractual relationship can have a considerable financial impact on Canadian employers. As in the case in all provinces, it is therefore important to accurately characterize an individual as an employee or independent contractor from the very start.
Even though a written contract characterizing an individual as one or the other may be useful when evaluating the parties’ intent, it won’t be determinative. Instead, the courts won’t hesitate to go beyond the text to examine the true nature of the relationship between the parties.