Employers today are struggling to attract and retain a shrinking pool of top talent, and within dealerships, this is no exception. As a result, dealers have needed to get more creative with their pay packages and structures.
Many key dealership employees are requesting to be paid as independent contractors, either as an individual or via their own company, instead of being paid as an employee. The idea is that paying them as contractors will allow them a tax deferral where they can benefit from lower “small business” tax rates and potentially pay less personal tax. However, in many cases, this structure carries significant risk to both the dealer and the potential contractor.
Paying individuals as independent contractors
Dealers should be aware of the considerable risks that they are assuming if they choose to pay an individual as an independent contractor. If the Canada Revenue Agency (“CRA”) later determines that this individual ought to have been classified as an employee, CRA can assess the employer for all unreported payroll remittances for the Canada Pension Plan and Employment Insurance (CPP and EI), along with what can be significant interest and penalties.
Paying individuals as contractors through their own corporation
Another structure that dealers may see is the request to pay an individual as a contractor via that individual’s company. While this may seem to be a convenient workaround to the risks mentioned above, it opens the dealer and especially the individual to risks that may be equally unattractive if CRA considers the individual’s business to be a Personal Services Business (“PSB”).
A PSB is not eligible for the preferential small business tax rate and instead is taxed at the highest corporate federal tax rate of 33 percent plus the applicable provincial tax rate. In most cases, this will be a higher tax rate than what the employee would pay if they had earned that income personally working for the dealership. In addition to the high tax rate, PSBs are also limited in the type of expenses that they can deduct for income tax purposes — a limited list including meals, travel expenses, and wages paid to the individual providing services (the “incorporated employee”) are allowable.
A corporation would not be considered a PSB if it employs more than five full-time employees — a difficult test to meet in this circumstance, as such corporations typically just have a single employee. In circumstances with five or fewer employees, the individual would need to argue that the answers to the follow- ing four tests indicate their role would be one of an independent contractor assisting a dealership, and not an employee of the dealership.
- Control – How much control does the company/operator have over their work? A contractor would be expected to have much more control than an employee.
- Chance of Profit / Risk of Loss – Does the company have the ability to increase its income or is there the risk that the company would have financial loss? An employee does not control income or carry risk of losing profit because they’re paid a fixed salary, while contractors can increase their income through efficiencies and also carry risk of financial loss.
- Ownership of tools – Does the company provide the tools to complete the contracts? An employer is normally responsible for providing its employees with tools, but an independent contractor would have their own.
- Integration – Is the company/operator integrated into the payer corporation? An employee is integrated into the operations of their employer, while an independent contractor is not.
From the employer’s perspective, paying individuals as subcontractors via their company is usually preferable. However, there are some disadvantages to consider. Below is a list of the potential pros and cons an employer should be aware of when considering compensating an individual through their company:
- The employer no longer has to make payroll remittances for that individual; they would save the employer portions of EI and/or CPP.
- If the individual is no longer considered an employee, the employer typically would not have to pay for them to be a part of the company pension plan or health benefits plan, nor pay for other costs such as vacation pay, statutory holiday pay, and severance.
- CRA has generally taken the position that as long as there’s a contractual arrangement between the employer and the corporation owned by the individual, it would not deny the subcontractor expenses that an employer incurs, nor assess penalties for not remitting payroll withholdings.
- A 2020 class action against a dealer re- resulted in the Ontario Superior Court awarding an individual, who had been compensated as an independent contractor, $5 million for unpaid employment benefits to which the individual felt they were entitled. The courts upheld that the individual, while not considered an employee, should still be entitled to the same benefits that an employee would receive due to the nature of the work being completed.
- A dealer could experience reputational damage if it’s perceived as having forced an employee to become an independent contractor as a means to avoid paying them employment benefits.
From the employee’s perspective, being paid through a company rather than as an employee has some significant risks. Even if the employee believes they’re an independent contractor based on the four tests, an audit by CRA could determine otherwise. Below is a list of the possible pros and cons an employee should consider in deciding whether to incorporate:
- If they believe that they can substantiate that the company is not a PSB and file as a regular small business corporation, they would be able to have access to the small business tax rate.
- Their company would receive their gross pay and have no payroll remittances or tax withholdings so they would receive more income upfront.
- If they don’t file as a PSB and CRA were to reassess, there would be additional tax to pay (with interest) and potentially gross negligence penalties for not self-declaring as a PSB.
- Assuming they do file as a PSB, they will need to either pay high-rate corporate tax or pay themselves a wage to bring taxable income to $0. In either situation, they’re going to pay either the same amount or more tax than they would have as an employee. Their company would also have to pay the employer portion of CPP on any wages paid, adding to the total cost.
- There are additional costs to incorporating and maintaining a company that they would not have to incur if they were an employee, e.g., corporate registration fees, business insurance, procurement and maintenance of equipment, and costs of corporate tax filings.
- They would not be able to benefit from other “perks” of being an employee, such as health benefits, company pension plan, or receiving vacation pay. In addition, they would no longer be protected as an employee under the employment standard laws in their province.
In a situation where an individual has previously been an employee for a period of time and then decides to incorporate, there would be a significant risk of reassessment by CRA to treat the company as a PSB. Unless there has been a significant change in the nature of the individual’s duties and relationship with the employer, it is likely that CRA would still view the individual to have an employee relationship as opposed to an independent contractor.
Due to the risks involved and the punitive tax rates associated with being assessed as a PSB, it’s therefore generally not recommended for individual employees to incorporate.
Written by: Whitney Procee
WHITNEY PROCEE is a member of MNP’s Tax Services team. With more than a decade of experience, Whitney focuses on specialty tax, working one-on-one with clients in a variety of sectors. She provides professionals, and clients in the auto dealership and agricultural and sectors with a breadth of tax planning options that allow them to choose the approach that best suits their needs.
Whitney delivers tailored corporate and personal tax planning, acquisitions and business sales and succession and estate planning services. She prides herself on providing great client service with a personable approach.
Whitney earned a Business Diploma from Lethbridge College in 2007 and a Bachelor of Management in accounting from the University of Lethbridge in 2009. She is a Chartered Professional Accountant (CPA), qualifying as a Chartered Accountant (CA) in 2012.