When you start a business, there isn’t really a playbook that explains how to implement the human resources function or how to mitigate risk to your business. Most often than not, it is trial by fire. Sometimes we will see a business wait until they have about 75 employees before they introduce human resources practices to their company. Other times, it might be during a firestorm where they are facing litigation stemming from a termination. A common myth seems to be that the human resources function is not required in a business until it grows beyond at least 50 employees. While a small business may not require a full-time HR professional immediately, there are certainly several HR practices that can be implemented to mitigate risk for a small business.
In today’s blog, we will discuss the employee versus contractor debate and provide a little guidance on the process of choosing which route to go.
Employees Versus Contractors
The good ol’ debate on whether to hire employees versus contractors has been around for a while, along with the potential repercussions of choosing Door #1 over Door #2. Making the wrong choice early in the life of your business can have a catastrophic impact and may even result in you going out of business. It certainly can be tantalizing to classify everyone as independent contractors, as the cost savings can be substantial. You can avoid having to make EI and CPP contributions, expensive benefits programs and retirement plans, pay vacation, among other costs related to an employer-employee relationship.
Let’s first look at some of the benefits of hiring independent contractors versus employees. First, hiring independent contractors can offer a business much more flexibility. If things are slow, you can easily provide written notice to a contractor without having to provide an expensive severance package. You can also easily modify working hours so that you can staff the organization based on workload. Another huge benefit for the company would be avoiding all those expensive perks, benefits programs, and statutory deductions as noted in the above paragraph.
Next, let’s look at the downside of hiring independent contractors versus employees. It is fairly simple; you would have to catch up on all those statutory deductions and vacation pay! This is where it can get expensive for a business. Imagine you are in business for ten years, and for much of this time, you’ve been utilizing a workforce of 100 independent contractors. Hypothetically, let’s assume that 50 of these people have been with the company for at least five years. If all 50 of these independent contractors were then classified as employees, the costs would be staggering, as you would have to catch up on deductions (EI, CPP) and vacation pay for 50 people for a 5-year period.
The next logical question would be; how will I know when I should hire someone as an employee versus an independent contractor? CRA has made that clear (relatively). They have designed a 4-point test which you can use for guidance. The test focuses on 4 areas of the employer-worker relationship; control of work and schedule, ownership of tools, opportunity for profit/loss for the individual, and integration of the business’s activities to those commercial activities of the worker. CRA will also look at whether you impose restrictive covenants in a contract, such as a non-compete, which would lend more to the employer-employee relationship. My advice is to discuss with your Accountant, Lawyer, or Human Resources Consultant to make an informed decision on whether to hire someone as an employee or independent contractor.
You might also go for ten years without any challenge from CRA, but it is extremely risky. It only takes one employee to raise their hand to CRA and say, “hey, I think I am an employee, and should have EI/CPP deductions on my cheque”. Once you’re on CRA’s radar, they will probably audit your entire workforce to make sure they are properly classified. The contractor may also inform CRA unintentionally during tax time. The bottom line is there is too much at stake here. It is better to take the time early on to make sure your business is setup correctly to avoid costly penalties down the road. In my opinion, the risk ain’t worth the reward…
Keep an eye out for our blog next week, where we will discuss the importance of investigations when receiving a harassment complaint.