Contractors working in Canada are subject to a similar battery of employment tests to the IR35 tests used for those working in the UK. These tests include the familiar-sounding ones for control, provision of tools and equipment, financial risk and opportunity for profit.
And if the tests sound familiar, so too is the potential for ambiguity, as the Canada Revenue Agency (CRA) says that no one factor determines whether the contractor is employed or self-employed. As is the case for UK contractors, each case is judged on its individual merit.
Further complications are that the interpretation of employment tests is subject to evolving case law, and, in addition to CRA, other organisations such as provincial or territory-based agencies may also have statutory powers over the enforcement of employment law.
IR35 future – lessons from Canada?
So, when considering the IR35 future, and finding a fair and workable IR35 successor that would tax disguised employees properly, without penalising contractors, are there lessons to be learned from the Canadian system?
One of the important differences between the UK and Canadian systems is where the responsibility lies for errors. In Canada, if a contractor is found to be a disguised employee, then it is the client that is punished. They have to pay the back taxes and other costs of employment on behalf of the worker, plus a fine of up to 20% of the unpaid taxes.
The situation in the UK is very different, where the burden of errors falls on the shoulders of contractors, who have to shoulder the full financial impact of IR35. If the UK’s IR35 successor mirrored Canada’s laws, contractors inside IR35 would not be liable for the unpaid taxes.
Employment status – Step 1 establishing intent
With the exception of the province of Quebec, which applies its civil code rather than the common law applied elsewhere in Canada, the CRA provides a guidance document, RC4110-10e, which provides information about what factors are applied to determine a worker’s status.
The CRA adopts a two step-process that is very similar to that used by HMRC in the UK. Step 1 is an assessment by the CRA of the intentions of the contractor/worker and client. It asks whether the relationship is a contract of services, where the contractor is really an employee, or a contract for services, where the relationship is a business one. This often requires examining the written contract between client and contractor.
Step 2 – key factors indicating employment status
In Step 2, the CRA asks a series of questions designed to reveal the true nature of the working relationship between client and contractor. The aim is to find out whether what the client and contractor claim in Step 1 is reflected in reality.
In Canada, if a contractor is found to be a disguised employee, then it is the client that is punished
The CRA’s guidance identifies the key factors it applies to determine employment status, providing examples of what it would consider self-employment or employment. These factors are:
- Control, which the CRA defines as, “the ability, authority, or right of a [client] to exercise control over a worker concerning the manner in which the work is done and what work will be done”
- Tools and equipment, where a genuine contractor supplies their own tools and is responsible for their upkeep and repair. The CRA also acknowledges that in some trades employees are expected to supply their own tools
- Subcontracting work or hiring assistants, which is not the same as the UK’s ‘substitution’ test, but is taken to imply a level of financial risk on the part of the contractor if they pay other workers
- Financial risk, which covers a range of factors, such as hiring subcontractors or staff, performing work at the contractor’s place of business, being hired for specific projects, liability for breach of contract or non-performance, not having employment benefits and the contractor actively marketing their services
- Responsibility for investment and management, which identifies making capital investment, hiring staff and having a ‘business presence’ as factors in favour of self-employment
- Opportunity for profit, which means a genuine contractor can control income and expenditure in order to show a profit, but allows for the possibility of making a loss. This is where, under CRA guidelines, employing substitutes is an indicator of self employment.
The Civil Code of Quebec considers slightly different factors:
- Performance of work, which simply means the worker must actually do the work
- Remuneration, which means that there must be a consideration, normally payment
- Relationship of subordination, which is similar to control, and uses ‘what, who, where, when and how’ questions to find out how the work is performed.
Clients or contractors can request a formal status review from the CRA, which will apply the above tests to determine whether the contractor is an employee or self employed.
There is also additional guidance provided for construction workers, and other occupations like hairdressing, fishing and taxi driving, all of which have special rules.
Further special rules apply to placement/employment agencies. As in the UK, workers can be on the agency payroll and are taxed and make pension and employment insurance payments accordingly. If the worker is a genuine contractor and considered self-employed, assuming they pass the tests of employment, then the CRA’s guidance says that neither the agency nor the client is required to pay tax and insurance.
Applying employment tests that are interpreted according to each individual case and influenced by case law is very similar to applying IR35 in the UK. But in Canada, it is the client that pays the price for errors, not the contractor.
If changes are made to IR35 in the future so that clients become liable, it may mean that UK agencies and clients take a greater interest in ensuring their contractors are outside IR35. But it could also mean that clients view the UK as a less attractive place to hire contractors, which could impact negatively on the UK’s contracting sector.