Controlling costs and staying flexible are important to nonprofits – especially during challenging economic times. Thus, some may implement a hiring freeze to control overhead, others may strive to build their volunteer base to handle more tasks, and some may hire external service providers on a part-time or project basis.

When engaging a contract worker, however, it is important to make the working relationship very clear. The distinctions between independent contractor and employee can sometimes be fuzzy and if the Canada Revenue Agency (CRA) later reclassifies a contract worker as an employee, your organization could be liable for significant costs and penalties. Here’s how to reduce this risk.

First, there are some important points to keep in mind if you plan to hire contract workers. When you hire a contractor, you do not deduct Canada Pension Plan contributions, employment insurance premiums, or income tax from this worker’s pay. Neither should you allow this individual to participate in any of your organization’s benefit plans. As well, you do not remit the employer’s share of an employee’s CPP contributions and EI premiums to the Canada Revenue Agency.

If the CRA later determines your contract worker to be an employee, your nonprofit could be liable for not only the employer’s share but also the employee’s share of CPP and EI premiums and withholding taxes. Penalties and interest may be levied on the under-remittance of these taxes. If your organization is based in Ontario, it could be liable for employer health tax on these payments. Holiday and vacation pay could also become liabilities.

Budget planning for 2010

GST is an additional cost when using a contractor rather than an employee because nonprofits do not qualify to claim 100% of the GST paid on expenses as an input tax credit.

Starting July 1, 2010 in Ontario and BC, the new harmonization tax (GST+PST) will increase the amount of non-recoverable tax incurred when hiring consultants.

When preparing your organization’s 2010 budget, you may need to include this added cost if you use the services of a significant number of independent consultants.

Avoid costly mistakes

As you can see, getting the relationship wrong could be a very expensive error – not only for your nonprofit, but also potentially for your volunteer directors. They could be held personally liable for unremitted employee source deductions if the CRA successfully challenges the working arrangement.

Such challenges are far from rare. For example, when a contractor completes work with an organization and does not have new work, visiting an employment insurance office and claiming the relationship with the organization was that of employer and employee is not unusual. In such cases, the CRA will often challenge the organization’s claim that it had an independent contractor relationship with the individual. This is one of the reasons why it is important to take the right steps to clarify the relationship between your organization and any contract workers that you hire.

To assess this relationship, the CRA will review the situation by asking both the organization and the worker to clarify whether they intended to enter into a “contract for services” (business relationship) or a “contract of service” (employer-employee relationship). The CRA will try to determine whether both parties had the same intention and may ask to review a written agreement that sets out the terms and conditions of the arrangement.

If the intent is not clear, as a next step, the CRA may ask both parties a series of questions to clarify the working relationship. These typically focus on the following areas.

• How much control each party has regarding what work will be done and how it will be done.
• Which party provides the tools and equipment to carry out the work.
• The degree of financial risk assumed by the worker; for example, whether the worker incurs any fixed ongoing costs or any expenses that are not reimbursed.
• Whether the worker has an opportunity to make a profit or to realize a loss; for example, where there is a fixed fee to do a job and it turns out to take longer to complete the assignment than the contractor originally estimated, the contractor is not entitled to additional compensation.
• The degree of integration of the contractor’s work in the entire organization’s operations; the work carried out by the contractor should be considered necessary to the organization, but not an integral part of it.

 

It’s important to know that these are only general tests and there are no absolute right or wrong answers. In fact, a number of cases have gone to court to contest a determination by the CRA of the employer-worker relationship. One case involved certain dancers hired by The Royal Winnipeg Ballet. In this case, the Tax Court of Canada ruled that these dancers, who had been engaged by the ballet company for a specific period of time, were in fact employees rather than independent contractors. Fortunately for The Royal Winnipeg Ballet, the Federal Court of Appeal overturned the trial decision, partly as a result of a written agreement that specified the nature of the workers’ relationship with the ballet company.

Additional points to ponder

You don’t want to have to do battle with the Canada Revenue Agency. It would obviously be helpful if the CRA provided organizations with a form for contract workers to sign agreeing that the intended relationship is that of independent contractor, in order to eliminate an organization’s potential exposure. So far, however, this is only wishful thinking…

While there may be no bulletproof protection, if you do hire contract workers there are steps you can take to minimize the risk of the CRA reclassifying these contractors as employees.

You might want to start by familiarizing yourself with the CRA publication, Employee or Self-employed? (number RC4110), for guidelines regarding how the CRA determines the appropriate employment status.

You can also develop a written agreement when you hire a contract worker that sets out the details of your “contract for services,” including the areas mentioned in the CRA booklet.

It also adds weight to the “contract for services” relationship if your service provider’s business is incorporated, and/or has a GST number that is noted on the invoices submitted to your organization.

As well, to minimize their exposure to liability, directors should specifically ask management in board meetings whether employee source deductions have been remitted on a timely basis. Board minutes should include the response to this question.

When hiring a contract worker, taking these steps to clarify the business relationship will help to ensure that rather than spending time negotiating with the Canada Revenue Agency, you can focus on carrying out the vital work of your nonprofit.

Bill Otton is a partner of BDO Dunwoody LLP. A Chartered Accountant (CA), Certified Trust and Estate Practitioner (TEP) and past president of the Estate Planning Council of Toronto, Bill provides a range of tax services to both nonprofit and for-profit organizations. You can reach him at (905) 946-2508 or BOtton@BDO.ca.