Transportation companies today often use subcontractors in place of employees, usually (though not exclusively) as drivers. In an increasingly competitive economy, the benefits of this decision can be significant.
But there are risks as well. Many companies have been unclear in their agreements with contractors, and left themselves and their contractors exposed to the risk of serious and costly repercussions with the Canada Revenue Agency (“CRA”).
BDO has helped many clients to identify tax risks associated with subcontractor relationships, and advised on creating arrangements that minimize or mitigate such risks.
Why engage subcontractors?
Subcontracting offers companies both financial and operational advantages.
Financially, the practice converts a significant portion of a company's fixed costs into variable costs. This means your company no longer has to worry about meeting payroll or having unused resources, as your volume of work fluctuates. Your investment in human capital can vary directly with your business activity – increasing when your revenue grows, and decreasing during slower periods – providing a much more efficient and effective way to manage your costs and cash flows.
Since subcontractors aren't on the payroll, the company is not responsible for remitting their payroll taxes – such as income taxes, CPP contributions, EI premiums and EHT – or other common employee benefits and obligations, including pensions, health, dental and life insurance, which can help reduce your total overhead costs. The Worker's Safety and Insurance Board (“WSIB”) is governed by a separate Act and may have different determinations for employee versus subcontractor status which should be consulted in each particular circumstance.
Operationally, using subcontractors can improve your company's flexibility and competitiveness, and your ability to respond quickly and effectively to new opportunities that present themselves. Additionally, many of the operational inconveniences typically associated with owning your own fleet, such as maintenance, repairs, permits and insurance are transferred to the subcontractor in such an arrangement.
Subcontracting drivers are responsible for their own efficiency – which can reduce your management costs. Company and drivers are in partnership, sharing the same desire to maximize revenues and minimize costs.
What are the risks?
Because of the different tax implications for employees and subcontractors, the CRA is very strict in distinguishing between them. It's imperative that companies be just as strict in their own arrangements.
If a driver is considered a subcontractor, fees paid to them may be subject to GST/HST, if the subcontractor earns over $30,000 in a year. Such GST/HST payments may qualify for an input tax credit which can reduce your overall GST/HST liability in a particular year.
The company should report all payments made to the subcontractor for the calendar year on a T4A slip.
On the other hand, as previously noted, if the driver is considered an employee, the company is responsible for remitting all payroll taxes and income tax withholdings on their earnings and possibly WSIB obligations.
The company should also report earnings on a T4 slip each year.
Failure to make these withholdings or tax filings can result in a costly diversion of cash to cover the payments, together with interest payments and possible fines, and can potentially trigger a full-scale payroll audit by the CRA.
It is vitally important for your company to ensure that your subcontractors meet the CRA's criteria, in order to minimize the risk of being reclassified by the CRA as employees.
What does the CRA consider?
There is no one-size-fits-all definition of a subcontractor – every business is different. Recognizing this, the CRA considers a number of factors, and may weigh them differently in different cases. All these factors should be taken into account when drafting agreements with subcontractors:
Control
Who controls the work done, and when and how it's done? Generally, a company manages its employees' priorities and workflows, but leaves subcontractors free to deliver their product or service in their own way (within agreed-upon parameters). Subcontracting drivers will typically schedule their deliveries and determine their own routes.
Similarly, an employee who wants to do work for another company would likely have to ask their employer's permission – while subcontractors often work for a number of different companies.
Tools & Equipment
Who owns them? Independent contractors typically provide their own trucks, tools and equipment. A driver who only drives a company-owned truck may be considered an employee.
Financial Investments
Subcontractors invest their own money in their businesses, and control their own costs, in order to make a profit. Employees typically are paid a fixed amount hourly or monthly, and bear minimal financial risk.
For example, if a subcontracting driver's truck breaks down and the load can't be delivered, the subcontractor might not get paid, whereas an employee driver would most likely continue to be paid.
Integration Test
Step back and look at the work activities being done by your people. Are they so integrated that an independent observer would conclude that the driver is an employee?
For instance, the CRA would conclude that an executive is an employee. They might feel the same about a driver who only works for one company. On the other hand, a driver who works for a number of companies looks more like an independent contractor.
Intent
The CRA will try to determine if the individual contracted to provide service to the company over an indefinite period (as an employee does), or to provide specific services for a more limited period (more typical of an independent contractor).
A recent case
If you're thinking this is all pretty complicated, you're not alone. To understand how crucially important interpretation is in this area, consider the Big Bird case.
In 2013, Big Bird Trucking Inc. of Calgary contracted with three drivers to provide services to the company. Big Bird provided the trucks, trailers and insurance, and offered loads to the drivers. The drivers were free to accept or decline any load, and a driver who did accept was free to hire another driver to do the driving. In order to be paid for a load, the drivers had to submit an invoice, with their GST number on it.
The CRA determined that the drivers were not independent contractors, but employees.
Big Bird appealed to the courts, and won. One of the reasons given was that, if Big Bird had not been paid by its client, the drivers would not have been paid either. The Judgment pointed out that the drivers didn't own their own trucks, and therefore were not in the transport business – but they did drive trucks, and could therefore be considered to be in the driving business because the drivers provided the services of driving which required the necessary qualifications and licenses.
Protect yourself
Since the CRA will consider a whole range of factors when looking at a particular case, it is important for the relationship between company and subcontractor to be clearly documented in a written contract.
Talk to BDO. Our tax experts can review your current and potential relationships with your independent contractors. We can provide tax advice that will assist you to maximize the advantages of entering into such a relationship while minimizing or eliminating the tax risk.