The incorporated employee

One of the most litigated personal tax issues in Canada concerns whether a person who provides services to a corporation is acting in his or her capacity as an “employee” or is an “independent contractor.”

Individuals often attempt, where possible, to structure their services as independent contractors, since the types of expenses that can be deducted to earn self-employment (business) income are far greater than the limited employment expenses permitted to be deducted by an employee.

Furthermore, the independent contractor is often tempted to incorporate and provide his or her services through the corporation which has access to the favourable low small business tax rates on its first $500,000 of active business income. Any amount not needed to fund the owner’s current lifestyle can then be left inside the corporation and invested, permitting a deferral of personal tax on the corporate earnings until they’re ultimately paid out as a dividend, perhaps many years later.

The Income Tax Act, however, contains a special anti-avoidance rule to prevent individuals who might otherwise be properly regarded as employees from incorporating their own companies which in turn provide services to what otherwise would have been their employers.

Under the Act, the “incorporated employee” is said to be operating a “personal services business” (PSB) and the consequences of this are severe. Income from a PSB is not eligible for the low small business tax rate and the corporation is restricted in the types of expenses it can write off for tax purposes; it’s limited only to the expenses an employee can deduct.

Traditionally, the courts have looked to a number of tests to determine whether a person is an employee or independent contractor. These tests include: the intent of the parties, the level of control exercised over the work being done and the chance of profit or risk of loss.

A recent case (609309 Alberta Ltd., Stan Nance v. the Queen, 2010 TCC 166) involved Stan Nance, who was an experienced Alberta ironworker and was employed by Spantec Constructors Ltd. (Spantec) in 1993 and 1994 until Spantec decided to close its Calgary office and end Mr. Nance’s full-time employment.

Spantec said, however, that it would like to have Nance continue working for it on an hourly basis.

Nance decided it would make sense for him to incorporate and, together with his then common-law spouse, incorporated 609309 Alberta Ltd. He provided all of the revenue- generating services to 609309’s clients and his then common-law spouse did the books, payroll, banking, liaising with accountants, etc.

In November 1997, Spantec and 609309 entered into a personal services contract which provided that 609309 would provide the personal services of Nance as a steel superintendent to Spantec. The contract provided that 609309 would receive $44 per hour worked.

In November 1998, a second contract was drawn up which provided that 609309 would provide Nance’s supervisory services on the same project at the same hourly rates.

It also provided that any expenses would be paid to Nance personally and not to 609309 and would be claimed using Spantec’s employee expense claim forms.

The main issue in the case, therefore, was whether Nance would reasonably be regarded as an employee of Spantec. Nance relied strongly upon the intention of the parties as evidenced by the terms of the personal services contract.

The judge, however, concluded that in the context of a PSB case, the intention of the parties is irrelevant since the “sought-after reduced (small business) rate and tax deferral could not be achieved to begin with unless the parties intended an independent contractor relationship.”

Secondly, the judge observed the opportunity for profit was limited to $44 per hour worked and all related expenses, including insurance, were borne by Spantec.

Finally, when it came to the control test, it was the opinion of the judge that the extent of control Spantec had and needed over the work done by Nance was such that a proper characterization of his services would have been one of employment. As the judge concluded: “[o]verall, it is simply hard to see how a worker on these contracted financial terms with Spantec could be said to be truly in business for himself.” The Judge ruled a PSB did indeed exist.

Jamie Golombek, CA, CPA, CFP, CLU, TEP is the Managing Director, Tax & Estate Planning with CIBC Financial Planning and Advice in Toronto.

Jamie Golombek

Tax & Estate

Managing Director, Tax and Estate Planning, CIBC Private Wealth Team Jamie Golombek is Managing Director, Tax and Estate Planning with CIBC in Toronto. As a member of the CIBC Private Wealth team, Jamie works closely with advisors from across CIBC to support their clients and deliver integrated financial planning and strong advisory solutions. He joined the firm in 2008 after 12 years with a global investment company, where he was involved in both internal and external consulting on all areas of taxation and estate planning. Jamie has also worked for Deloitte as a tax specialist in the Toronto office, where he specialized in both personal and corporate tax planning. Jamie is quoted frequently in the national media as an expert on taxation. He writes a weekly column called “Tax Expert,” in the National Post, has appeared as a guest on BNN, CTV News, and The National, and for several years was a regular personal finance guest on The Marilyn Denis Show. He received his B.Com. from McGill University, earned his CPA designation in Ontario and qualified as a US CPA in Illinois. He has also obtained his Certified Financial Planning (CFP) and Chartered Life Underwriting (CLU) designations. In 2023, Jamie was named a CPA Ontario Fellow. The FCPA is the highest distinction that can be bestowed upon a CPA who brings distinction to themselves and to their profession through leadership and achievement in their professional, community or personal lives. Jamie is a past chair of the Investment Funds Institute of Canada’s Tax Working Group. He is also a member of CPA Ontario, the Illinois CPA Society, the Estate Planning Council of Toronto, the Canadian Tax Foundation and the Society of Trust and Estate Practitioners. For nearly two decades, Jamie taught an MBA course in Personal Finance at the Schulich School of Business at York University in Toronto.