Authored by Philip A.S. Milley, Associate Director of Legal Affairs
A common issue faced by charities is how to properly classify individuals as either employees or independent contractors. Courts refer to the distinction as contracts “of service” (employee) versus contracts “for services” (independent contractor). Whatever you call it, the determination of whether an individual is an employee or an independent contractor is important to get correct. Whether one is an employee or an independent contractor is fact specific and the determination must be completed on a case by case basis. It is advisable to seek legal advice when making this determination.
Why is the distinction important?
Employees and independent contractors are treated differently with respect to various rights and obligations. Employees enjoy some rights on termination. They also enjoy certain entitlements under employment standards legislation such as overtime pay, minimum wage, and paid vacation which are generally not enjoyed by independent contractors. Furthermore, employers are generally obligated to make various source deductions and remit payments respecting income tax and workers’ compensation amounts.
What’s the Problem?
Organizations are attracted to the cost savings and increased flexibility contractors offer. Organizations commonly intend to create a independent contractor relationship to avoid the costs and liabilities that are seen to come with an employment relationship. Problems arise when the relationship suggests an employee employer and not an independent contractor relationship.
Often, individuals who become independent contractors do not fully understand the consequences of doing so. Individuals are rarely informed and seldom understand the consequences and obligations of not being classified as an employee. Being classified as an independent contractors means that an individual can be responsible for, among other things, EI, CPP, Worker’s Compensation, insurance, and other potential liabilities.
Getting the classification wrong can result in the organization paying past source deductions, remittances, penalties or wrongful dismissal damages. This is exactly what happened in the recent Tax Court of Canada case Sistema Toronto Academy Inc. v MNR that reinforces the principle that charities should not merely rely upon their subject intention to create an independent contractor relationship, but ensure that their conduct demonstrates that an independent contractor relationship is created.
In this case, the Minister of National Revenue ruled that Sistema was responsible for various payments as the result of the determination that its instructors were engaged in “insurable and pensionable employment”, within the meaning of paragraph 5(1)(a) of the Employment Insurance Act and paragraph 6 (1)(a) of the Canada Pension Plan. The issue the court considered was whether the instructors were engaged under a contract of service (as employees) or a contract for services (as independent contractors) during the periods covered by the rulings.
Material Facts of the Case
Sistema Toronto Academy Inc. (“Sistema”), a registered charity, provided free after-school music instruction to disadvantaged youth in elementary schools in Toronto. Sistema engaged professional musicians to provide musical instruction on behalf of the charity. In 2011, instructors were hired as employees, which was clear from the employment agreement. In September 2012, Sistema decided that newly hired instructors would work as independent contractors. The only material difference in how the two groups of instructors were treated was respect to source deductions. Instructors engaged in September 2012 or later did not have source deductions taken from their pay, while those hired prior did.
In 2014 the engagement letter for instructors was modified to clarify that the instructor were independent contractors, which was signed by several of the instructors. The revised engagement letter modified the following terms of the agreement:
- The term “employment” was changed to “engagement”
- Sistema no longer agreed to pay the instructors vacation pay and for statutory holidays
- Sistema no longer agreed to pay severance pay and to provide notice of termination
- The instructors were required to use their own instruments
- The revised letter specifically set out that no taxes or other source deductions would be taken and that the instructors were required to determine their obligations for HST
- Restriction on taking other work that might conflict with the instructors’ duties was removed
Despite these changes very little in the relationship between Sistema and the instructors changed. The following factors were noted by the court as relevant to its determination.
- instructors were required to provide their services four times a week at 3:45 and were not flexible in scheduling their work.
- Sistema set the repertoire of pieces to be played.
- Some instructors submitted lesson plans during the material times.
- Instructors were responsible to set the curriculum for the students but Sistema held a meeting for the purpose to develop a common curriculum.
- Sistema required the common use of terminology for students.
- Ad hoc meetings were held each week to relay information to instructors.
- Sistema held professional development workshops
- The instructors were subject to informal evaluations and random classroom visits
- If an instructor was unable to teach a class he was required to contact the centre coordinator
The “Fourfold Test” Applied by the Court
The Court first examined the express intention of whether the parties intended to create an independent contractor relationship. The Court then proceeded to examine the parties’ conduct to determine the actual nature of the parties’ relationship. The Court applied the “control test” factors that were set by the Supreme Court of Canada in the cases Sagaz in assessing the parties’ conduct. The control test examines who controls the work and how, when and where it is to be done. In theory, if the worker has complete control over the performance of his work once it has been assigned, it might qualify the worker as an independent contractor. On the other hand, if the employer controls the performance of the work or has the power of controlling the way the employee performs their duties the worker may be an employee.
The Court noted that in the case of specialized employees, which was the case here, the “control test” is insufficient and the “fourfold test” should be applied. The “fourfold test” realizes the same end as the “control test” through examining the below factors in determining whether the relationship is more akin to an employment or independent contractor relationship. They factors are:
1. Control (i.e. the “control test”);
a. The employer’s power of selection of the employee;
b. Whether the employer paid wages;
c. The employer’s right to control the method of doing the work; and
d. The employer’s right to suspend or dismiss the worker.
2. Ownership of tools;
3. Does the individual have a chance of profit; and
4. Who bears the risk of loss?
The Court’s Conclusion
The Court concluded that even though the parties may have intended to create an independent contractor relationship the instructors were more accurately engaged under a “contract of service” and were employees. The Court considered the degree of control exercised by Sistema, or the right to exercise control over the instructors, to be more consistent with an employment relationship. The acquiescence or acceptance to having no source deductions made was not convincing evidence to the Court that an employment relationship was not intended. Sistema was therefore liable to the Minister for the unpaid source deductions.
What this Means for Charities
Charities should be cautious when making the determination as to whether an individual is an employee or an independent contractor as significant financial consequences may flow from an incorrect characterization. Charities should be wary of ignoring the objective reality of the relationship and falling into the trap that thinking an intention to create an independent contractor relationship is sufficient. Legal counsel can assist in drafting adequate agreements and establishing proper practices so risk is mitigated.
Noteworthy is provided for general information purposes and does not constitute legal or professional advice. Every organization’s circumstances are unique. Before acting on the basis of information contained in this blog, readers should consult with a qualified lawyer for advice specific to their situation.