CRA WORKER CLASSIFICATION AUDITS
What Canadian Business Owners Need to Know
If you've received a letter or a phone call from the Canada Revenue Agency (the “CRA”) regarding your contractors, or a questionnaire asking how your workers are paid, who sets their hours, or who supplies their tools, it's natural to wonder what's actually being investigated. These first contacts from the CRA rarely explain what the CRA is actually looking to uncover or why, and that uncertainty can be unsettling on its own, especially when you don't know whether it's routine or the start of a formal audit.
Here's what you should know - if your business had or has “contractors” or “consultants” and the CRA instead determines that such workers were or are “employees” then the ultimate tax consequences that may follow, including, but not limited to, unpaid payroll liabilities, penalties and/or interest, can be substantial. Since the CRA’s enforcement powers are broad, they may investigate a significant number of historical years and the ultimate tax to be paid will be due from your business or directors of the business, personally.
This page discusses what a CRA worker classification audit is, how the CRA makes a determination that your contractors or consultants may actually be employees, what's at stake if the CRA audits or reclassifies your workers, and how Outsiders Law defends Canadian business owners including, for certain eligible files, on a “no-fee-unless-we-win” basis.
What Is a CRA Worker Classification Audit?
The CRA routinely runs employer compliance audits, sometimes as part of a broader payroll or source deduction review, to check that businesses are correctly classifying their workers. Employees are classified on payroll with source deductions for income tax, Canada Pension Plan contributions (“CPP”) and employment insurance payments (“EI”) and receive T4 slips. Contractors or consultants of a business require none of such activities, invoice the business on their own account and are taxed by the CRA separately. The issue arises if a business designates a worker as a contractor, does not make the requisite CPP and EI payments to the CRA and then, multiple years thereafter, is told by the CRA that such worker was, at law, an employee and that all of such historical source deductions are now owing together with applicable interest and penalties.
The CRA investigation into this issue usually starts quietly. You may receive a call from the CRA asking about your workers. You may receive an innocent-looking questionnaire. You may receive a “trust accounts examination - payroll” letter requesting certain information.
Or, you may receive a request to provide several years’ worth of: (1) payroll journals (registers) that show salaries, wages, taxable benefits, and commissions for each pay period and each employee, including deductions for income tax, Canada Pension Plan contributions, and employment insurance premiums; (2) summaries from the payroll journals (registers), showing the total income tax deductions, Canada Pension Plan contributions, and employment insurance premiums for each pay period; (3) list of subcontractors and self-employed individuals, their contact information, and copies of contracts and invoices; (4) bank statements and cancelled cheques; (5) electronic funds transfer statements; (6) detailed (names, amounts, and addresses) list of current accounts receivable (including the business's merchant number) and accounts payable; (7) list of assets; and/or (8) corporate documents (minute book, director registry, shareholder register).
In all of such queries, the CRA will request that a director of the business be present to answer CRA questions. None of these first contacts will tell you what the CRA is looking to actually do. None of these first contacts will tell you what the CRA thinks you owe. That number shows up much later, in a notice of reassessment, once the CRA has completed their review and obtained the answers they were looking for from you. The answers that you provide the CRA in these preliminary queries are critical and may be used against you.
How the CRA Decides: Contractor or Employee?
There's no single element that confirms whether a worker of yours is actually a contractor or employee at law. The CRA, and if it goes further, the Tax Court of Canada, will apply a multi-factor legal test generally organized around a few principles:
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Control - who decides how, when, and where the work gets done?
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Tools and equipment - who owns and maintains what is needed to do the work?
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Financial risk - in this arrangement, does the worker share in potential profit or risk of loss or are they paid for their time regardless of outcome?
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Integration - is the worker incorporated and/or running their own business with other clients, or is the worker really functioning as part of yours?
No single factor decides it, and a written contract calling someone a “contractor” or “consultant” is not sufficient. The CRA and the courts look at the substance of the relationship on a day-to-day basis. The CRA can reclassify the worker even if your paperwork says otherwise, which is exactly why this is a legal issue, not a question for your accountant or your bookkeepers.
What Happens If the CRA Reclassifies Your Contractors as Employees
If the CRA determines that your contractors or consultants are employees then your business becomes liable for any and all current and past payroll obligations that weren't withheld and remitted at the time meaning current and past due income tax, CPP contributions, and EI premiums, plus penalties and interest. Further, once the CRA has determined that one or more years of classifications may be incorrect, they usually continue their historical review and may even go back to when your business first started operating in certain situations. Because these audits look back over several years and across every worker in a similar arrangement, the numbers begin to exponentially multiply. Several workers over several years reclassified as employees is likely to become a significant tax liability for the business and its directors.
Are You Personally Liable?
Often, yes. Under certain sections of the Income Tax Act (Canada) and its associated regulations, directors of the business in question may be held personally, and jointly, liable for the businesses’ tax liabilities. The corporate structure doesn't automatically shield you. In some instances, Outsiders Law may be able to defend these directors, personally, on the basis of the “due diligence” defense in order to limit this personal tax liability exposure. But building that defence requires strategical decision making and legal evaluation of the issues at hand and it has to happen before or during the dispute, not after you have given the CRA all of the answers they wanted you to give them. This is another reason why this is a legal issue and not one for your accountant or your bookkeeper.
Why This Is a Legal Fight, Not an Accounting One
There is no doubt that your accountant is essential to your business. However, your accountant will not be adequately equipped, positioned and/or licensed to argue a multi-factor common-law test against the CRA, draft the correct notice of objection and/or take a matter to the Tax Court of Canada if required. This is a legal fight, decided with reference to legal tests and case law applied to your specific facts. You need someone who can make that argument on your behalf, and who is prepared to double-down in court if the CRA won't be reasonable. That's what a tax lawyer does, and it's what we do.
How Outsiders Law Defends You
We are tax lawyers. We represent Canadian business owners through CRA worker classification audits, CPP/EI rulings, payroll reassessments, and the appeals that follow, including to the Tax Court of Canada if necessary.
For certain elgibile files, we may even work for free on a contingency basis. You pay nothing to us unless we win. If we don't win, you don't pay.
Frequently asked questions
Calgary:
1900, 350-7th Ave SW
Phone: 537-333-3352
