Should I hire an employee or a contractor?

The label doesn’t decide it

Picture a developer who works only for you, joins every standup, uses a company laptop and GitHub account, follows your sprint plan and sends a monthly invoice for the same amount. On paper they’re an independent contractor. In practice, almost every factor regulators look at points toward employment.

Ontario’s guide to the Employment Standards Act (ESA) is direct about this: it’s the relationship that matters, not the label. Charging HST, sending invoices, or having no tax, CPP or EI deducted doesn’t settle the question.

What the CRA looks at

Outside Quebec, the CRA first asks what the parties intended, then checks whether the actual working conditions match. The factors are:

• Control over how and what work is done.
• Who provides the tools and equipment.
• Whether the worker can subcontract or hire helpers.
• Financial risk.
• Investment in and management of their own business.
• Opportunity for profit.

The CRA lists the Supreme Court of Canada’s decision in 671122 Ontario Ltd. v. Sagaz Industries Canada Inc., 2001 SCC 59, among the cases behind this approach. Quebec uses a different test based on the Civil Code.

What Ontario’s ESA looks at

The ESA guide lists similar signs of employment: the business controls what, when and where the work is done, provides the tools, the person can’t subcontract, and the business can discipline them. Signs of a contractor include a real chance of profit and risk of loss, and control over how, when and where the work gets done.

Since January 1, 2023, the ESA has excluded certain business consultants and information technology consultants altogether, but only if all the conditions in s. 3(7) are met: the consultant provides services through a corporation of which they’re a director, or a shareholder who is party to a unanimous shareholder agreement, or through a sole proprietorship with a registered business name, and there’s an agreement setting out when they’ll be paid and an hourly rate of at least $60, excluding bonuses, commissions, expenses and benefits, which is actually paid. An individual freelancer invoicing in their own name doesn’t fit. And the exclusion only takes the person outside the ESA; it doesn’t decide their status for CRA purposes or at common law.

What misclassification costs

The bill usually arrives at a bad moment, when someone leaves on poor terms or investors start asking questions.

• Payroll. The CRA says an employer who fails to deduct CPP contributions or EI premiums has to pay both the employer’s and the employee’s share, plus penalties and interest.
• ESA enforcement. Employers can’t treat covered employees as if they aren’t employees. An employment standards officer can issue a notice of contravention that leads to a penalty, a prosecution, or both.
• Termination. Someone found to be an employee may claim ESA termination entitlements, and potentially more under their contract or the common law.
• IP. If the person really is a contractor and the contract is weak, the company may not own what they built. See who owns code a contractor writes.

Offshore developers

The ESA applies where the employee’s work is performed in Ontario, or outside Ontario as a continuation of work performed in Ontario. A developer who lives and works in another country is normally governed by that country’s rules, which is a question for local counsel there.

Tax is separate. The Income Tax Regulations require anyone paying a non-resident a fee for services rendered in Canada to withhold 15%. Whether that applies depends on where the work is actually done, so speak to your accountant before paying a non-resident who works in Canada, even briefly.

The IP point doesn’t change offshore: a contractor anywhere keeps their copyright unless they assign it in writing.

Setting up your first engineering hires

• Decide honestly. If you need someone full-time, part of the team and directed day to day, consider hiring them as an employee from the start.
• Write the contract to match reality. A real contractor agreement describes deliverables, lets the contractor control their methods and tools, and lets them work for others.
• Include an IP assignment and moral rights waiver in every version: employees, contractors, interns and advisors.
• Revisit it. A three-month contract that turns into two years of full-time work may have drifted into employment.
• Don’t rely on a non-compete. Since October 25, 2021, the ESA has prohibited non-compete agreements with employees, with exceptions for certain sales of a business and for executives (people holding offices such as CEO, president, COO, CFO, chief legal officer or another chief executive position). Confidentiality and non-solicit clauses do more useful work.

Asking the CRA to decide

A worker or a payer can ask the CRA for a CPP/EI ruling through the CRA’s online accounts or with Form CPT1. The request has to be made by June 29 of the year after the year in question. It can give certainty on a key hire, although many founders prefer to restructure the relationship clearly instead.

Founders who are also employees

A founder can hold shares and work for the company under an employment or services agreement at the same time. Document each role separately, including the IP assignment, alongside the shareholder agreement. See hiring and equity.