Employed Versus Self-Employed - why does this matter?

Sometimes it is difficult to determine if an individual is self-employed or an employee and the question is  if this distinction does really matter? The issue is important because many employers find it beneficial to hire sort-term consultants, rather than long term employees. Employer costs of EI. (Employment Insurance), CPP (Canada Pension Plan) and benefit packages are reduced and the employer does not need to commit to the contractor for a long term.

Tax implications for Self-Employed 

For tax purposes the distinction between an employee and an independent contractor is important for the following reasons:

1. The deductibility of expenses is considerably more restricted for employees. Self employed individuals may be in a position to claim more deductions.

2. Employers must remit income tax, EI and CPP payments to the CRA (Canada Revenue Agency) for employees only. 

 The deductibility of expenses


An employee can only deduct those expenses that are specifically allowed under ITA (Income Tax Act) Part I, Division B, Subdivision a, Section 8, whereas a self-employed individual may deduct all expenses incurred to earn business and property income as permitted by ITA,  Part I, Division B, Subdivision b.

The deductibility of expenses for sales/negotiation employees
 
Expenses incurred for the purpose of earning income from employment for employees who sell property or negotiate contracts may be deductible only if the following  five conditions are met:
a. he/she must be employed in the year in connection with the selling of property or negotiating of contracts for his/ her employer;
b. under the terms of his/her contract of employment he/she must be required to pay his or her own expenses;
c. he/she must be ordinarily required to carry on his duties away from his/her employer's place of business;
d. he/she is remunerated in whole or in part by commissions or other similar amounts fixed by reference to the volume of the sales made or the contracts negotiated.
e. he/she was not in receipt of a reasonable allowance for traveling expenses in respect of the taxation year that was not included in computing his or her income.

An allowance is a fixed amount which is paid to an employee in excess of his or her salary without the requirement that the employee be accountable for the amount expended. An unreasonable allowance is one that is less than a reasonable amount, greater than a reasonable amount, or deemed not to be reasonable. A reasonable allowance is not taxable, thus any expense deductions are not allowed if a reasonable allowance is received. An unreasonable allowance has to be added to the taxable income and only then the expenses incurred for the purpose of earning income are allowed.

Non-Tax implications for Self-Employed

The noon-tax implications for a self-employed person include:

1. they are ineligible for general EI benefits, holidays and employer-paid or other non-cash benefits;
2. they have a potential liability issue for the service they perform;
3. they cannot collect severance pay;
4. they lack job security, and thereby assume increased economic risk

The difference between being employed versus self-employed is important because self -employed individuals are treated as businesses and are allowed to deduct all reasonable expenses incurred for the purpose of producing income from business. Employees, on the other hand are strictly limited to those deductions specifically listed in section 8.

It is interesting to note that for labour law purposes, individuals usually prefer to be employees to gain protection for their severance, pension and injury compensation rights, but prefer to be self-employed for tax purposes.  With regret this option is not available.

The courts have applied the following tests in order to determine whether an individual is an employee or self-employed:
* The economic reality of entrepreneur test - examines several economic factors such as control, ownership of the tools and chance of profit/risk of loss. In cases where the taxpayer doing the work supplies neither funds nor equipment needed to do the work, takes no financial risks or managerial responsibility and has no liability, the courts have applied the economic reality test and held that the taxpayer is an employee.
* Integration or organization test - examines whether the individual doing the work is economically dependent on the organization. The more dependent the individual is on the organization, the more he or she will appear to be an employee.
* Specific result test - examines whether the individual doing the work and  payer agree that certain specified work will be done and possibly with the use of assistants provided by the worker. In this situation it may be inferred that an independent contractor relationship exists. In the CRA's view, this test is satisfied where the facts suggest that  a person is engaged to achieve a defined objective and is given all the freedom to obtain the desired result.

It has to be noted that no one test can be used to determine whether someone is an employee or is self-employed and all tests should be considered together before a conclusion is reached.

Sources:
Income Tax Act;
Federal Income Taxation: Fundamentals, 5th Edition- published by CCH  Canadian Limited

Eugeniu Braila, CPA

What Is the Difference Between a Sales Order & an Invoice?

Businesses use a great deal of documentation in order to keep companies running smoothly. Doing so generally results in greater revenue. Two of the most basic documents companies uses are sales orders and invoices. Although there are some similarities between the documents (e.g., both may list the company and purchaser addresses), there also are major differences.

Action

• Sales orders indicate that the company that is providing goods or services needs to take action (i.e., to complete the order). Usually this involves finding the product, packaging it, etc., or setting up a meeting so that services can be rendered. Invoices indicate that the purchaser of goods or services needs to take action. This typically means that the purchaser needs to compensate the company monetarily for the products or services, which can be done by sending the company a check or money order, transferring money from a bank account, or going to the company website and using an online form to pay with a credit card.

Trigger

• Sales orders are triggered by the purchase order of the consumer. This is because a company cannot list the items or services that an individual wants until the individual lets the company know what is desired. Invoices are triggered by the completion of a sale or service. This is because the company cannot charge an individual for products that were never delivered or for a service that never was given.

Listing

• Sales orders list the products or services that the consumer wants. This can be a single item/service or it can be an extensive list of multiple products/services. These often are listed with an item/service number and a short description. Invoices list the amount of money owed for those products or services. The invoice may reiterate the product and service list to show clearly how the total owed was obtained, but the main objective is to indicate that money is due.

Date

• Sales orders indicate the date the consumer's request for a product or services was processed. This means that the date listed indicates a time in the past. Invoices indicate the date that money is due for those products or services. This means that the date listed indicates a time in the future.

Use

• Sales orders are used to approve, track, and process the completion of an order. For example, once the sales order is received by the purchaser, if there are any errors such as missing items/services, incorrect items/services, etc., then the purchaser can contact the company to revise the order and correct it. Invoices are used to communicate that the order is complete. By this time the goods/services have been delivered or rendered, so the individual cannot make changes.
  
  Eugeniu Braila, CPA 

What books and records must be kept for a Canadian individual or a business ?

If you are a person carrying on a business (individual, partnership, corporation, registered charity, trust etc.) and are required to pay or collect taxes according to the Income Tax Act, Employment Insurance Act, Canada Pension Plan, or Excise Tax Act (which includes GST/HST), you have to keep books and records. The records that must be kept include books of accounts and records which provide the ability to calculate taxes payable.  Books and records must be supported by "source documents" which substantiate the amounts in the books of account.  Canada Revenue Agency (CRA) indicates that supporting documents for the income tax return of an individual should be kept for six years, in case they select your return for review.  They may request more documentation than official receipts as proof of deductions or credits claimed, including cancelled cheques or bank statements.  For instance, for a tax return filed in April 2009 regarding the 2008 income tax return of an individual, the source documents must be kept until at least January 2015.  However, it would be better to retain the documents until six years after the date on the notice of assessment or notice of reassessment.
Source documents include (but are not limited to) invoices for purchases and sales, deposit slips, cheques, and contracts.  These books and records are used to prepare financial statements of the business, which must be prepared according to GAAP (generally accepted accounting principles).   Recent changes in accounting standards means that now, financial statements must be prepared according to International Financial Reporting Standards (IFRS) or Accounting Standards for Private Enterprises (ASPE).

For purposes of income tax, most books of accounts, records, and source documents have to be retained for a minimum of six years after the end of the last tax year to which they relate.  In the case of records regarding capital purchases, the last tax year to which they relate would be much later than the acquisition date.  It would be the tax year in which a disposal of the capital property occurred, because the purchase records would be required to calculate the gain or loss on disposal.  Thus, records regarding capital property should normally be kept until six years after the end of the tax year in which the capital property was sold. 

For more info see: http://taxtips.ca/smallbusiness/booksandrecords.htm 

Eugeniu Braila, CPA