Independent Contractors: Don’t Judge a Book by its Cover
By Paul Martin
There is a widespread, but potentially risky, practice within the dental industry of characterizing hygienists as “independent contractors”, as opposed to employees. Despite the prevalence of this practice, there remains much confusion surrounding the distinction between the two categories of worker. Improperly labeling, and paying, a hygienist as an independent contractor, as opposed to an employee, can have serious legal consequences from both a tax and employment law perspective.
Who is an independent contractor?
Both the dentist and the hygienist can benefit from being in an independent contractor relationship. However, as the old adage goes, if something sounds too good to be true, then it probably is. The reason for this is that regardless of how the dentist and the hygienist frame the relationship, the CRA and the Courts will look behind the title utilized by the parties, and will employ a comprehensive test to determine the true nature of the relationship. Both institutions have created guidelines to follow in determining whether or not a worker is an employee or independent contractor. Some of these factors include:
- How much control the dentist has over the hygienist;
- Whether or not the hygienist provides his or her own tools and equipment;
- Whether the hygienist can subcontract his or her work or hire assistants;
- The degree of financial risk taken by the hygienist;
- The degree of responsibility for investment and management held by the hygienist;
- The hygienist’s opportunity for profit; and
- Any other relevant factors, such as written contracts (more on this later).
Ultimately, all of these factors are synthesized to answer one, overarching question: Who is the hygienist in business for, herself, or the dentist? If it is determined that for the most part, the hygienist is in business for herself, then the Courts and Government will likely classify her as an independent contractor. If it is determined that the hygienist is in business to serve the dentist, then she will be classified as an employee.
Mischaracterizing the nature of the relationship can have serious tax and employment law consequences for a dentist.
One of the primary reasons both dentists and hygienists prefer to classify the relationship as one of “independent contractor” is that both parties can reduce their obligations to the CRA.
For instance, in a typical employment relationship, the hygienist is paid an hourly wage (ie. $30.00 per hour), and the employer deducts and remits income tax, Canada Pension Plan (“CPP”) contributions, and Employment Insurance (“EI”) contributions, which are collectively known as “source deductions.” The employer then also makes matching contributions for CPP and EI. However, when a hygienist is paid as an independent contractor, the hygienist is paid a gross sum (ie. $30.00 per hour), without source deductions made by the dentist. The hygienist is then responsible for remitting her own income tax, CPP, and, if she chooses, EI. The dentist is also relieved of the obligation to make matching contributions for CPP and EI. This arrangement can obviously be mutually beneficial. On the one hand, the dentist is not responsible for his or her portion of CPP and EI, which results in a cost savings. On the other hand, the independent contractor is entitled to file taxes as an independent, and can take advantage of a number of tax deductions that reduce overall income, and therefore tax payments. The independent contractor can also defer tax payments, as well.
Of course, the government does not appreciate being duped, and will not hesitate to ensure that taxes, CPP, and EI are properly remitted. It is for this reason that the CRA frequently conducts audits of dental offices concerning the characterization of hygienists as independent contractors.
When the CRA audits a dental office, and determines that a hygienist who is being paid as an independent contractor is actually an employee, the dentist who has failed to properly remit taxes may be liable to pay the taxes that should have been remitted, as well as a penalty on the outstanding amount. Further, if the hygienist failed to remit their taxes (or claimed significant deductions, which are deemed improper for an employee), then the penalty could be increased if the dentist “knowingly” did not remit the taxes, or exhibited “gross negligence” in failing to do so. This could put the dentist in a position where the hygienist’s effective salary is actually higher than what was paid to her, as the hygienist will keep the taxes she was supposed to remit, and the employer will then make the additional tax contributions on her behalf.
Further, if the CRA determines that the hygienist is actually an employee, the CRA will seek payment of the proper amounts for CPP and EI. The dentist who has failed to remit the matching contributions for CPP and EI will be required to remit the past payments. Further, if the hygienist has not remitted her CPP and EI contributions, the CRA can also recover those unpaid contributions for CPP and EI from the dentist, along with penalties and interest.
There are also HST implications. When a hygienist is paid as an independent contractor, the dentist may be responsible for paying HST (13% in Ontario) for those services. The dentist then claims for an input tax credit and receives a credit equivalent to the HST paid. However, if the CRA determines that the hygienist is in fact an employee, and HST was not actually payable on the services provided by the hygienist, the dentist will not be entitled to claim the input tax credit for the HST paid. Essentially, the dentist ends up paying an additional 13% to the hygienist, which cannot be recovered. It would then be up to the dentist to try and reclaim that 13% from the hygienist. If the hygienist refused to repay the money, then the only recourse would be to sue the hygienist. This would obviously not be good for employer-employee relations.
A properly drafted independent contractor agreement will help to minimize the above-noted tax risks, as the contract should include a clause whereby the hygienist agrees to indemnify the dentist against any claims made by the CRA as a result of mischaracterizing the relationship. In this way, if the CRA looks to the business owner for payments that should have been remitted, and levies penalties, the dentist can seek payment for those amounts from the hygienist.
When an employee is dismissed from their employment, the employer must provide reasonable notice of the termination, or pay-in-lieu of notice (this obligation should always be minimized by a proper employment law contract). Historically, independent contractors were not protected by the common law principles applicable to employment law relationships. So, while an independent contractor may have been entitled notice (or pay-in-lieu of notice) upon termination of the independent contractor relationship, this notice was usually not as substantial as in situations where an employee with a similar length of service was dismissed. Avoiding the obligation to provide reasonable notice of termination would obviously represent a significant benefit for the dentist, but a major corresponding detriment to the hygienist.
It never ceases to amaze us when an independent contractor, whom has chosen to be classified as such for tax purposes, is dismissed, and then turns around and claims she was an employee the entire time, in an attempt to extract a larger payment out of the dentist. In other words, the hygienist will want to have their cake, and eat it too!
As we have posted in the past, wrongful dismissal lawsuits can have disastrous consequences on dental practices. In the absence of a properly drafted employment contract, an employer will have to provide an employee with common law reasonable notice of termination. For illustrative purposes only, this notice will be in the vicinity of one month of notice per year of service. Hence, if the employee has worked for 12 years, she will be entitled to approximately 12 months of notice upon dismissal.
Take then the hygienist who has worked for 12 years as an independent contractor, when in reality that title applied in name only. Frequently, when the dentist decides to terminate the independent contractor relationship, and proceeds to do so upon the assumption that minimum notice is required, the dentist will be sued for wrongful dismissal, as the hygienist will claim she was an employee the entire time. If the dentist has indeed mischaracterized the relationship, the dentist will then have to provide the hygienist with reasonable notice of the termination. Given that the hygienist will be deemed an “employee” with 12 years of service, the dentist could be liable for wrongful dismissal damages in the vicinity of 12 months. This would be quite a rude awakening for the unsuspecting dentist.
Further muddying the waters on this issue, in 2009, the Ontario Court of Appeal seemingly created a new category of worker, the “dependent contractor”. A dependent contractor is a sub-category of the independent contractor. The Court of Appeal stated that if an independent contractor has a “relationship of exclusively” with a business, then they are clearly dependent, and are therefore entitled to reasonable notice, even though they are not employees. In our experience, the majority of hygienist independent contractors in dental offices fall under this dependent contractor category. While they may not actually be employees, as they meet a number of the independent contractor criteria listed above, they also have a relationship of exclusivity with the dentist that results in dependency.
Initially, as the case law developed, dismissed dependent contractors were deemed to be entitled to less reasonable notice than dismissed employees, but of course more notice than true independent contractors. This presumption seems to be evaporating, as recent cases have provided dependent contractors with significant reasonable notice periods, in line with the amount of notice an employee in similar circumstances would receive.
Hence, in our opinion, whether a hygienist is an employee or dependent contractor is an academic argument only, as both are entitled to reasonable notice of termination, which is likely equal.
Put Proper Contracts in Place
Just like with employees, it is imperative that dentists ensure that proper contracts are in place with independent contractors. A proper agreement will include a termination clause, which outlines the maximum amount of notice the dentist must provide the independent contractor upon termination of the contract. The termination clause, if properly drafted, should cover termination in the event that the hygienist is ultimately deemed an employee or independent contractor, thereby negating the risks associated with improperly characterizing the relationship. This will insulate the dentist from a potential wrongful dismissal claim by a hygienist who suddenly claims to be an employee or dependent contractor.
Further, as outlined above, a proper agreement with an independent contractor will include provisions to protect the dentist in the event the CRA conducts an audit of the relationship, and re-classifies the relationship.
If you have concerns about hygienists who are working as independent contractors in your office, please contact Matthew Wilton at firstname.lastname@example.org, or Paul Martin at email@example.com, or by phone at 416.860.9989.
*The foregoing is not intended to be legal advice and is provided for educational purposes only. You should retain a lawyer to seek advice prior to taking any legal steps.