Difference between subcontractor and employee

Hiring help in your business is a big step, but it comes with legal responsibilities.

In Canada, the difference between hiring an employee and a subcontractor isn’t just about what you call them, it’s about how the relationship functions in practice, and the Canada Revenue Agency (CRA) takes this distinction very seriously. Misclassification can lead to costly audits, back payments, and penalties, and I’ve personally seen it happen to clients, again and again.

We are going to talk about:

Key CRA factors used to distinguish contractors from employees
The financial risks of misclassifying a worker in Canada
What you need to track and issue when hiring subcontractors

Let’s dive into what the CRA looks for, and how you can protect your business.

1. Why the CRA Cares So Much About Worker Classification

The CRA isn’t just nitpicking when it scrutinizes the difference between employees and subcontractors, it’s enforcing a legal framework that protects the integrity of the tax system. And in recent years, the rise of remote work, freelancing, and digital service-based businesses has triggered even closer scrutiny of how workers are being classified.

When a business classifies a worker as a subcontractor, that worker is expected to:

Invoice for services
Collect and remit their own income taxes and GST/HST (if applicable)
Make their own CPP contributions and handle their own expenses

By contrast, employees have income tax, CPP, and EI withheld by their employer, who is also responsible for submitting the employer’s share of CPP and EI. When a worker is misclassified as a subcontractor, the CRA misses out on these automatic deductions, and that’s a big red flag.

This is why the CRA treats the issue so seriously. If you’re audited, they’ll look at the substance of the relationship, not the label you gave it. And if they determine that someone you’ve called a contractor is really an employee, the consequences can be steep.

I’ve had multiple clients audited on this exact issue. In every case, the CRA determined that the contractor should have been classified as an employee. In those cases, the CRA assessed:

Back payments of both employer and employee portions of CPP and EI
Interest and penalties
Retroactive amounts going back as far as 6 years

The takeaway: this isn’t a technicality. The CRA takes classification very seriously, and so should you.

2. The CRA’s Key Tests for Worker Classification

The CRA doesn’t rely on a single factor to decide whether a worker is an employee or an independent contractor. Instead, they use a multi-factor test to assess the nature of the relationship. Each working relationship is evaluated on a case-by-case basis, and no one factor is decisive on its own.

Here are the five key areas the CRA examines:

1. Control

Who directs the work? If you control what tasks are done, when they’re done, and how they’re performed, you’re likely in an employee relationship. Contractors typically decide when and how they complete the work, they operate independently and manage their own schedules.

2. Ownership of Tools

Who provides the tools and equipment needed to do the work? If the worker brings and uses their own tools (laptops, software, equipment), that’s a sign of a contractor relationship. If you provide the tools, including paying for software, internet, phones, or office space, this starts to look like employment.

3. Chance of Profit / Risk of Loss

Independent contractors can profit by working more efficiently or managing multiple clients, but they also take on financial risk. They cover their own costs, set their own rates, and absorb any losses. Employees don’t carry this risk, they earn a wage regardless of how profitable the business is.

4. Integration / Economic Dependence

Is the worker financially dependent on your business? Are they an integral part of your operations? If they rely on you for the majority or all of their income, and especially if they don’t have other clients, this strongly leans toward an employment relationship.

5. Intentions of the Parties

The CRA will look at what both parties intended the relationship to be, but this is not enough by itself. Even if both sides agreed to a “contractor” arrangement, and have a signed contract, the CRA will override that label if the actual relationship reflects an employer-employee dynamic.

Important: A signed contractor agreement helps show intent, but it won’t protect you if the other factors suggest an employee relationship.

3. The Cost of Getting It Wrong

Misclassifying a worker as an independent contractor when they should be an employee isn’t just a technical slip, it can become an expensive, multi-year problem.

When the CRA audits your business and determines that a contractor should have been classified as an employee, they can issue a retroactive reassessment going back as far as six years. And they won’t just ask you to fix things moving forward, they’ll demand repayment of:

Employer AND employee portions of CPP contributions
Both sides of EI premiums
Interest on those amounts
Penalties for non-compliance

Even if the worker has already filed taxes as a contractor, the CRA can come after you for the full amounts, especially if the worker hasn’t made their required contributions properly. In some cases, the worker may even be refunded what they paid, and you, the business owner, are left on the hook for the whole bill.

It doesn’t stop there.

If the relationship ends, and the contractor believes they were actually functioning as an employee, they may pursue:

Severance or termination notice, depending on provincial labor laws
Back pay or entitlements for statutory holidays, vacation, or overtime
Legal claims for wrongful dismissal

What’s worse is that a signed contractor agreement won’t protect you if the facts of the working relationship tell a different story. Courts and the CRA will look past the paperwork and examine how the relationship actually worked in practice.

If the CRA determines you got it wrong, saying “I didn’t know” won’t save you from financial consequences.

That’s why understanding these rules before hiring is so critical, especially as your business grows and you begin outsourcing more work.

4. Contractor Compliance Basics for Business Owners

Even when you’ve correctly classified a worker as an independent contractor, your responsibilities don’t end there. To stay compliant with the CRA, you must still follow a few key rules, especially when it comes to documentation and tax reporting.

Issue T4A Slips for Contractors Paid Over $500

If you pay an independent contractor more than $500 in a calendar year, you are required to issue them a T4A slip. This slip reports how much you paid them and is submitted to the CRA along with your other year-end tax documents.

Many business owners forget this step, assuming it only applies to employees, but it absolutely applies to subcontractors too.

Failing to issue a T4A can lead to penalties and make your business look disorganized in the eyes of the CRA during an audit.

Track Contractor Information from Day One

To issue a T4A properly, you need to collect the following from each contractor before their first payment:

Full legal name or business name
Social Insurance Number (SIN) or Business Number (BN)
Mailing address
Contact information
Total amount paid to them in the calendar year

Keeping this information organized is not just helpful, it’s essential for compliance.

Ask me for a Contractor Information Spreadsheet if you need a simple way to keep this data organized and audit-ready.

Tip: Collect Invoices

You should always request and keep copies of invoices from your contractors. These invoices should include the date, amount, description of services, and any applicable taxes. In the event of a CRA audit, being able to show a clear paper trail reinforces that the relationship was indeed contractor-based, not employment.

Being proactive about compliance doesn’t just help you avoid penalties, it builds trust with contractors, protects your business, and keeps you on the right side of the CRA.

5. How to Protect Yourself When Hiring Help

If you’ve decided it’s time to get support in your business, congratulations, that’s a major milestone. But before you hand over work to a new team member, it’s vital to protect yourself by being intentional and compliant from the start.

Here’s how to do that:

1. Assess the Relationship Before You Hire

Before signing anything or assigning work, ask yourself:

Will I be setting their hours or daily tasks?
Will they rely solely on me for income?
Am I providing the tools, software, or space they need to work?

If the answer is “yes” to several of these, you may be looking at an employee relationship, even if you planned to call them a contractor.

Use the CRA’s classification factors from earlier in this article as a checklist, and when in doubt, seek legal or accounting advice.

2. Use the Right Kind of Contract

The contract you use needs to reflect the actual nature of the relationship. A contractor agreement won’t protect you if the worker is functionally an employee, and vice versa.

For employees: Get a lawyer to draft a province-specific employment agreement.
For contractors: Use a professionally reviewed independent contractor agreement.

Don’t rely on free templates unless you know they’ve been vetted for Canadian legal standards.

3. Monitor the Relationship Over Time

Worker relationships evolve. A contractor you hired for occasional projects might become your go-to person, working regular hours, relying on your income, and effectively becoming a core part of your business.

If that happens, it may be time to reclassify them as an employee. Continuing to treat them as a contractor could put you at risk of reclassification by the CRA.

Set a reminder to review all working relationships annually, and update contracts or classifications as needed.

4. Don’t Guess – Ask for Help

Misclassification isn’t something you can afford to “figure out later.” If you’re unsure, consult with:

A small business accountant familiar with CRA audits
An employment lawyer
A qualified payroll provider

A short consult now can save you tens of thousands of dollars down the line.

Bringing someone into your business is an exciting step, but it also comes with responsibility. Understanding the difference between a subcontractor and an employee, as defined by the CRA, is essential to protecting yourself from costly mistakes.

The rules aren’t always black and white, and even well-intentioned business owners can get tripped up. That’s why it’s so important to approach hiring with clarity, solid documentation, and a full understanding of what the CRA looks for.

If you have questions about your situation, or you’re unsure how to move forward, feel free to reach out. I’m happy to answer quick questions or let you know how to book a call if you’d like more hands-on support.

Hiring help should move your business forward, let’s make sure it doesn’t create a headache down the road.

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