Why? Because the Income Tax Act imposes very strict limits on the expenses that an employee may claim. On the other hand, the Act allows an independent contractor (i.e., self-employed individual) to deduct all reasonable expenses incurred for the purpose of earning income.

Additionally, if you are self-employed, you will receive the full payment for services rendered; there will be no withholdings for income tax, Canada Pension Plan or Québec Pension Plan (CPP/QPP) contributions, or Employment Insurance (EI) premiums. In fact, as self-employed, you won't be paying into the EI program. You will, however, have to make a contribution to the CPP/QPP based on your self-employment earnings.

In borderline cases, when taxpayers have filed as "self-employed," the Canada Customs and Revenue Agency (formerly Revenue Canada) has often taken the position that an employee-employer relationship exists and assessed tax on that basis. This has resulted in many court cases. The jurisprudence in this area has established a set of criteria used in deciding if the relationship to the company/person for whom one is working is that of an employee or of a self-employed individual. The courts have relied on four tests to make this determination.

The Control Test

The control test attempts to assess whether a "master-servant" relationship exists. In such a relationship, it would be the "master" (i.e., employer) who primarily controls how and when the work is to be done. If this tends to be the case, then the situation is more likely to be looked upon by the CCRA as an employer-employee relationship.

A basic problem arises when applying the control test in the case of work performed by experts or specialists. For example, it may be very difficult to dictate how work is to be performed by an in-house legal expert. As a result, the control test has become less relevant in today's increasingly specialized work environment.

The Economic Reality Test

This test looks at several factors, including the extent to which an individual has a chance of profit or risk of loss relating to activities he or she performs. For example, if an employer bears all the expenses and provides all of the tools used by an individual in the performance of his or her tasks, then the individual is less likely to be considered an independent contractor. Individuals who run their own businesses, on the other hand, may reap their own financial rewards as well as be exposed to liabilities relating to their business activities.

The Integration Test

The integration test can be applied from two different perspectives. One approach is to look at the extent to which an individual is dependent on an organization. The more the person relies on the income derived from services performed for the organization, the more it appears that the individual may be considered an employee.

The second perspective applies the test from the organization's point of view. The question then becomes, "To what extent is the individual's work considered an integral part of the organization's success?" There are some inherent problems with this viewpoint, however, since it can always be argued that all of the functions within an organization are important to its continued success.

The Specified Result Test

This test is based on the fact that an independent contractor is usually hired to complete a specific project. In an employee-employer relationship, the employee will perform tasks on an ongoing basis; there is no specified result. An employee is generally available to his or her employer to provide continuous service without reference to an established goal.

Case Study: Lafleur and Polis

In the case of Lafleur v. Minister of National Revenue, heard before the Tax Court of Canada in 1984, all of the above tests were considered in reaching a judgment as to whether engineering research expenses were deductible as business expenses or whether they arose from a contract of employment. Two taxpayers, Jean Lafleur and Michael Polis, were engineering professors employed by the École Polytechnique de Montréal. The professors performed work in a research Center sponsored by the school. One type of research done at the Center was sponsored research, whereby a sponsoring agency would pay for all research costs as well as fees to the professors. Lafleur and Polis used the school's equipment and some of its staff when performing the research. However, they also received fees for consulting services which did not employ the use of any of the school's property or other resources in any way.

The Tax Court judge held that the fees received for consulting services clearly represented business income. Income derived from the sponsored research proved more difficult to characterize, however. The results of applying the control and economic reality tests were inconclusive.

In applying the specified result test, the Court pointed out that Lafleur and Polis were hired directly by the sponsor to carry out a specific project. Therefore, the argument in favour of an independent contractor relationship was stronger.

The integration test was considered a matter of substance over form. Although it was acknowledged that the school held responsibility for sponsored research from an administrative standpoint, the work was performed, and the report prepared, by the professors.

After considering all four tests, the Court held that the sponsored research represented a business activity carried out by the professors which was independent of the contract of service they had with the school. As a result, some expenses claimed by the taxpayers, which would have ordinarily not been deductible in computing employment income, were allowed as expenses incurred to earn self-employment income.