Canadian Payroll Tax Guide

Applies To Contract Of Service Relationships | Employer - Employee Status


WHAT'S IN THIS ARTICLE
IntroductionNew Payroll Admin |
Hiring Your 1st Employee | CRA Tests | Employee or Self-Employed | Other PR Topics | PSB Incorporated Employee | Independent Contractors

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Canadian Payroll Tax GuideCanadian payroll tax obligations are complex

By L.Kenway BComm CPB Retired

Edited March 22, 2024  |  Updated March 15, 2024  |  Originally Published on Bookkeeping-Essentials.com in 2010


Canadian payroll tax is a complex compliance obligation for many reasons. This payroll tax guide lays out some your responsibilities. You don't want to screw this up.

As a small business owner, this needs to be on your radar. You need to make this an important priority in your long list of things you need to get done in a day, a week, a month. I say be kind to yourself. It'll be easier on yourself if you get it right from the start.

There are three types of worker relationships. How to proceed depends which type of contract you are entering into.

  1. An employer-employee relationship is a contract of service;
  2. An independent contractor relationship is a contract for services.
  3. A personal services business (PSB) relationship which has its own special category called incorporated employee.

CRA has a process to determine the employment status of an employee in their eyes. Sometimes a business wants an incorporated employee relationship to avoid costly payroll taxes and clearly define the intent of their working relationship as not that of employer-employee. This relationship is sometimes referred to as a disguised employee and may have negative tax effects for the incorporated employee and potential risk for the payer - the business hiring the incorporated employee.


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Payroll Tax Guide

What To Do If You Are New To Payroll Administration

Before you jumping in on the instructions in this Payroll Tax Guide, it would be wise to educate yourself about your payroll compliance responsibilities. A good place to start are the CRA webcasts.

It's important these days to ensure you are getting your information from a reliable source. For that reason, I recommend using the Canada Revenue Agency's website as the final determinant. Over the years, CRA has published many informative webcasts located in the video gallery under videos for businesses.

If you are a new business owner with payroll, take time to watch the Canada Revenue Agency (CRA) 2019 webcast Payroll 101 - What you need to do if you're new to payroll administration.  I would review this BEFORE you hire your first employee. It explains the various steps you need to take when hiring your first employee including getting a business number and opening a payroll account with CRA.

Another option for learning about payroll tax deductions in Canada quickly is to watch the 2016 webcast Payroll Basics: How Payroll Works on the CRA website. It covers employer responsibilities and the consequences of non-compliance; 

This webcast covers "the first four steps of the payroll cycle, how to calculate gross and net pay, and how to calculate the amounts to withhold from an employee’s pay. We will also discuss the employer’s portion of Canada Pension Plan contributions and Employment Insurance premiums."

If you prefer to read as I do, every CRA webcast includes a written transcript.

If you are thinking of hiring an employee for your business, Robert Half International has Salary Guide tools available for free. The tools could help you determine how much the position should pay.

In summary, the CRA's videos for business gallery is a good reliable source to learn about your compliance responsibilities around payroll tax deductions.



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How to Hire Your First Employee Properly

Simplified Step-By-Step Instructions

Step One - Determine the worker's employment status in accordance with Canada Revenue Service (CRA) criteria. Employer - Employee relationship? Or Independent Contractor relationship? Or Personal Services Business?

As the payroll tax rates are different for an employee versus a self-employed independent contractor or an incorporated employee, misclassification of a worker can be extremely costly to the employer. Let's examine how CRA tests and monitors employment status.

CRA Employment Status Tests

Over the years the courts have determined that four tests need to be met to determine employment status - (1) The Control Test, (2) The Integration Test, (3) The Economic Reality Test, and (4) The Specific Results Test.

After a 2013 Federal Court of Appeal hearing - Connor Homes vs Canada National Revenue - CRA has taken these tests and monitors the following areas for consistency in making their determinations of whose business is it:

  1. Determination of intent - Is it a contract of service (employee) or a contract for services (business relationship) or a personal services business (incorporated employee)? Is there a written contract? Or is the agreement verbal? Does the subcontractor have multiple clients / customers ... or just one (you)? Were invoices issued? Is the independent contractor a GST HST registrant?

  2. Is the actual relationship consistent with the intent - Degree of control between parties becomes an important criteria. Who exercises control over (a) what work is done, (b) who does it, (c) how it is done, and (d) where it is done?

  3. Is the actual relationship consistent with the intent - Who provides/owns the tools and equipment?

  4. Is the actual relationship consistent with the intent - Can the work be subcontracted out? Can assistants be hired to help?

  5. Is the actual relationship consistent with the intent - Who is at financial risk? Who makes the capital investment? Does the independent contractor have a business presence?

  6. Is the actual relationship consistent with the intent - Does the self-employed worker have an opportunity for profit as well as a risk of loss?

  7. Is the actual relationship consistent with the intent - From the worker's perspective, how integrated is the worker to the business? Is the work performed as an integral part of the business, or done on behalf of the business but not integrated into that business? Does the worker behave in a "businesslike" manner as someone in business for themselves?

For more in-depth information and specific questions to ask, refer to the CRA publication RC4110 Employee or Self-Employed?


In September 2010, Deloitte's newsletter Privately Speaking published a column authored by Tracy MacKinnon that is still relevant today. She noted:

"Whether an individual is an employee or a contractor is not a question of choice but a question of fact. And yet, making such a determination is not perfectly clear, as represented by a series of court cases on this issue. In a relatively recent case, the court concluded that the intent of the individual and the company must be one of the factors that is considered in determining the status of the individual."

The article explained that the CRA payroll tax guide at that time did not mention intent. [It does now.]

Before you decide to misclassify an employee to avoid the numerous payroll tax rates, consider the severity of the penalties. Ms. MacKinnon explained the consequences if the CRA deems a subcontractor to be an employee that are still pertinent today:

  • "Penalties of 10% on income tax, CPP and EI which are not withheld on the first failure to withhold, with the penalty potentially increasing to 20% for repeated offences, as well as non-deductible interest on the amounts owing;
  • Payment of both the employee and the employer’s portion of CPP and EI plus penalties and interest;
  • Late filing penalties on the failure to file T4 Statement of EI forms."

Ms. MacKinnon recommended that all support documentation supporting your decision that the person is an independent contractor should be available BEFORE CRA comes knocking. This recommendation still holds today.


Step Two - If you determine you will have an Employer - Employee relationship, open a payroll account with CRA.

If you are already registered for GST, opening a payroll with CRA is easy. Just call them.

If you have not applied for your Business Number (BN) from CRA yet, you will have to do this first. During the registration process, they will assign you a payroll account as well.

It is important to note that the business has to register for a payroll account BEFORE their first remittance due date.

CRA states, "The first remittance due date is the 15th day of the month following the month in which the business began withholding deductions from the employee's pay, unless CRA tells the business to remit using a different frequency."

Step Three - Have the employee complete a CRA Form TD1 - Personal Tax Credits Return

Before starting work, have the employe fill out the TD1 form.

The TD1 form provides information including their social insurance number. You will need the TD1 form to:

  • setup your employee in your payroll program;
  • determine their payroll withholdings each pay period; and
  • prepare a T4 slip - Statement of Remuneration Paid, in February each year.

Step Four - Open a separate bank account for source deductions collected.

Payroll withholdings are held in trust for the government until such time as you are required to remit them to CRA. These amounts must not be used as operating capital for your business or to fund your personal lifestyle.

Find more information about funds collected in trust here.

Step Five - Choose a payroll software as a subscription service (SaaS) to calculate and send employee pay cheques. Use the app to do your first payroll run.

The easiest way to do these calculations is to subscribe to payroll software as a subscription service (SaaS) like QuickBooks Online (which also tracks all your business transactions and your sales tax). QuickBooks Online offers direct deposit of employees' earnings as part of their SaaS.

CRA does have an online payroll calculator but it is tedious to use, does not save your results so does not provide the year-to-date information you will need to calculate your annual T4 slip for the employee.

The SaaS app will calculate the employee's gross pay first. You will have to decide if the employee's earnings will be based on an annual salary or an hourly rate or commission or some other method.

You must take into consideration labour laws in your province which may require vacation pay or overtime pay. The SaaS program usually takes care of this for you.

The SaaS app will take into consideration any tax credits that apply to the employee based on the information on their TD1 form.

Payroll deductions are calculated for each pay period next - both the employee (CPP, EI, WIT) and employer (CPP and EI) portions.

Employers are required to calculate and remit their portions of CPP and EI contributions at the same time as the employees' source deductions. Find our the employer-employee contributions rates here.


Step Five Sidebar 1: Are there government regulations to paying employees by direct deposit? Can a business make it mandatory to pay by direct deposit? 

Generally, payroll direct deposits must be paid into the employee's account NOT third party accounts and side deals are illegal.

Each province / territory has a labour code dealing with the rules around paying employees by direct deposit. Federally regulated employers follow the Canada Labour Code.

Quick overview of some of the provinces rules for direct deposit:

  • BC's Employment Standards Act provides for direct deposit. An employer must pay all wages (a) in Canadian currency, (b) by cheque, draft or money order, payable on demand, drawn on a savings institution, or (c) by deposit to the credit of an employee's account in a savings institution, if authorized by the employee in writing or by a collective agreement.
  • Quebec's Labour Standards Act allows employers to implement a direct deposit system after having obtained the employee's written consent and as long as the employee has access to a bank account from a financial institution. If an employee does not have access to a bank account from a financial institution, the employer must continue to pay that employee's wages by cash or cheque. However, this rule does not apply where the transfer as well as the institution has been determined by collective agreement.
  • Newfoundland and Labrador's Labour Standards Act states the employer must pay the wages: (a) at the place of employment during regular working hours, (b) at the employee's normal residence, (c) by mail, (d) personal delivery, (e) by direct deposit into the employee's bank account with the employee’s consent. The wage must be paid in a lawful Canadian currency  by cheque,  money order,  or direct deposit into the employee's bank account.
  • Ontario's Employment Standards Act brought in direct deposit regulations in 2000. An employer may pay an employee's wages by direct deposit into an account of a financial institution if, the account is in the employee's name; and no person other than the employee or a person authorized by the employee has access to the account.
  • All other provinces and territories allow employers to pay wages direct deposit into the employee’s account at an institution insured by the Canada Deposit Insurance Corporation (CDIC).
  • Federally regulated employer follow the Canada Labour Code. It allows an employer to pay its employees any wages to which they are entitled “as established by the practice of the employer.” As such, if the employer has an established practice of paying by direct deposit, an employee of a federally regulated employer cannot insist her wages be paid other than by direct deposit.

Employers cannot change the way it pays an employee's earnings unilaterally if it is fundamental term of the employment contract. Best practice is to require new employees to participate in direct deposit as a condition of employment and obtaining written consent where required.


References:

  1. Can a Canadian company mandate direct deposit or is there a legal requirement to make it optional? By Brian Kenny Canadian at HR Reporter Feb 15, 2006
  2. Payment and Statement of Wage Requirements in Quebec by Yosie Saint-Cyr LL.B. at HRinfodesk August 2006.
  3. Labour Standards Act in various provinces

Step Five Sidebar 2:  How do you determine the payroll tax rates for statutory holidays?

To determine the pay rates for statutory holidays, refer to your provincial labour standards if you are under provincial regulations ... or federal labour standards for those under federal jurisdiction.

For BC ... There are two links about the BC Ministry of Labour on Statutory Holidays ...

  • https://www2.gov.bc.ca/gov/content/employment-business/employment-standards-advice/employment-standards/statutory-holidays
  • https://www2.gov.bc.ca/gov/content/employment-business/employment-standards-advice/employment-standards/statutory-holidays/calculate-statutory-holiday-pay

Statutory pay equals an average day's pay. BC employees are entitled to statutory holiday pay if they work or take the day off. Employers should base their calculations on the last 30 days worked prior to the statutory holiday – including vacation days.

It should also be noted that Easter Sunday, Easter Monday, and Boxing Day are not a statutory holidays in B.C.

For Alberta ... https://www.alberta.ca/paid-holidays-directive

If a general holiday falls on a regular workday, an employee may receive the day off work and their full salary for the day. If a general holiday does not fall on a regular workday and the employee does not work on the holiday, no general holiday pay is owed.

For Ontario ... ontario.ca/document/your-guide-employment-standards-act-0/public-holidays

In Ontario, an employee is generally entitled to take all statutory holidays off work and be paid public holiday pay. Most employees qualify for stat holiday pay if their workplace is covered by the Ontario Employment Standards Act and they meet the requirements of 'the first and last rule'.

For federal standards and all other provinces / territories, try this link ...

  • canada.ca/en/employment-social-development/programs/employment-standards/holidays.html

An employee working for a federally regulated employer is entitled to a day off with pay for the general holidays.

Reference: Peninsula Group Limited has great Stat Holidays & Pay information for a lot of the provinces updated to 2024. 

Step Six - Remit source deductions to CRA by assigned due date.

The easiest way to file and pay your source deductions is to file the PD7A form - Statement of account for current source deductions is online using CRA's My Payment or My Business account.

Learn more about making payments online here.

As mentioned in step two above, the frequency of your remittance is determined by your remitter type and assigned to you by CRA when you open your payroll account.

Generally, CRA assigns NEW small business owners a quarterly remitting frequency. Find more information on source deduction remittances here.

Step Seven - Request employees submit a new TD1 form by the end of December. Prepare and issue the annual T4 slip - Statement of Remuneration Paid.

At the beginning of every calendar year, employees need to submit a new TD1 form to you so you can setup the new year's payroll information. It's also a way to confirm the employee's contact information for T4 preparation.

Report the income paid to the employees and any qualifying deductions on a T4 slip - Statement of Remuneration Paid. The T4 slip must be issued annually to employees by the last day of February. Learn more about your T4 reporting obligations here.



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Payroll Tax Guide

Dig Deeper Into Other Payroll Issues

Where do you want to go next? One of these articles are not available on this site yet but will be soon. For now, you will find it on Bookkeeping-Essentials.com by clicking on the image. 




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Personal Services Business - A Special Category

 
The Incorporated Employee Is Not a Contractor or Self-Employed

Howard Levitt, a Canadian employment lawyer, describes personal services businesses as an intermediary category of workers that own their own business but are largely dependent on one client.

Although a PBS is a Canadian Controlled Private Corporation (CCPC), it operates under different rules. PBS rules came into existence to prevent family owned corporations and/or incorporated employees from gaining access to the small business deduction.

Usually a business wants an incorporated employee relationship to avoid costly payroll taxes and clearly define the intent of their working relationship as not that of employer-employee. This places more of an administrative burden on the incorporated employee as well as additional ongoing costs. Today's personal services business (PBS) rules may have a negative tax for the incorporated employee.

Business Owner Alert

If you hire an incorporated employee, you are not responsible for withholdings as you are entering into a contract for services. You do need to be aware incorporated employees can sue for wrongful dismissal and you still have secondary liability if the worker doesn't pay their self-employment taxes.

Dependent Contractor / Non-Employee Alert

There is a tax issue when you are a sole shareholder and employee of a corporation in Canada. Incorporated employees need to be aware of this tax issue and how it affects them.

If you are thinking about going in this direction, find out more information about personal services businesses here.



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References: CRA Publication IPG-069 Determining the Employer/Employee Relationship