Choosing between hiring an employee or engaging an independent contractor is one of the most important decisions for Ontario businesses. The classification affects tax obligations, payroll costs, CRA compliance, and audit risk.

Many Ontario businesses face CRA reassessments and penalties due to worker misclassification. This guide explains the tax differences between employees and contractors in Ontario, how CRA determines status, and how to choose the right option in 2025.

Why Worker Classification Matters in Ontario

Incorrectly classifying a worker can result in:

• CRA payroll reassessments
• CPP and EI arrears
• Penalties and interest
• Loss of expense deductions
• Increased CRA audit risk

CRA focuses heavily on employee vs contractor misclassification, especially in Ontario.

Key Tax Differences: Employees vs Contractors (Ontario)

Employees – Tax Treatment

When you hire an employee in Ontario, the business must:

• Withhold income tax, CPP, and EI
• Remit employer portion of CPP and EI
• Issue T4 slips
• Register for a CRA payroll account
• Follow Ontario employment standards

Employees are generally more expensive from a payroll perspective.

Contractors – Tax Treatment

When you hire an independent contractor:

• No payroll deductions required
• Contractor invoices for services
• Contractor pays their own income tax and CPP
• HST may apply if contractor is registered
• T4A may be required in some cases

Contractors appear cheaper upfront—but misclassification risk is significant.

CRA Tests to Determine Employee vs Contractor Status

CRA looks at substance over form. Contracts alone are not decisive.

1. Control

• Who decides how, when, and where work is done?

2. Tools & Equipment

• Who provides tools, software, and equipment?

3. Chance of Profit & Risk of Loss

• Can the worker earn more or lose money?

4. Integration

• Is the worker integrated into your business operations?

If CRA determines the worker is actually an employee, tax consequences apply retroactively.

Payroll Cost Comparison (Ontario)

Category

Employee

Contractor

CPP

Employer + Employee

Contractor pays both

EI

Employer + Employee

Not applicable

Payroll remittances

Required

Not required

T4 / T4A

T4 required

T4A may apply

CRA audit risk

Moderate

High if misclassified

HST Considerations in Ontario

• Contractors may charge 13% HST if registered
• Employees never charge HST
• Incorrect treatment of HST is a major CRA red flag

Ontario businesses must verify contractor HST registration.

Common CRA Audit Triggers in Ontario

• Long-term “contractors” working like employees
• Single-client contractors
• Contractors using company email, office, and equipment
• No written agreement
• No business registration by contractor

These scenarios often lead to CRA payroll audits.

How to Reduce CRA Risk

• Perform worker classification reviews
• Use properly drafted agreements
• Maintain documentation
• Review status annually
• Consult a CPA before hiring

Proactive planning prevents costly corrections.

When Hiring an Employee Makes Sense

• Long-term, ongoing work
• High level of control
• Core business operations
• Desire for stability and retention

When Hiring a Contractor Makes Sense

• Project-based work
• Specialized expertise
• Short-term needs
• Independent business relationship

How a CPA Helps Ontario Businesses

A CPA can:

• Review worker classification
• Assess CRA audit risk
• Set up payroll correctly
• Advise on cost-effective hiring
• Represent you during CRA reviews

Frequently Asked Questions (FAQs)

Can CRA reclassify a contractor as an employee?

Yes. CRA can reassess prior years and demand CPP, EI, penalties, and interest.

Do contractors charge HST in Ontario?

Yes, if they are registered and providing taxable services.

Is a written contract enough to prove contractor status?

No. CRA evaluates the actual working relationship, not just contracts.

Is hiring contractors cheaper than employees?

Not always. Misclassification penalties often outweigh short-term savings.

Should I consult a CPA before hiring?

Yes. Early advice prevents long-term CRA issues.