Contractor or Employee? How It Changes Every Expense You Pay Them

Whether the person you pay is an employee or an independent contractor is not something you decide in the contract. It is a conclusion CRA draws from how the work actually happens, and it changes the treatment of every dollar that moves between you - the fee itself, the source deductions, the sales tax, and, less obviously, the expenses you hand back to them.

Most owners understand the first part. The expense part is where even careful businesses get it wrong, because the two mechanisms look identical in the bank statement and are completely different in the Excise Tax Act. Paying a contractor for a hotel night and reimbursing an employee for the same hotel night produce the same outflow and two different input tax credit paths.

The 60-second version

Classification follows the relationship, not the paperwork. CRA weighs control, tools, chance of profit and risk of loss, and integration [1].
Misclassification is assessed against the payer, for unremitted income tax, CPP and EI, plus penalties under ss. 227(8) and 227(9) [4].
Contractor expenses are part of the contractor's supply. Rebilled costs are normally taxed on the invoice and claimed as an ordinary ITC under s. 169 [5].
Employee reimbursements use s. 175. The employer is deemed to have received the supply and paid the tax, and claims the ITC on that basis [6].
The evidence differs too. For a contractor you need a compliant invoice with a GST/HST number; for an employee you need the underlying vendor receipt.
You can ask. Form CPT1 gets a written CRA ruling before the relationship becomes a multi-year assessment [2].

How does CRA decide whether someone is an employee?

CRA's approach, set out in RC4110 [1], is a two-step analysis built on Canadian common law. First it asks what the parties intended: did both understand this to be a contract of service (employment) or a contract for services (business)? Then it tests that intent against the actual working relationship, using factors drawn from the leading cases in this area, principally the Federal Court of Appeal's decision in Wiebe Door Services and the Supreme Court's decision in Sagaz Industries.

Control. Who decides how, when and where the work is done? Set hours, mandatory methods, direct supervision, and required attendance point to employment. A worker who decides the sequence, the method, and the schedule, subject only to a deliverable and a deadline, points the other way.

Tools and equipment. Who supplies them, who maintains them, and who bears the cost of replacement. Significant investment in equipment by the worker suggests a business; using the payer's laptop, vehicle, workspace and software suggests employment.

Chance of profit and risk of loss. This is the most under-weighted factor by small businesses. A true contractor can make more by working efficiently and can lose money on a bad job - fixed-price work, quoting errors, warranty rework, carrying their own insurance. A worker who is paid for hours and cannot lose money has no entrepreneurial risk.

Integration. Is the worker running their own business that happens to serve you, or are they a component of yours? Multiple clients, their own branding, their own subcontractors and the ability to send a substitute all point to independence. Being introduced to your customers as part of your team does not.

No factor is decisive; the picture as a whole is. And because the conclusion rests on practice rather than paperwork, a relationship can start as legitimate contracting and drift into employment over three years without anyone signing anything new.

What does misclassification actually cost?

It is assessed against the payer, not the worker, and it is retroactive. The employer is liable for the income tax that should have been withheld under s. 153 [3], for both the employee and employer shares of CPP contributions, and for EI premiums, together with the failure-to-deduct penalty in s. 227(8) and the failure-to-remit penalty in s. 227(9) [4], plus interest running from each missed remittance date.

There is a sales-tax layer on top. If the worker was in fact an employee, the amounts invoiced were not consideration for a taxable supply, so any input tax credit the payer claimed on those invoices was not available, and CRA can reassess the GST/HST as well. And there is a labour-law layer beyond CRA entirely: provincial employment standards may entitle a reclassified worker to vacation pay, overtime, and notice of termination, none of which a tax ruling resolves.

The asymmetry is what makes this dangerous. The worker who wanted contractor status for their own deductions bears almost none of the downside. The business does.

How do expenses work when you pay a contractor?

A contractor's costs are their own. When they rebill you for travel, materials or software, that amount normally forms part of the consideration for their supply, so GST/HST applies to the full invoice - fee and rebilled expense alike - and you claim an input tax credit on the tax the contractor charged, under s. 169 of the Excise Tax Act [5].

Three practical points follow.

You need a compliant invoice, not a receipt bundle. The Input Tax Credit Information (GST/HST) Regulations prescribe what documentation you must hold, including the supplier's GST/HST registration number at the applicable levels of consideration [7]. If the contractor is not registered, there is no tax on the invoice and no credit to claim - and no, you cannot claim tax on the hotel receipt behind it, because the hotel supplied the contractor, not you.
Their underlying receipts are not your records. Whether the contractor kept the hotel receipt is their compliance problem. Your record is the invoice.
Verify registration before claiming. A number that turns out not to be valid on the date of the supply is a denied credit, and CRA provides an online service for confirming a GST/HST account number before you rely on it; RC4022 explains who is required to be registered and what registrants must show [8].

One caution: expenses that are restricted in your hands stay restricted. If a contractor rebills client meals, the limits on meals and entertainment still bite - see the 50 percent rule.

How do expenses work when you reimburse an employee?

Completely differently, and the governing provision is s. 175 of the Excise Tax Act [6]. Where an employer reimburses an employee for property or a service the employee acquired for consumption or use in the employer's activities, the employer is deemed to have received that supply and to have paid the tax the employee paid. The employer then claims the input tax credit on that deemed tax, to the extent the cost relates to commercial activity.

The reimbursement itself is not a supply, so no tax is charged on it, and the employee is not billing you. What you need instead is the employee's original vendor receipt, because the deeming rule attaches to the tax the employee actually paid; the tax is evidenced by that receipt and nothing else. An expense claim form saying "Hotel - 212.00" is not enough to support the credit.

Where you pay a flat allowance rather than reimbursing actual cost, the rules shift again - allowances have their own treatment for both income tax and GST/HST purposes, set out in T4130 [9], and the choice between the two approaches is covered in per diem versus actual expense reporting. The essentials of building the policy itself are in employee expense reimbursement policy, and the ITC mechanics generally in our input tax credit guide.

What should a small business do about this in practice?

Start from the relationship, not the invoice. For every long-running worker, write down honestly where they land on control, tools, risk and integration, and re-check it annually - drift is the usual cause of an unpleasant ruling. Where there is genuine doubt, file a CPT1 and get the answer in writing [2].

Then make the paperwork match the conclusion. Contractors: a signed agreement, a real invoice bearing a GST/HST registration number where applicable, and no expense-claim forms. Employees: a written reimbursement policy, submitted vendor receipts, and allowances documented for what they are.

MapleExpense captures and files both streams - contractor invoices and employee receipts - so the underlying vendor documentation is attached to each claim and available when the credit is questioned. What it will not do is tell you which of the two a given worker is. That judgment stays with you and your accountant, and the record-retention requirements that apply to both are the same ones described in books and records retention.

Frequently asked questions

What factors does CRA use to decide if someone is an employee or a contractor?

CRA examines the intent of both parties and then tests that intent against the working relationship using four central factors set out in guide RC4110: control over how, when and where the work is done; ownership of the tools and equipment used; the worker's chance of profit and risk of loss; and the degree of integration of the worker into the payer's business. No single factor decides the question. CRA weighs the whole relationship as it actually operates, which means a contract describing someone as an independent contractor carries little weight if day-to-day practice looks like employment.

What happens if you misclassify an employee as a contractor in Canada?

The payer is generally assessed for the amounts it should have withheld and remitted - income tax under s. 153 of the Income Tax Act, the employee and employer shares of CPP contributions, and EI premiums - plus penalties and interest. The Income Tax Act imposes a penalty for failure to deduct under s. 227(8) and for failure to remit under s. 227(9), and CPP and EI carry parallel obligations. The payer also generally loses any input tax credit it claimed on the worker's invoices, because employment is not a taxable supply, and may face provincial employment-standards claims for vacation pay, overtime and termination notice.

Do you claim GST/HST on a contractor's invoice?

Yes, if the contractor is a GST/HST registrant and the invoice shows the tax and the registrant's GST/HST number. The tax the contractor charges you is claimed as a normal input tax credit under s. 169 of the Excise Tax Act, to the extent the service was acquired for use in your commercial activity. The supporting documentation must meet the Input Tax Credit Information (GST/HST) Regulations, which prescribe what the invoice must show at each level of consideration, including the supplier's registration number.

Can you claim GST/HST on an employee expense reimbursement?

Yes, through a different mechanism. Section 175 of the Excise Tax Act deems the employer to have received the supply the employee acquired, and to have paid the tax the employee paid, when the employer reimburses an employee for property or services acquired for consumption or use in the employer's activities. The employer then claims an input tax credit on that deemed tax. Practically, this means the employer needs the employee's underlying vendor receipt, not merely an expense claim form, because the receipt is what evidences the tax paid.

Does an employer reimburse a contractor for expenses the same way as an employee?

No. A contractor's expenses are the contractor's own business costs. When the contractor passes them through, they normally form part of the consideration for the contractor's supply, so GST/HST is charged on the full invoice - including the rebilled expense - and the payer claims an input tax credit on the tax the contractor charged. An employee reimbursement is not a supply at all; it is repayment of a cost the employee incurred as agent of the employer, and the employer relies on the deeming rule in s. 175 to recover the tax.

Can a worker be an employee for CPP and EI but a contractor for income tax?

In practice the determinations track each other, because CRA applies the same common-law analysis to the employment relationship under the Income Tax Act, the Canada Pension Plan and the Employment Insurance Act. A ruling requested on form CPT1 addresses the worker's status for CPP and EI purposes, and that conclusion effectively governs the income tax withholding obligation as well. There is a distinct concept of employment for EI purposes in certain regulated categories, but it does not create a general ability to treat the same worker as an employee for one statute and a contractor for another.

How do I get a binding answer on a worker's status?

Either party can ask CRA for a ruling by filing form CPT1, Request for a CPP/EI Ruling, which asks CRA to determine whether the worker is an employee or self-employed and whether the earnings are pensionable or insurable. The ruling is issued in writing and can be appealed. Requesting one before the relationship starts, or as soon as a doubt arises, is far cheaper than discovering the answer through an assessment covering several years of unremitted source deductions.

Sources cited in this article

CRA Guide RC4110 - Employee or self-employed?
CRA guide setting out the two-step intent and factor analysis: control, tools and equipment, chance of profit and risk of loss, and integration.
https://www.canada.ca/en/revenue-agency/services/forms-publications/publications/rc4110.html
Form CPT1 - Request for a CPP/EI Ruling
Form used by a worker or payer to ask CRA to rule on employment status and on whether earnings are pensionable or insurable.
https://www.canada.ca/en/revenue-agency/services/forms-publications/forms/cpt1.html
Income Tax Act, s. 153
Requirement to withhold and remit income tax from salary, wages and other remuneration.
https://laws-lois.justice.gc.ca/eng/acts/I-3.3/section-153.html
Income Tax Act, s. 227
Penalties for failure to deduct or withhold under subsection 227(8) and for failure to remit under subsection 227(9).
https://laws-lois.justice.gc.ca/eng/acts/I-3.3/section-227.html
Excise Tax Act, s. 169
General input tax credit rule, including the requirement to hold prescribed documentation before claiming.
https://laws-lois.justice.gc.ca/eng/acts/E-15/section-169.html
Excise Tax Act, s. 175
Deemed receipt of supply and deemed payment of tax where an employer, partnership, charity or public institution reimburses an employee or member.
https://laws-lois.justice.gc.ca/eng/acts/E-15/section-175.html
Input Tax Credit Information (GST/HST) Regulations, SOR/91-45
Prescribed information a claimant must obtain before claiming an input tax credit, including the supplier's GST/HST registration number.
https://laws-lois.justice.gc.ca/eng/regulations/SOR-91-45/
CRA Guide RC4022 - General Information for GST/HST Registrants
Registration, taxable supplies, and the treatment of reimbursements and allowances for input tax credit purposes.
https://www.canada.ca/en/revenue-agency/services/forms-publications/publications/rc4022.html
CRA Guide T4130 - Employers' Guide, Taxable Benefits and Allowances
When an amount paid to an employee is a reimbursement, an allowance, or a taxable benefit, and the related GST/HST consequences.
https://www.canada.ca/en/revenue-agency/services/forms-publications/publications/t4130.html

All sources verified 2026-09-23. Spotted a link that has moved? Email [email protected] and we will correct it.