How to set up your contractor or employee the right way

Hiring help is a big step for any small business — and a sign your business is growing. Whether you're bringing on a contractor for a short-term project or hiring your first employee, it’s important to get the setup right from the start. The way you classify and document your working relationship can have serious tax and legal implications down the road. 

At True North, we’ve seen too many business owners run into trouble with CRA audits and costly reclassification issues — simply because they didn’t know the rules. Here's what you need to know to make the right call, stay compliant and build a strong foundation for your growing team.

Why it matters: the real cost of getting it wrong

You might think you’re hiring a contractor. You might even have a signed subcontractor agreement. But if the Canada Revenue Agency (CRA) disagrees, that contract won’t protect you — and the consequences can be expensive.

When you classify someone as a contractor, you don’t withhold or remit CPP (Canada Pension Plan) or EI (Employment Insurance), and you're not on the hook for vacation pay or other employee entitlements. But if CRA later decides that person should have been an employee, you could be facing:

• Back payments of both the employer and employee share of CPP and EI
• Interest and penalties on missed payroll remittances
• Reassessments on the worker’s personal tax filings
• Potential legal issues if the contractor pushes back

And it doesn’t just affect you. The person you hired could now owe back taxes and face their own penalties if CRA decides they weren’t running a true business. That’s not a fun call to make — or receive.

What the CRA looks for when classifying workers

The CRA doesn't go by job titles or what your contract says. They’ll look at the real working relationship to determine whether someone is a contractor or an employee.

Here are the main factors the CRA considers:

• Control – Do you decide when, where and how the work is done?
• Ownership of tools – Does the worker use your equipment, or their own?
• Risk and reward – Can they profit or lose money based on how efficiently they work?
• Integration – Are they part of your day-to-day operations, or running their own business?
• Perks and benefits – Do they get vacation pay, RRSP matching or health benefits?

If you’re calling them a contractor, but treating them like an employee, the CRA could reclassify the relationship — and the cost can add up fast.

When hiring a contractor makes sense 

When done right, working with independent contractors can be a great option — especially for project-based work, seasonal needs or accessing specialized expertise.

The advantages:

• No need to manage payroll deductions (CPP, EI or income tax)
• No obligation to provide vacation pay, benefits or sick days
• Greater flexibility with contract terms
• Potential cost savings for short-term or occasional work
  
  

But these benefits only apply if the contractor is genuinely independent. That means they’re likely working with other clients, setting their own hours and using their own tools.

How to document the relationship properly

Whether you’re bringing on an employee or a contractor, good documentation matters — for both legal protection and CRA compliance.

If you’re hiring an employee, make sure to:

• Provide a clear employment agreement outlining hours, pay and expectations
• Register a CRA payroll account
• Withhold and remit income tax, CPP and EI
  Issue a T4 at year-end

If you’re working with a contractor, you’ll want to:

• Have a signed subcontractor agreement that outlines scope, timelines, rates and deliverables
• Ensure the contractor has a business number and issues invoices
• Avoid offering benefits or controlling how they do their work
• Issue a T4A if you pay them over $500 in a year

A well-documented file helps protect your business if CRA ever audits or questions the classification.

How we help small business owners get it right

At True North, we help small business owners like you plan ahead and avoid surprises.

If you’re unsure how to classify someone, or you’ve already brought someone on and want to double-check, we can:

• Walk you through CRA’s criteria in a simple, clear way
• Review the working relationship and spot any red flags
• Help you review a subcontractor agreement
• Set you up with payroll if an employee relationship is the better fit
• Build a paper trail so you're ready if CRA ever comes calling

We’ll give you the clarity and confidence to move forward without second-guessing.

Bottom line: plan ahead and protect your business

Bringing someone on — whether contractor or employee — should feel like a step forward, not a risk. Getting the setup right from day one keeps your business compliant, protects your working relationships and helps you avoid expensive surprises down the road.

Don’t guess. If you’re not sure how to proceed, ask. We’re here to help.

Let’s talk about building your team the right way

🔎 Have questions? Ask us about our advisory services. We’re here to help you plan ahead and protect what you’ve built.

📘 Download our free ebook
The Path to Starting Your Own Business has everything you need to get set up, stay compliant and build your business the smart way — from day one.

Read more about Starting a Business topics that may be helpful to you and your small business.