Canada: Classifying Workers as Independent Contractors Is Risky

Ensuring compliance with employment laws in Canada not only reduces liability but also fosters a fair and transparent workplace.

Amid all the economic uncertainty — tariffs, stock market instability, and an impending federal election — U.S. and Canadian employers are increasingly resorting to laying off their workers. In doing so, many are exposing long-standing but risky employment practices, particularly in how they classify workers — as independent contractors or employees.

The distinction is more than just a label. The misclassification of employees as independent contractors carries significant legal and financial consequences for employers, which often only come to light after terminations.

Employers generally misclassify workers as independent contractors to avoid payroll taxes and other statutory obligations. In the case of U.S. employers engaging Canadian workers, such classifications may also allow companies to circumvent Canadian registration and compliance requirements entirely. However, the classification of a worker is not solely determined by the terms of a contract but also by the factual nature of the working relationship.

Recently, we received a response to a demand letter sent on behalf of a client who had been classified as an independent contractor. The employer’s legal counsel contended that, because the contract explicitly identified the worker as an independent contractor, no severance pay was owed. While it is true that bona fide independent contractors are not entitled to severance pay unless contractually stipulated, the determination of employment status is not dictated by contract language alone.

The mere assertion by an employer that a worker is an independent contractor — regardless of how long they have been classified or compensated as such — does not make it so. Ultimately, only the Canada Revenue Agency (CRA), the Ministry of Labor, or a court of competent jurisdiction can make a legally binding determination regarding employment status. If a worker is found to be an employee rather than an independent contractor, they are entitled to severance pay in accordance with employment standards legislation and common law principles.

There is no single determining factor in distinguishing between an independent contractor and an employee. Courts undertake a holistic analysis of several key factors, including:

1. Degree of control:

• Does the employer dictate the worker’s tasks, hours, and methods of performing work?
• Does the worker exercise autonomy, or are they closely supervised?

2. Financial risk and investment:

• Does the worker assume financial risk, such as the possibility of nonpayment or loss of clients?
• Has the worker made significant investments in their own business?
• Does the worker provide their own tools and resources?

While the intent of the parties, as expressed in the contract, is a relevant factor, it is not determinative. Even if a worker is deemed an independent contractor, they may still be classified as a dependent contractor — a category that carries different consequences.

A dependent contractor is a contractor who relies primarily on a single client or employer for their income and is thus financially dependent. Courts have consistently held that dependent contractors are entitled to severance pay, akin to employees, recognizing the economic vulnerability of such workers. The difference is that they are not protected by most Employment Standards Acts, permitting contracts for termination for less compensation than the statutory minimums.

For workers who have been terminated, it is crucial to recognize that being labeled an independent contractor does not necessarily preclude entitlement to severance pay. Many misclassified workers are, in fact, owed common law notice upon termination, just as any other employee would be.

Employers facing economic challenges may be caught off guard when confronted with severance obligations for individuals they believed to be independent contractors. Given the potential legal and financial ramifications, both workers and employers are strongly advised to seek legal counsel before making decisions regarding employment classification. Properly structuring employment relationships from the outset can mitigate costly legal disputes in the future.

Ensuring compliance with employment laws not only reduces liability but also fosters a fair and transparent workplace. Workers should be proactive in understanding their rights, while employers must take necessary precautions to align their classification practices with legal standards. Failure to do so can result in significant financial penalties, reputational damage, and litigation. Ultimately, a well-informed approach benefits both parties by creating certainty and stability in employment relationships.  

Howard Levitt and Puneet Tiwari are attorneys with Levitt LLP in Toronto. © 2025 Levitt LLP. All rights reserved. Reposted with permission of Lexology.