How do I decide if someone is an employee or a contractor?

Look at the substance, not the label: financial risk, control over the work, who supplies the tools, and whether the worker can subcontract or send a substitute. The CRA weighs these together. When in doubt, get advice — misclassification can trigger back taxes and penalties.

What are source deductions?

They are the CPP/QPP contributions, EI premiums, and income tax an employer withholds from employees’ pay and remits to the CRA. The employer also pays its own share of CPP/QPP and EI on top of the withheld amounts.

What is a Personal Services Business?

A PSB is, in effect, an incorporated employee — a corporation providing services that the individual would otherwise perform as an employee of the payer. PSBs lose the small business deduction and face severely restricted deductions, so the structure can backfire badly.

Should I use a payroll company?

For most new employers, yes. The book recommends it to save time, avoid calculation errors, and have remittances made automatically — which removes the temptation to spend withheld trust money on operating costs.

Can I be held personally responsible for unpaid payroll remittances?

Yes. Source deductions are trust amounts, and directors can be assessed personally for unremitted CPP, EI, and income tax for up to two years after they last served as a director. This personal exposure is one of the biggest reasons to remit on time.

What paperwork do I file for employees?

You remit deductions on schedule and file annual T4 slips and a T4 summary reporting each employee’s pay and deductions. A payroll provider or accountant can handle the filings for you.

Hiring your first employee in Canada: payroll, source deductions, and director’s liability

Hiring your first employee is a milestone — and it comes with real obligations to the Canada Revenue Agency. Get the basics right and payroll is routine; get them wrong and the consequences can reach your personal bank account. This guide covers the employee-versus-contractor question, how source deductions work, and why directors must take remittances seriously. It draws on themes from tax lawyer Dale Barrett’s start-up guide, available on our page.

Employee or independent contractor — does it matter?

It matters a great deal, and you do not get to decide by simply labelling the relationship. As the book puts it, if you put a sign on a duck that reads "camel," the CRA will still look at how it walks, quacks, and swims and declare it a duck — and may add penalties. The CRA looks at the substance of the relationship, not the label.

There is no single test. The CRA weighs a combination of factors, including how much financial risk the worker takes, how much control you have over who does the work and how it is done, and who supplies the tools and equipment. A worker who can profit or lose, sends substitutes, sets their own methods, and brings their own tools looks like a contractor; someone you direct closely and pay regardless looks like an employee.

Degree of financial risk the worker takes on
Level of control over who does the work and how
Who supplies the tools and equipment
Whether the worker can hire their own assistants or send a substitute

Beware the "incorporated employee" (Personal Services Business)

Asking a worker to incorporate does not automatically make them a contractor. If an incorporated worker effectively functions like an employee of your business, the CRA may treat their company as a Personal Services Business (PSB) — what the book calls an "incorporated employee."

The consequences are harsh for the worker’s corporation: a PSB is not eligible for the small business deduction and its allowable deductions are severely restricted, almost as if the corporation did not exist. This is common in industries like trucking. If you are asked to incorporate, or you ask workers to, get professional advice on PSB risk.

How do you set up payroll and source deductions?

Employers in Canada must deduct CPP (or QPP in Quebec) contributions, EI premiums, and income tax from employees’ pay. What the employee receives is their gross pay minus these deductions. You must set the deductions aside, remit them to the CRA on schedule, and file the required paperwork including T4 summaries.

On top of the amounts withheld from the employee, the employer also pays the employer’s share of CPP/QPP and EI. To set up payroll: open a payroll (RP) program account under your business number, register each employee, calculate deductions each pay period, remit on time, and issue T4s annually.

Open a payroll (RP) account under your business number
Withhold CPP/QPP, EI, and income tax from each paycheque
Pay the employer’s share of CPP/QPP and EI on top
Remit to the CRA on schedule and file T4s each year

Should you outsource payroll?

The book strongly recommends that new owners consider an outsourced payroll company, for three reasons: it saves the time of preparing paperwork and doing calculations, it reduces the risk of costly errors, and a good provider deducts the right amounts each pay period and remits them automatically.

That last point is the real protection. The most dangerous payroll mistake is using withheld money to pay rent, staff, or suppliers when cash is tight. Automating remittances removes the temptation entirely.

Why directors can be personally liable for remittances

Source deductions, like collected GST/HST, are "trust" amounts the business holds for the government. A central purpose of incorporation is to shield personal assets — but trust amounts pierce that shield.

Directors have a duty to ensure trust debts are paid and can be assessed personally for unremitted GST/HST, CPP, and EI for up to two years after they last served as a director. The book is candid that although the law uses a "reasonable director" test, in practice the CRA often applies something closer to a "perfect director" standard, treating directors as guarantors of the debt. The takeaway: never let payroll or sales-tax remittances slide.

This is general information, not legal, tax, or accounting advice. Rules, rates, and thresholds change often and vary by province — verify current requirements with the Canada Revenue Agency, your province, and a qualified professional before you act.

Frequently asked questions

How do I decide if someone is an employee or a contractor?: Look at the substance, not the label: financial risk, control over the work, who supplies the tools, and whether the worker can subcontract or send a substitute. The CRA weighs these together. When in doubt, get advice — misclassification can trigger back taxes and penalties.
What are source deductions?: They are the CPP/QPP contributions, EI premiums, and income tax an employer withholds from employees’ pay and remits to the CRA. The employer also pays its own share of CPP/QPP and EI on top of the withheld amounts.
What is a Personal Services Business?: A PSB is, in effect, an incorporated employee — a corporation providing services that the individual would otherwise perform as an employee of the payer. PSBs lose the small business deduction and face severely restricted deductions, so the structure can backfire badly.
Should I use a payroll company?: For most new employers, yes. The book recommends it to save time, avoid calculation errors, and have remittances made automatically — which removes the temptation to spend withheld trust money on operating costs.
Can I be held personally responsible for unpaid payroll remittances?: Yes. Source deductions are trust amounts, and directors can be assessed personally for unremitted CPP, EI, and income tax for up to two years after they last served as a director. This personal exposure is one of the biggest reasons to remit on time.
What paperwork do I file for employees?: You remit deductions on schedule and file annual T4 slips and a T4 summary reporting each employee’s pay and deductions. A payroll provider or accountant can handle the filings for you.