Why does a my client insist on my incorporation?

Question

I'm a software engineer out of Quebec, Canada. My current contract is going through a headhunting firm. I bill the headhunting firm and they bill the company I'm actually doing work for and take a percentage. I'm fine with the arrangement so far.

I'm a registered self-employed worker, however, the head hunting firm, is INSISTING hard that I incorporate. I don't have an immediate problem with it except for a few fees and extra paperwork. I might even be able to turn it into a beneficial condition for myself.

However, when someone insists like this and tells me that it's a way to protect myself in in case XYZ happens, I wonder what's in it for them and why the immediacy, what am I not aware of.

So my question is this: What are the advantages for the headhunting firm that arise form my incorporation?

Answer 1

It avoids the risk (to them) of your being reclassified (by the CRA) to be their employee and for them being liable retroactively to pay the employer portion of payroll taxes (plus interest and maybe penalties). You could also demand pay in lieu of notice, vacation pay etc. if you decided to call yourself an employee. You need to talk to a Quebec-based tax accountant familiar with your kind of business about all the ramifications of this.

You should not enter into this too lightly, the paperwork overhead is significant, the T2 returns are designed for professional accountants, not individuals (the guide is 120+ pages), and paying someone to do them for you will probably cost $2K per year minimum, plus you'll have to remit withholding taxes (employer and employee portions) monthly and collect and remit the Quebec version of HST at least quarterly. If you're late on any of the the ~20 payments and filings per year, there are significant penalties, and even if they screw up something (allocations to the wrong year is a popular one) it will take your time to straighten it out. Winding it down will cost more time and probably money.

Edit: Quebec is one of the two provinces (Alberta is the other) where the Feds do not administer the corporate tax returns for the province, so there may be an additional annual filing for the province, with potentially different rules and language. This hassle was eliminated in Ontario years ago. Again, talk to a tax accountant.

Since payments and filings are separate transactions in general, you're looking at roughly one such item per week, but the bulk of the work will be the quarterly and annual ones (eg. T4A summaries, corporate tax return, prov tax return, QST returns).

I can't really think how this would protect you, since you're unlikely to be granted major credit or be able to take on other liabilities without a personal guarantee of some kind, and if you do take on liability then big clients will often insist on proof of adequate insurance (maybe $5M or more).

There can be some compensating advantages, but it's up to your accountant and you to figure out if it is worth it.

Answer 2

The CRA uses a multi-question test to determine whether you are an independent contractor or an employee. (There are special rules for Quebec: scroll down.) Nothing in these rules mentions being incorporated, having a separate bank account for the business, having a business phone that is different from your personal phone and is listed in the phone book, having business cards or getting letterhead printed, yet I have heard people urge others to incur these expenses in order not to be considered an employee.

Here is an example in real life that is happening now. I have a client who has employees. The manager tells the employees what to work on, and tells them they have to come in Saturday for the deploy. They ask him if they want a day off. In contrast, he asks me if it's possible for me to come in on a particular day, and he asks me if I would like to be part of a particular meeting or project, or take on a task. I tell him I can't be in next week because I have something else planned. My customer provides laptops to their developers; I bring my own. The relationship is clearly different. (And yes, I have an office, letterhead, a business phone, a business bank account and credit cards, plus other employees and other clients, but these things don't appear on the CRA list other than a mention of exclusivity and the vague phrases "advertises and actively markets his or her services" and "has established a business presence".)

The cost to the company if you are deemed an employee is significant: they have to pay everything they should have remitted for you plus everything they should have deducted from you. The cost to you of incorporating is non trivial. If you have several clients and legitimate business expenses, thank them for their interest in helping you and assure them you have it all under control. If this will be your only client, for months or years at a time, take a good hard look at the list on the CRA site. If the situation they want you to enter is "iffy" against that list, explore whether there are ways to make it more securely obvious that you are not an employee.

When we first started our business we did not incorporate. One of us had employment income and being a partnership (like a sole proprietorship but more than one person, no incorporation, simple form to fill out) allowed us to deduct the company losses from our personal income at tax time. Once the company was consistently profitable, we incorporated it and retained both a lawyer (many over the years) and an accountant.