Office and Employment Income

• Author: Vern Krishna
• Profession: Professor of Common Law, University of Ottawa Barrister at Law
• Pages: 118-154

118

CHAPTER 6

OFFICE AND

EMPLOYMENT INCOME

“Classif‌ication is the beginning of wisdom.”1

A. GENERAL COMMENT

In this and the ch apters immediately following, we begin to parse income

according to its source. Section 3 specif‌ies the manner and sequence in

which income from each source f‌lows into the computation of net income.

Section 3 identif‌ies the following sources:

• Off‌ice;

• Employment;

• Business;

• Property;

• Capital gains; and

• Other income.

The section is mandatory and rigid, and neatly, but not easily, com-

partmentali zes the sources into segregated pigeonholes. Segregation by

source adds a considerable amount of complexity in the statute.

Employment income is the single largest source of government

revenues. Hence, tax revenues from this source play a critical role in

1 Edwin Rober t Anderson Seligman, D ouble Taxation and Intern ational Fiscal

Cooperation (New York: The Macmillan Company, 1928) at 58.

Off‌ice and Employme nt Income119

government f‌inancing. Even a small leak in the taxation of employ-

ment income can have substantia l revenue consequences to federal and

provincial trea suries. Thus, we see the CRA f‌ighting cases i nvolving as

little as $300 all the way up to the Supreme Court of Canada.

The employment income rules affect individuals, each of whom is

a potential voter. Thus, although the law is sensitive to the need for

government revenues, it must also be seen as fair.

There are three basic issues in the taxation of employment income:

1) Characterization: What is the nature of the relationship that gives

rise to income?

2) Timing: When do we tax it?

3) Scope: What is taxable?

There are four distinguishing features of employment-source in-

come. First, deductions from employment income are strictly controlled:

subsection 8(2) prohibits the deduction of any employment-related ex-

pense unless the Act specif‌ically authorizes it. This rule keeps a tight

rein on employment deductions. In contrast, we presume that deduc-

tions from business or investment income are acceptable if they com-

ply with commercial and accounting principles. The presumption is

that business expenses are deductible unless the statute specif‌ically

prohibits them.2 Thus, deducting expenses against business income is

much easier than again st employment income. This di fference between

business and employment income is a powerful incentive for taxpayers

to characterize their income as business income.

We withhold tax on employment income at source,3 and hold the

tax in trust for the Crown.4 In contrast, there is no systematic with-

holding at source on business income. Taxpayers who earn business

2 Income Tax Act, RSC 1985, c 1 (5th Supp) [ITA], subs 9(1); Royal Trust Co v MN R,

[1957] CTC 32 (Ex Ct) (payment of dues and mem berships in community and

social clubs on b ehalf of employees deductible where employe es expected to

make contact s and generate business); Dominion Taxicab As sn v MNR, [1954]

SCR 82 (fees to company contract ing with taxica b owners not deductible; funds

contingently rece ived not income); Bank of Nova Scotia v Canada, [1980] CTC

57 (FCTD), aff’d [1981] CTC 162 (FCA) (value of foreign ta x credit determined

in accordance w ith ordinary commerc ial principles, taki ng weighted rate of

exchange at ti me tax payable).

3 ITA, ibid, para 153(1)(a).

4 Ibid, subs 227(4). Failure to w ithhold tax on employment income rend ers the

employer liable to a civ il penalty of 10 percent plus intere st at a prescribed rate

(subs 227(8)) and to crimi nal penalties (subs 238(1)). Directors of a corporation

who fail to wit hhold and remit taxes may b e personally liable (subs 227.1(1)).

INCOME TAX L AW120

income must make instalment payments on account of their estimated

tax payable.5

Employment income is generally taxable on a cash basis.6 Business

and investment income are taxable on an accr ual or as-earned basis, no

matter when the taxpayer receives the income.7

Because of these restrictions on the computation of employment

income, individuals generally prefer independent contractor status for

tax purposes. This distinction causes some tension in the characteriza-

tion of employment relationships.

Hence, we must address six issues:

• Is the taxpayer an employee?

• Does the taxpayer hold an off‌ice?

• Has the taxpayer received remuneration or taxable benef‌its?

• What is the value of the remuneration or benef‌it?

• When did the taxpayer receive the remuneration or benef‌it?

• Is the taxp ayer entitled to any statutory deductions from employment

income?

B. CHARACTERIZATION OF EMPLOYMENT

R EL AT IONSHI P

There is a fair volume of litigation concerning the nature of working

relationships. The issue occurs in different contexts — tax law, Canada

Pension Plan claims, Employment Insurance, and labour law. The doc-

trine of employee relationships has evolved, and continues to do so, as

working conditions and workplace relationships change.

“Employment” is the position of an individual in t he service of some

other person.8 Thus, the f‌irst step in the characterization of employ-

ment income is to determine whether a contract of service relationship

exists between the taxpayer and the source of his or her income.

In traditional relat ionships, characterization depends on the degree

of control and supervision that a person exercises over another in the

provision of services. In an employment relationship, the employee is

under the direct control and superv ision of the employer and is obliged

5 Ibid, subs 156(1).

6 Ibid, subs 5(1). There is an im portant exception for “salar y deferral arrange-

ments”; see para 6(1)(i), subs 248(1)”salary deferral a rrangement” and subs

6(11).

7 Ibid, s 9.

8 Ibid,subs 248(1).