Should your family-run business pay into El for relatives?

• Author: Bissonette, Laurie
• Position: BUSINESS SENSE

Is your company paying too much El? Many family-run companies fail to realize family members working in the business are usually not eligible to collect Employment Insurance if they're laid off for any reason, including shortage of work, maternity leaves, etc. That means neither the company nor the employee should be paying El premiums.

Premiums can cost the employee and employer more than $2,000 each year. For example, in 2014 employers will pay $1,279 for each insurable employee who earns $48,600 or more and the employees will each pay $913. However, there is a saving grace: employers and employees who have overpaid may be able to claim refunds going back three years.

The rules are intended to prevent abuse of the EI system by stopping employers from creating artificial employment situations for family members.

But how is eligibility determined? An employee is not eligible to claim El benefits and thus does not have to pay premiurns if he or she controls more than 40 per cent of the corporation's shares or if the employee and employer are not dealing at arm's length.

The 40 per cent share ownership rule is fairly straightforward, but determining whether there is a non-arm's length relationship between the employer and employee can be more complicated. Employees who are closely related to their employers are usually not dealing at arm's length. These relatives include a spouse or common-law partner, children, parents, and brothers and sisters of an owner.

When ruling on a particular situation, the Canada Revenue Agency looks at the nature of the employment along with the relationship between the parties. To determine whether employees are not dealing at arm's length with their employers, the CRA considers the circumstances of their employment.

In some situations, relatives can be considered to be at arm's length if the circumstances of their employment are substantially similar to those that would exist if they were dealing at arm's length. These employees would pay El premiums and be eligible for benefits if they were laid off. If you can convince the CRA that the company would have entered into a similar employment contract with an employee who was not a relative, then it will consider the employment to be arm's length.

To determine whether an employee is not dealing at arm's length with the employer, the CRA looks at a long list of factors. For example, does the employee's pay reasonably compare to that an arm's-length employee would...