Not dealing at arm's length for purposes of the Employment Insurance Act (EIA)
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Not dealing at arm's length for purposes of the Employment Insurance Act (EIA)
- Introduction
- Employer responsibilities
- The meaning of “not to be dealing at arm's length”
- Who does the non-arm's length issue affect
- Determining if an employee and an employer are not dealing with each other at arm's length
- Employees who are shareholders, corporate directors, corporate officers, or members of a corporation without share capital
- How to request a ruling
- For more information
- Legislative references
Introduction
This article provides information on the expression “not dealing at arm's length”. It also provides information on what the Canada Revenue Agency (CRA) looks at when determining whether an employee and an employer are dealing with each other at arm's length for the purposes of the Employment Insurance Act (EIA).
It is important to determine whether the parties are dealing at arm's length because, if they are not, the employment may not be insurable under paragraph 5(2)(i) of the EIA. This determination directly affects an employee's entitlement to employment insurance (EI) benefits.
Note
The Canada Pension Plan (CPP) does not have provisions regarding non-arm's length employment relationships. Therefore, this article does not deal with whether an employment is pensionable under the CPP in non-arm's length situations.
Employer responsibilities
All employers are required by law to deduct EI premiums from most amounts they pay to their employees. Employers must remit these amounts to CRA along with their share of EI premiums. However, if the employment is not insurable, the employer is not required to make those deductions. For more information on employer responsibilities and obligations, go to our Payroll menu page.
The meaning of “not dealing at arm's length”
For the purposes of the EIA, an employee and an employer may be considered not to be dealing at arm's length with each other. This would be the case when the circumstances of the employment are not substantially similar to the ones offered by the employer to their other employees or to ones that are offered in an open labour market, and there is no reasonable justification for these differences.
Who does the non-arm's length issue affect
The EIA refers to the Income Tax Act (ITA) to determine whether persons are not dealing with each other at arm's length. As a result, there are two categories of employees whose employment may be affected by the non-arm's length provisions: related persons and non-related persons to their employer. Each category is discussed below.
Related persons
Employees are related to their employer if they are related by marriage (including common-law partnerships), adoption, or blood (parents, siblings, or children). The employee can also be related to an employer that is a corporation when the employee is related to a person who either controls the corporation or is a member of a related group that controls the corporation.
For more information on how to determine if a person is a related person, you can consult folio S1-F5-C1, Related persons and dealing at arm's length.
When the employer (individual or corporation) and the employee are related to each other (related persons), they are deemed not to deal with each other at arm's length according to the ITA. Therefore, any employment between related persons is considered not insurable. However, the EIA contains a provision, paragraph 5(3)(b), to make such an employment insurable if the CRA is satisfied, when considering all the circumstances of the employment, that it is reasonable to conclude that the parties would have entered into a substantially similar contract of employment, if they had been dealing with each other at arm's length. In that case, the CRA will determine that the parties are dealing with each other at arm's length and the employment is insurable (unless it is non-insurable or excluded under another provision of the EIA).
Non-related persons
The ITA states that it is a question of fact whether persons who are not related to each other were, at a particular time, dealing with each other at arm's length. For EI purposes, this means that an employment between a non-related employee and an employer can be found not insurable when it is apparent from the circumstances of employment that they were not dealing with each other the way arm's length parties normally would.
The Tax Court of Canada in Parrill v. Canada (M.N.R.), which was later confirmed by the Federal Court of Appeal, gave the following explanation of when non-related persons are considered not to be dealing with each other at arm's length:
“Parties are not dealing at arm's length when the predominant consideration or the overall interest or the method used amount to a process that is not typical of what might be expected of parties that are dealing with each other at arm's length.”
In situations where the parties are non-related, the same circumstances of employment as those with related persons have to be considered. The analysis of all the circumstances of the employment is necessary to establish if it is reasonable to conclude that the parties would have entered into a substantially similar contract of employment if they had been dealing with each other at arm's length. If the circumstances are substantially different, the employee and employer would be considered, in fact, not to be dealing with each other at arm's length, and the employment will not be insurable.
Determining if an employee and an employer are not dealing with each other at arm's length
The approach for determining if the employee and the employer are not dealing with each other at arm's length is the same whether or not the parties are related. After gathering all the information about the working relationship, all the circumstances of the employment need to be considered to determine if arm's length parties would have accepted the same circumstances of employment.
The expression “all the circumstances of employment” refers to all the relevant facts regarding the employment. This enables the CRA to understand not only what, when, and how it occurred, but also why it occurred that way. All the circumstances of the employment must be reviewed to see if someone else would have been hired under a similar contract of employment.
Generally, the following four factors are examined when looking at all the circumstances of employment:
Remuneration paid
Terms and conditions of employment
Duration of work performed
Nature and importance of the work performed
A combination of factors determines whether the parties are dealing with each other at arm’s length, not just a single factor.
Remuneration paid
This factor refers to the amount of earnings or compensation that an employer pays an employee in exchange for the performance of duties, as well as the manner in which it is paid.
When the amount of the remuneration and the manner of payment reasonably compares to those that persons dealing at arm's length would accept for similar work, an arm's length relationship is suggested.
However, if the amount and manner of remuneration are not reasonably comparable to those that persons dealing at arm's length would accept for similar work, and there is no justification to justify these differences, a non-arm's length relationship is suggested.
The following chart provides examples of employment circumstances that affect this factor:
| An arm's length relationship is suggested when... | A non-arm's length relationship is suggested when... |
|---|---|
| the employee's rate of pay is reasonable in light of the nature and importance of the work, the time the employee spends doing the work, the employee's skills and qualifications, and the rate of pay received by other employees performing similar work; | the employee's rate of pay is considerably out of line with the nature and importance of the work, the skills and qualifications that the employee holds, and in comparison to other employees with similar roles and responsibilities (and there is no justification for doing so); |
| the employee is paid with usual frequency by the employer and receives and handles their pay in a similar manner to that of other employees; | the employee's wages are not regularly received or are received in a manner different from other employees, or in a manner that would be unacceptable in the labour market (and there is no justification for doing so); |
| the employee receives and enjoys all the wages they are owed, and are paid for all the work performed; | the amount the employee actually receives is considerably less, or more, than that owed or reported as paid to them (and there is no justification for doing so); |
| the employee's financial benefits package (wages, bonuses, etc.) is similar to that enjoyed by other employees. | the employee enjoys bonuses or other forms of additional pay and financial benefits that are unavailable to other employees (and there is no justification for doing so). |
Terms and conditions of employment
An employee and an employer agree to certain terms and conditions under which the employee will perform services, such as job requirements, work routine, schedule, or benefit plans.
In situations where the terms and conditions of employment are substantially similar to the ones in an arm's length employment relationship, this suggests that the employment relationship is at arm's length.
However, when the terms and conditions of employment are substantially dissimilar to arm's length employment relationships, and there is no justification to justify these differences, a non-arm's-length relationship is suggested.
The following chart provides examples of employment circumstances that affect this factor:
| An arm's length relationship is suggested when... | A non-arm's-length relationship is suggested when... |
|---|---|
| the employee's hours and days of work are reasonable; | the employee's hours and days of work are significantly and inexplicably different from the rest of the employer's operations (and there is no reasonable justification); |
| the employer's method of recording and tracking the hours the employee worked is similar to the method used for other employees; | the employer does not track, record, or control the employee's working hours in a similarly stringent or verifiable fashion as other employees' working hours (and there is no reasonable justification); |
| the employee's workday is accounted for in the services, duties, and tasks for which they are responsible; | the quantity of work performed or required to be performed does not substantially account for the employee's working hours, and neither the employer nor employee can account for non-productive time (and there is no reasonable justification); |
| the employee's participation level in the company benefit plans, and the cost to the employee, compares reasonably to that of other employees; | the employee participates in benefit plans that are not available to other employees at the same cost, or the employee is excused from participation in otherwise mandatory plans (and there is no reasonable justification); |
| the employee's access to, and use of, corporately-owned business-specific assets is consistent with the position held by the employee and the purpose for which the assets were intended, and similar to other employees. | the employee enjoys a level of access to, and use of, corporately-owned, business-specific assets that is inconsistent with their position, responsibilities and duration of employment and that level of access or use is not available to other employees in similar positions (and there is no reasonable justification). |
Duration of work performed
An employment's duration (when it occurs, and how long it lasts) should correspond reasonably to the length of time such work should take to perform, and to the employer's normal business cycle and history. Most employers experience factors such as seasonal highs and lows, unforeseen events, or other factors, that affect the decision to hire and lay off employees.
A reasonable timing or duration of employment may suggest an arm's length relationship.
An unreasonable timing or duration of employment may suggest that the employee and the employer are not dealing with each other at arm's length within their employment relationship.
Factors that occur outside the employment period may be considered when they are relevant in establishing if the employee and the employer were not dealing with each other at arm's length.
The following chart provides examples of employment circumstances that affect this factor:
| An arm's length relationship is suggested when... | A non-arm's length relationship is suggested when... |
|---|---|
| the employee is hired at a reasonable time of year in light of the employer's business cycle and hiring history, as well as the hiring pattern of other employees; | the occurrence of the employment is substantially different with the employer's business cycle, the nature of the employee's work, or the hiring of other employees (and there is no reasonable justification); |
| the employee is engaged for a reasonable length of time considering the nature of work, the employer's business needs, or other employee work-periods. | the duration of the employment is substantially different with the nature or amount of work performed, the employer's business needs, or the work periods of the employee's supervisors, employees who worked under the employee's supervision, or other employees (and there is no reasonable justification). |
Nature and importance of the work performed
Costs, such as wages, associated payroll costs, employee benefit plans, or insurance, make the decision to hire employees important for a business. An employer in the open labour market hires employees to perform services that are necessary and important to the business operation.
If an employer hires an employee to perform services that are important to the business operation, it may indicate an arm's length relationship.
On the other hand, if an employer hires an employee to perform services that are accessory or unnecessary to the business operation, it may indicate a non-arm's length relationship.
It is also important that the remuneration paid is in accordance with the nature and importance of the work performed.
The following chart provides examples of employment circumstances that affect this factor:
| An arm's length relationship is suggested when... | A non-arm's length relationship is suggested when... |
|---|---|
| the services performed by the employee are integral to the employer's business activity and are important to its operation; | the services performed by the employee are an accessory to the employer's business (not integral to it), the work would normally be considered too insignificant or irrelevant to the employer's trade or business to warrant the expense of hiring an employee to perform these services (and there is no reasonable justification); |
| the employer has historically employed an employee to perform this work, or the work requires ongoing performance and the employer has employed someone else to perform it before and after the employee's period of employment; | the employer had historically not employed anyone to perform the same work, or had not required the services of an employee to have the same work completed before or after the period in question (and there is no reasonable justification); |
| the employee possesses the necessary skills and qualifications that other employees would possess to perform the required work. | the employee does not have the necessary qualifications, licenses, certifications, or experience to perform the job – particularly if the rate of pay does not reflect the employee's low qualification level (and there is no reasonable justification). |
Employees who are shareholders, corporate directors, corporate officers, or members of a corporation without share capital
Determining if an employee, who exercises another corporate responsibility for the corporation, is dealing at arm's length with the employer involves the same considerations as with any other employment relationship. Only circumstances attributable to the employment contract, and not those that arise from the corporate role as a shareholder, director, or corporate officer, are relevant to the question of insurability of that employment.
However, it is not always possible to separate these roles (for example, employee vs. shareholder). In some smaller businesses where the shareholders are also directors and employees, the directors/employees make decisions that impact their employment (adversely or otherwise) to a degree that would not reasonably occur between persons dealing with each other at arm's length. In such instances, it is difficult to conclude that the employee and employer share separate economic interests. In that case, it might be reasonable to conclude that the persons were not dealing at arm's length with respect to their employment relationship.
Any analysis of the circumstances of employment must be made against similar occupations (for example, a manager position), to see if the circumstances are reasonable in comparison to other employees with similar experience and qualifications. This is particularly true in the case of employees who are shareholders, since they are often employed in executive or managerial positions. The circumstances of the employment are often considerably different for executives and senior managers than for other employees.
The following chart provides examples of employment circumstances that affect these types of situations (for example, when the employee has separate roles in the business such as that of a shareholder and an employee):
| An arm's length relationship is suggested when... | A non-arm's length relationship is suggested when... |
|---|---|
| the employee signs guarantees that are not substantial, or that do not affect their personal assets or property, and it is justified by their other role in the business; | the employee signs substantial guarantees that can affect their personal assets or property (and there is no reasonable justification); |
| the employee has individual signing authority on the corporate bank account or has the right to withdraw limited funds, and it is justified by their other role in the business. | the employee has individual signing authority on the corporate bank account and has the right to withdraw any funds at any time (and there is no reasonable justification). |
| An arm's length relationship is suggested when... | A non-arm's length relationship is suggested when... |
|---|---|
| the employee loans the employer an amount and there is documentation supporting repayment of the loan; | the employee loans the employer an amount and there is no documentation supporting repayment of the loan (and there is no reasonable justification); |
| the employee loans the employer an amount and the interest rate is what is normally acceptable in the market place. | the employee loans the employer an amount and the interest rate is not what is normally acceptable in the market place (and there is no reasonable justification). |
| An arm's length relationship is suggested when... | A non-arm's length relationship is suggested when... |
|---|---|
| all employees/shareholders are involved in making decisions pursuant to their respective votes in the corporation. | the employee/shareholder has |
| An arm's length relationship is suggested when... | A non-arm's length relationship is suggested when... |
|---|---|
| the employer uses the employee's property or assets to conduct business and offers compensation for rent or utilities in a way that is common to current market-place practices. | the employer uses the employee's property or assets to conduct business without sufficient compensation for rent or utilities (and there is no reasonable justification). |
How to request a ruling
If an employee or an employer is not sure whether an employment is insurable, either party can ask the CRA for a ruling. More information on the ruling process is available at How to get a CPP/EI ruling.
For information on the possible implications of a CPP/EI ruling, go to Have you received a CPP/EI ruling.
For more information
To get more information, call the CRA’s business enquiries line at 1-800-959-5525.
Legislative references
- Paragraphs 5(2)(i), 5(3)(a) and (b) Employment Insurance Act
- Subsections 248(1), 251(1), 251(2), 251(4), 251(6), 252(1), 252(2), and paragraph 251(5)(a) Income Tax Act
Page details
- Date modified:
- 2019-05-03