Contractors vs employees: how to get it right

Jason Ennor, Co-founder and CEO at MyHR
By Jason Ennor, Co-founder and CEO at MyHR

Employee or independent contractor? At MyHR, we get regularly asked this question and there seems to be some genuine confusion about the differences.

Employees and contractors offer different pros and cons to employers. You may be trying to manage some uncertainty and avoid committing to permanent employees, or you may be resourcing for a complex project and need some highly-skilled contractors that are available immediately.

On the other hand, you may want an ongoing commitment from your people and are comfortable locking in an employee for an ongoing period of time, or you want to avoid expensive contractors and want to manage your work in-house.

Individuals also might decide to enter a contracting relationship for the flexibility or for perceived tax benefits. They may be looking for work and tell an employer they’re “okay waiving their employment rights” to get some income.

However, the choice is not theirs to make. In New Zealand, the actual, day-to-day nature of the employment relationship determines whether somebody is an independent contractor or an employee. Getting this wrong can cause your business significant issues and cost on two fronts: tax and employment law.

You only need to scan recent rulings by the Employment Court and you can see how risky it is for employers to treat workers as contractors when the employment relationship is actually more formal.

One case went to the Court of Appeal, which overturned an Employment Court ruling and found that contract drivers working for two pizza franchises were employees. The franchisees subsequent appeal was dismissed by the Supreme Court and they were ordered to pay $15,000 in costs to their employees (who they thought were contractors).

The Government, too, announced last year it had convened a working group between BusinessNZ, the Council of Trade Unions, and the Ministry of Business, Innovation and Employment (MBIE) to consider options to better protect the rights of workers classed as contractors, including the ability to be covered by Fair Pay Agreements.

So it is increasingly clear that employers cannot avoid their employment obligations and people cannot choose to opt out of their employment entitlements or statutory tax requirements.

There are definite differences between employees and contractors, so we’ve created this practical guide to help minimise the risk to your business.

The difference between an employee and a contractor

There is plenty of advice online to help with differentiating between the two. Type “contractor” into the search fields of the Employment NZ website or Inland Revenue website. Both have useful comparison tables.

For a less formal, common-sense assessment, remember: If it looks like a duck, swims like a duck, and quacks like a duck, then it probably is a duck. No amount of convincing yourself (or others) that it’s a golden swan will make it not a duck!

Employees

Employees are in a contract “of service” serving the employer under an employment agreement.

They are told what to do, hours are generally fixed, and they dedicate their time and effort primarily to one organisation. They are provided tools to complete the work. They must apply for time off, and their employer has a lot of control over how and when they do their job.

Employees are paid by a payroll system, with automatic PAYE deductions. They’re eligible for KiwiSaver and have all minimum rights under New Zealand employment laws, such as leave entitlements, holiday pay, and ability to raise a personal grievance, e.g. for disadvantage, unfair treatment, or unjustifiable dismissal.

The employer has to keep employee records, e.g. their employment agreement and wage, time, and leave records.

Any significant changes to their employment must happen through consultation - this might be a change to their duties and responsibilities, their hours of work, location, or potentially, their pay and benefits. Employers cannot unilaterally make decisions without consulting their employees as part of this process.

It’s most likely that a senior, or important, member of the team would be an employee.

Contractors

Contractors are working in a contract “for service”, serving themselves by delivering outcomes to their clients. This is a commercial relationship, not an employment relationship. 

Contractors are usually self-employed and can work freely for a number of organisations. They dictate their own time-off and may or may not be available for work. They provide their own equipment and tools, and usually will choose how and when they do the work.

They keep their own records, invoice for their work, pay their own taxes and ACC, and if their turnover is at least $60,000 a year, they must be GST registered.

It’s unlikely that a senior, or important, member of the team would be a contractor.

Most employment relationships clearly fall into one of these 2 categories. Some types of work could be managed by engaging either a contractor or an employee (usually fixed-term or casual), e.g. project work, one-off engagements, less regular and more flexible work, or jobs that are highly specialised and don’t happen every day.

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Practical tests

There are a couple of practical tests around termination and leave that can really highlight the true nature of the employment relationship.

Termination

If both parties are comfortable with the understanding that the work may cease at short notice and without any official process, then it is likely a contractor relationship.

However, if the individual has an expectation of fixed hours and ongoing work, and would feel aggrieved at being told “don’t come to work on Monday”, this means they are more likely an employee.

Leave

If both parties are comfortable with the individual “booking themselves out” for periods of time at their own discretion, then it is likely a contractor relationship.

But if the employer would feel upset at the individual announcing their intention to go away for a couple of months, then there is an expectation that the person is available at the employer’s requirement and should apply for leave. This person is most likely an employee.

If you are struggling to classify your worker, using either the “walks like a duck” test, the termination test, or the leave test,  then try the more formal online checklists or seek some professional advice.

Don’t run the risk of falling foul of NZ's tax or labour laws.

You could be liable for extra costs like unpaid tax and minimum wages, or holidays and leave entitlements. You might also be fined or get other penalties from the Employment Relations Authority and/or the IRD.

Find out about other common employment agreement mistakes.