Contractors vs Employees

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

Employee or independent contractor? Here's a practical guide to approaching this common question which can cause significant issues if you get it wrong.

I am regularly asked to give an opinion on the difference between contractors and employees. Usually, this is because the parties want to set up a contractor relationship and all too often the relationship is better defined as employment.

Sometimes the individual is seeking a contracting relationship for perceived tax benefits. They might tell an employer that they “choose” to be a contractor and they’re “okay waiving their employment rights” in favour of an independent contractor relationship.

However, this choice is not theirs to make. The nature of the employment relationship defines whether somebody is an independent contractor or an employee. People cannot choose to opt out of employment entitlements and people also cannot opt out of their statutory tax requirements.

Getting this wrong can cause significant issues and cost on two fronts: tax and employment law.

So how do you know the difference?

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.

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.

This means they’re paid by a payroll system, with PAYE deductions. They’re eligible for KiwiSaver and have all minimum rights under employment laws.

Contractors

Contractors are working in a contract “for service”, serving themselves by delivering outcomes to their clients. They are 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.

They invoice for their work, pay their own taxes, and if they earn over $60,000 in a year, they must be GST registered.

The nature of the employment situation is usually obvious, although project work of fixed duration or finite funding could be debated. In most cases, the same rules above can be applied and a position and fixed-term employment could apply.

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Practical tests

A couple of practical tests I recommend which can really highlight the true nature of the relationship are around termination and leave.

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 would feel aggrieved and being told “don’t come Monday”, then they may have an expectation of fixed hours and ongoing work, which 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 be “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 an employee.

If the duck test or the termination or leave test don’t give you a clear view, then try the more formal online checklists or seek some professional advice.

Don’t run the risk of falling foul of 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.

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