Brick layer with blue sky background: employee vs contractor - what's the difference?

There are quite distinct differences between employees and independent contractors, although sometimes it can prove difficult to definitively categorise a worker as one or the other. For this reason the courts have developed a number of legal tests to help businesses classify workers.

Definitions

Before we cover these legal tests, it may help to first understand the differences between employees and contractors.

Note that, regardless of which category a worker falls into, health and safety laws apply to all employees and contractors.

Employees

An employee is a person who carries out work for reward under the terms of an employment agreement, with the reward almost always in the form of a wage or salary.

All employees have minimum employment rights under New Zealand's various employment laws, including the Employment Relations Act 2000, Minimum Wage Act 1983 and the Holidays Act 2003.

Employers are required to maintain records on their employees, detailing the terms of employment as well as wage, time and leave information.

Independent contractors

A contractor delivers services to a third party under an independent contractor agreement, and the services they render are charged to the third party on an invoicing basis.

Contractors pay their own taxes and ACC levies, and are not covered by most employment-related laws. This means they do not get things like annual holidays or sick leave, and they cannot bring personal grievances.

Businesses who use contractors are not required to hold records on contractors.

Legal tests

Defining a worker as either an employee or a contractor is not always clear-cut, so a number of tests have been devised to help businesses decide on the correct classification. These are:

  • Intention test

    This takes into account how both parties view the contract and define the working relationship from their perspective.

    Note that, although the intention of both parties is relevant, on its own it is not enough to determine the true nature of their relationship. In other words, the business and the worker cannot simply "decide" to be employer/employee or client/contractor - a number of other tests would need to support the intention.

  • Control test

    This determines who controls how and when the work will be performed (eg working hours, when holidays are to be taken, etc): if the business mostly controls these, the worker is likely an employee; if the worker has a lot of autonomy, he or she is likely a contractor.

  • Independence test

    Used to determine what level of risk is incurred by the worker, such as investment in plant and machinery, the ability to subcontract work, or ability to work for other people. The greater the independence, the greater the likelihood the worker is a contractor.

  • Integration test

    This test considers the level of dependence the worker has on the business, such as who provides the tools, and who pays for the materials used. A contractor would be responsible for supplying and maintaining his/her own tools of the trade.

  • Economic reality test

    Finally, the fundamental/ economic reality test will ascertain the working relationship based on what the normal commercial practice is for the type of work performed. It will consider things such as whether the worker: pays their own taxes and ACC bills, works for profit, is GST registered, advertises for work, and issues invoices to obtain payment. 

It is important to note that meeting some of the above tests does not necessarily mean you can assume someone is an independent contractor. Each situation needs to be reviewed on a case-by-case basis, with the entirety of the working dynamic taken into consideration to reach a conclusion. It is advisable to seek professional advice in this regard to avoid potential costs in the event you get it wrong.

Why does any of this matter?

Employees and contractors have very different rights and responsibilities, and as such, so do the businesses who use them carry out work for them.

Classifying a worker incorrectly (either accidentally or deliberately) could result in the business becoming liable for unpaid PAYE taxes, minimum wage shortfalls, and leave entitlements not provided, as well as potential penalties from Inland Revenue and/or the Employment Relations Authority.


Need help determining whether a worker is an employee or contractor? Contact Vicki Cozens, our employment, HR and payroll specialist, for help and advice.

       Vicki Cozens, Chartered Accountant at Ean Brown Partners Ltd

Vicki Cozens

Chartered Accountant

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