By Edwards Law for On Your Terms
17 July 2023
Before hiring any staff you should understand the difference between employees and contractors. The difference can be complicated, but it is important. Getting it wrong can expose your business to significant costs. This blog outlines their differences and why it’s important to get it right.
What is an Employee?
An employee is hired to do work under an individual employment agreement, in return for payment. A written employment agreement is a legal requirement under New Zealand employment law.
Employees have rights under various employment laws, including the right to paid holidays and paid sick leave. Employers are required to deduct tax from the employee’s wages, known as PAYE, and must pay the PAYE to the Inland Revenue on behalf of the employee.
The law imposes an overarching legal duty of good faith between employers and employees as well as an implied duty of fidelity, meaning the employee must act in the best interests of the employer.
If a dispute arises between an employer and an employee, the employee can raise a personal grievance and pursue their claims through the Employment Relations Authority. Employees can raise claims about their treatment while employed, or about their dismissal.
So what is a Contractor?
A contractor is someone who is engaged by a business or organisation to perform services under an independent contractor agreement. You can hire a contractor without a written agreement, but having the key terms of the engagement in writing can help avoid future disputes. Contractors are self-employed and earn income by invoicing the business for their services at an agreed rate or fee.
Contractors must pay their own tax and ACC levies – meaning the contractor is responsible for paying the tax due to the IRD. Contractors generally have greater freedom than employees and can undertake work for more than one business.
Contractors are not covered by employment law, so are not entitled to paid holidays and sick leave, and there is not a legal duty of good faith between a contractor and a hiring business.
If a dispute arises between a contractor and principal, such as a claim for unpaid invoices or breach of contract, the issue cannot be taken to the Employment Relations Authority, instead, the Disputes Tribunal or the District Court have jurisdiction.
Why does it matter whether someone is an employee or a contractor?
If a business gets it wrong, or the relationship changes over time, the worker may be able to raise a claim in the Employment Relations Authority seeking a determination that they are an employee. If the Authority grants such an order, the business may have to pay unpaid PAYE, unpaid minimum wages and unpaid holiday and leave entitlements. So, it can be a costly mistake to make. The worker may also be awarded compensation concerning their treatment at work or the termination of their contract.
So how do you figure out whether someone is an employee or a contractor?
Generally, the parties will agree in their contract whether the individual will be an employee or a contractor. However, just because the contract says someone is a contractor, does not mean they are.
What is more important is the ‘true nature’ of the relationship. This may end up being completely different in reality from what the parties said and agreed at the outset.
When determining the true nature of the relationship, the Employment Relations Authority will consider:
- The degree of control exercised over the worker’s work content, hours and methods. The greater the control exercised over the worker, the more likely it is that the person is an employee. If the worker has greater freedom, this indicates a contractor relationship.
- How integral the worker is to the business. Generally, the work performed by an employee will be fundamental and integral to the employer’s business. However, work performed by a contractor is usually supplementary to the business. Relevant factors to consider include whether the worker wears a uniform, whether the work is continuous, whether the worker provides their own tools and equipment and whether the worker is integrated into a team via meetings and other events.
- The economic reality of the relationship, including:
- payment of a salary or wage with PAYE/ACC deducted from it points to an employment relationship, whereas a contractor will invoice for fees and is responsible for their own tax.
- Minimum wage does not apply to contractors, and they can increase their profits by cutting costs whereas an employee’s pay rate is generally set.
- Employees are required to perform the work personally, whereas contractors may be able to have someone else perform the services (for example, engage sub-contractors or have their own employee perform the work).
- A contractor may work for multiple entities at the same time, whereas employees generally work for one employer at a time.
- Employees do not carry financial risk in performing their work. On the other hand, contractors do carry financial risk (e.g., under-quoting) and are responsible for their own losses due to poor management.
Key Points
Failing to correctly classify a worker as an employee or contractor can be costly for your business. When determining the difference between employees and contractors, consider the type of agreement, payment entitlements and the true nature of the relationship. Also, consider the degree of control exercised over the worker’s work content, hours and methods, how integral the worker is to your business and the economic reality of the relationship.
If you have any questions or are still unsure about the difference between employees or contractors or your obligations to each, do not hesitate to reach out to the friendly team at Edwards Law – Employment Law Specialists.
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