Update 16 September 2024: changes were announced by the government. See below for more details.
As a small business owner, you wear many hats, and a very important one is ensuring that you classify your workers correctly. Misclassifying an employee as a contractor can lead to unexpected costs including paying for leave, minimum wage and public holiday entitlements.
This issue has gained even more attention recently, as seen in the landmark ruling where the New Zealand Court dismissed Uber’s appeal, deciding that drivers should be treated as employees, not contractors. This ruling serves as a powerful reminder of the importance of getting worker classification right.
Read more about the Uber case here
To avoid these costly mistakes, it’s essential to understand the key differences between contractors and employees.
Why the distinction matters
The first thing to know is that contractors are not employees. This isn’t just a minor detail—it’s a significant legal distinction. Employees have minimum employment rights under the law, such as the right to sick leave, paid holidays, and a guaranteed minimum wage. Contractors, on the other hand, are governed by General Civil Law and do not have these same rights. Because of this, you should clearly outline the nature of the relationship in your service agreements.
Remember:
An employee works in your business and is part of your business.
A contractor is running their own business.
Four tests to determine the difference
If you’re unsure whether a worker is a contractor or an employee, you can use these four tests to help you decide:
- Intention test: This test looks at what both you and the worker intended the relationship to be. Did you both agree that this person would be a contractor, or was there an intention of employment? Documenting this intention in your agreements is essential.
- Control vs independence test: This test examines how much control you have over the worker. If you’re dictating their work hours, tasks, and how they do their job, they’re likely an employee. Contractors typically have more freedom to set their own hours and methods.
- Integration test: This test considers how integrated the worker is within your business. Employees are usually a core part of your daily operations, while contractors tend to perform specific tasks that are not central to your business.
- Fundamental reality test: This test looks at the economic reality of the relationship. Contractors often work on a per-project basis, invoice for their services, and may even have their own employees or advertise for more work.
Read more at employment.govt.nz
Upcoming changes (announced 16 September 2024)
The government is planning to clarify the law regarding whether a worker is a contractor or employee, aimed at maintaining the status quo for contractors who have explicitly agreed to a contracting arrangement.
Under the proposed amendment to the Employment Relations Act, a new test will include four key criteria:
- A written agreement specifying the worker is an independent contractor.
- The business does not stop the worker from working for other businesses, including competitors.
- The worker is not required to work specific hours or can subcontract the work.
- The worker’s contract is not terminated if they decline additional tasks.
If all four conditions are met, the worker would be classified as a contractor. However, if any of these conditions aren’t satisfied, the existing legal test, specified in the previous section, will apply.
How contractors are paid
One of the key differences between employees and contractors is how they are paid. Employees are paid through your payroll system and have taxes and other deductions automatically handled. Contractors, however, are usually paid by invoice, and their payments are considered business expenses, like paying your electricity bill.
If you do decide to pay a contractor through your payroll, they need to be on the withholding tax (WT) tax code. Withholding tax is a tax on certain payments made to contractors, where you deduct the tax from their pay and pass it on to the IRD. It’s also important to note whether your contractor is registered for GST, although this doesn’t affect the WT tax code.
Protecting your business
Correctly classifying your workers is not just about compliance—it’s about protecting your business. Misclassification can result in having to pay back wages, taxes and even facing penalties. By understanding the difference between contractors and employees and applying the appropriate tests, you can avoid these risks and ensure that your business runs smoothly.
In the end, a clear understanding of these distinctions will help you make informed decisions, keep your business compliant and avoid unexpected costs. This knowledge is a vital part of running a successful small business.
If you have any questions, please get in touch, we’d be happy to assist.
