Using contractors over employees can seem attractive. There is no need to pay holiday pay, PAYE, ACC or Kiwisaver contributions. As a business owner, you can turn the contractor’s services on and off at will. Yet there is nothing cut and dried about the distinction between employees and contractors and it pays to step carefully in this area. Employers need to be careful that their arrangement is not seen as a sham.
There are several tests to determine whether an employment relationship exists or if one party is contracted by the other. The tests have come about from case law and are applied by the IRD and the Employment Relations Authority. None of these rules is black and white. Broadly the tests are:
1. Do you “control” the employee? A genuine contractor will make their own decisions on when they go on holiday, what hours they work, the standard of their work and the how much they will charge. If you make these decisions, you could risk having the relationship defined as that of an employer-employee.
2. Is the contractor truly independent? Can they hire or fire their own staff? Do they provide their own equipment? Are they responsible for their own profits and losses? Do they direct others to carry out your work and pay them from their own funds? You are really assessing just how autonomous the contractor is. If the person is in fact an employee, your company may be responsible for wrongful dismissal in any employment action.
3. What is the intention of the parties? It is important to note that if the actual circumstances point to an employment relationship then referring to it as an independent contract will make no difference to the true situation. The tax treatment of the person is important here – whether or not PAYE is deducted – as is the presence of an hourly wage with regular hours. The length of the relationship can be important as well. A contract setting out the understanding between the two parties really is essential. Whatever you do, don’t rely on a handshake.
4. The Fundamental Test. This test is really the inverse of the control test above. In essence, the test seeks to determine whether or not the person is in business on their own account. One way to test this is whether or not the contractor could sell their business. Are they responsible for their work and have to correct errors and mistakes at their own cost? An essential part of this test is the ability to terminate the contract rather than dismiss an employee.
5. Is the type of work undertaken close to that of an existing employee? A contractor who performs the same duties as an existing employee could argue that they are in fact an employee of the company as they are “integrated to the business” not an “accessory” to it. That means you would be up for all those taxes and levies you thought you were off the hook for.
Generate Accounting is able to advise you in this area so please talk to us first if you plan to hire contractors on a regular basis.
