Contractor or Employee? How do I know?

17/04/2017 | Ontrack Bookkeeping Ltd

I know, its a confusing topic right? There are so many questions! How does the average New Zealander figure it out?
Well, hopefully we can help unravel the mystery of the Contractor versus Employee confusion.

In a nutshell, an employee is said to have a “contract of service” with an employer, while a contractor is said to have a “contract for service”.

Why the difference is important

An employee is engaged by a principal (the other party) to perform services under a contract of service (commonly called an employment agreement).
The nature of the relationship between an employer and a person working for them is important because it affects, among other things, whether the:

Person is covered by the Employment Relations Act 2000, Holidays Act 2003, Minimum Wage Act 1983, and other employment-related legislation (if so, they will be entitled to paid leave, the minimum wage, etc);
Employer must deduct PAYE and incur other tax liabilities;
Employer is liable to pay the ACC employer levy in respect of the person;
Person is able to claim work-related expenses for tax purposes; and
Person has access to personal grievance procedures.

The definition of “employee” in the Employment Relations Act 2000 includes any person of any age employed by an employer to do any work for hire or reward under a contract of service.

Self-employed contractors

Self-employed people are sometimes referred to as contractors, subcontractors, or independent contractors; these terms mean the same thing. A contractor is engaged by a principal (the other party) to perform services under a contract for services (commonly called an independent contractor agreement).

Contractors are self-employed and earn income by invoicing the principal for their services. A contractor pays their own tax and ACC levies.

Contractors aren’t covered by most employment-related laws. This means they don’t get things like annual leave or sick leave, they can’t bring personal grievances, they have to pay their own tax, and general civil law determines most of their rights and responsibilities. Businesses don’t have to hold contractor records.

Getting it right when hiring a contractor

Make sure that you’re hiring a contractor and not a temporary employee.
Don’t include any contractors in your employer schedule unless you are deducting schedular payments.
Include the contractor’s fees in your business accounts as a cost.
If the contractor isn’t a New Zealand or Australian citizen make sure they have a permit to work in New Zealand.
If the contractor needs to be registered to do their work, eg an electrician, make sure their registration hasn’t expired.

Being a self-employed contractor

If you’re a self-employed contractor you aren’t an employee so you don’t have to have PAYE tax deducted from your income, although some earnings may be subject to tax on schedular payments.
If you are an independent contractor you’re responsible for meeting your own tax obligations.

Some of the mistakes independent contractors make

Not filing their IR3 income tax returns on time.
Not declaring all their contract income on their IR3 income tax returns.
Not being registered for GST if their turnover is more than $60,000 per year.
Not accounting for GST on their income when required.
Claiming private expenditure against their income.
Incorrect splitting of their income with their spouse.

If you need help, contact the Ontrack Team to discuss how we can help you get it right.

EMPLOYEE OR CONTRACTOR?

The following table outlines some of the main indicators that distinguish a contract of service and a contract for services.

Contract of service (employee)	Contract for services (contractor)
The employer decides what will be done, when, how, and by whom.	When, how, and by whom is decided by the contractor.
The employer provides tools, equipment, and material.	Tools, equipment, and materials are provided by the contractor.
Payments are automatically generated and paid on a weekly, fortnightly, or monthly basis.	Payment generated on presentation of invoice either by progressive payment or on completion of the contract.
Employer pays for public and annual holidays, sick leave, etc.	No payment for absence – payment only on performance.
Employer deducts PAYE.	Contractor is responsible for tax, insurance, and other liabilities, but withholding tax may be deducted.
Employee carries out work personally and may not delegate or subcontract.	Contractor may subcontract.

Check out the four legal tests that can help with decision making on the employment website.

This topic is covered in depth in our Payroll Essentials Training Course.

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