Employee vs Contractor - know the difference

There are many differences between contractors and employees that affect the rights and obligations of the business and the worker.

• An employee works in your business and is part of your business.
  
  
• A contractor is running their own business.

Depending on the type and nature of business, you may have employees or contractors, or both. It is important to review which are which to understand your employee and tax obligations. No further discuss the tax obligations contact us.

To make the correct decision you must focus on the real nature of the working relationship not just the label the parties have given it.

The courts have developed some legal tests to help you tell the difference, they are:

• Intention test
• Control vs independence test
• Integration test
• Fundamental/economic reality test

Intention Test

The intention of the working relationship is relevant, but it does not on its own determine the true nature of the relationship between them. Intention is typically indicated in the written agreement between the parties.

Employee

- An employee MUST have an employment agreement (contract of service) in writing.

Contractor

- has a ‘contract for services’ with a principal, rather than an employment agreement.

Holiday pay

- A contractor does not have to be paid holiday pay, whereas an employee does.

Getting paid on public holidays

-  A contractor does not get paid extra  for working on a public holiday.

Control vs Independence Test

Employee

- greater control exercised over the worker’s work content, hours and methods.

Contractor

- greater freedom to choose who to work for, where to work, the tools used and so on.

• Control over work, time, location – a Contractor controls the work to be done while an employee largely directed by the employer.
• Set hours - A contractor generally has more discretion regarding how much time is spent at work compared to an employee who will likely have set times and days to be at work.
• Control over their availability - A contractor generally has more control over their own availability while an employee generally has to request permission from their employer to take a day off, or to go on leave.
• Supervision and direction - A contractor has their own “plan” of what work to do each day and is usually a specialist in their field of work, and so does not need to be closely supervised or instructed how to do their job.

Employees have to complete the work the way the employer specifies. What work is done, where it’s done, how it’s done, and when it’s done are all up to the employer. The employee then completes the work as required.

Contractors are not subject to the same rules. They decide when and how the work is done, so long as it meets the obligations laid out in the contract. For example, a contractor could choose to work three 10-hour days to complete a job, rather than working four 8-hour days.

Integration Test

This test looks at whether the work performed by the employee is integral to the employer’s business. Usually the work performed by a contractor is only an accessory to the business.

A person is more likely to be considered to be an employee of the organisation when:

• The type that is commonly done by employees
• Continuous (Not a one-off project)
• For the benefit of the business rather than for the benefit of the worker.

Works with own equipment

- If the business is responsible for providing the equipment, tools, and other assets required to perform the job, that’s characteristic of an employee and if the worker is providing these items, they are likely a contractor.

Team integration

- A contractor is less likely to be integrated into the team e.g. not invited to company events

Basis of payment

-  An employee is usually paid a set amount per period of time, whereas a contractor may be paid by results.

Reimbursed for work related expenses

- An employee is more likely to be reimbursed for work related expenses, whereas for a contractor, these form part of the costs of running their business.

Uniforms

- An employee is likely to wear the employer’s uniform (if it has one) whereas a contractor would supply their own clothes.

Fundamental / Economic Reality Test

The test involves examining the total situation of the work relationship to determine its economic reality. A contractor is a person in business on their own account.

Fees

- A contractor charges a fee for their services, whereas an employee is paid a wage.

Minimum wage

-  A contractor paid whatever rate is agreed to. An employee must receive at least the minimum wage.

Pays taxes

- the employer pays PAYE tax and ACC on the employee’s behalf, and the employee is paid net wages or salary. A contractor generally pays their own tax directly to the IRD. In special situations the person the contractor is contracted to may deduct withholding tax (WT) on their behalf. 

GST registration

- A contractor must register for GST if earning over $60,000.

Have employees

-  A contractor can often get someone else to do the work instead of him/her either by subcontracting the work, or employing their own staff.

Mainly working for one entity

- A contractor may work for multiple principals at the same time e.g. a builder having contracts to do work for Company ‘A’, Company ‘B’ and Company ‘C’.

Advertises for work

- An employee looks for work e.g. answers a job ad looking for a worker, compared to a contractor who often advertises his/her services.

Invoices

- A contractor usually issues invoices setting out their fees or charges in order to get paid. An employee usually gets paid automatically, and receives a pay slip.