When does a contractor become an employee?

by | Oct 24, 2023 | Employment Agreements

In this month’s free webinar we will be exploring in more detail the difference between a contractor and employee…. And how getting that wrong can be exceedingly expensive! (click here to register)

The good news…
There is no point at which a contractor automatically becomes an employee.  Someone working full-time in your office for 10 years could be a genuine contractor.  Ultimately, what the courts are looking at is what was the genuine understanding of both parties about the arrangement.  And the courts don’t like people trying to take advantage of the system when it suits them i.e. taking the benefits of being a contractor when it suits them (flexibility, tax deductibility etc), and the benefits of being an employee when it suits them (right to raise a Personal Grievance, paid leave etc).

When does it come into dispute?
The 2 main triggers for the contractor v’s employee argument to come up are:

  1. When the individual gets their tax bill at the end of the year, hasn’t saved that money, so tries to deflect it onto the company by saying “ I thought you were paying my tax Mr/Mrs Employer”
  2. When there is a dispute and the individual tries to raise a Personal Grievance against the company.  NB they can raise claims through small claims court, but not a personal grievance

The onus then sits with the individual to prove that they genuinely believed themselves to be an employee.  However, if they successfully make that argument then the employer could become liable for the tax grossed up on what they have already paid them (so about 50%), plus back annual leave, sick pay, etc (about 21.5%).  Add this to the fact that, particularly if the argument has come about because they got their tax bill, because of the way provisional tax etc works they could have been working with you for close to 2 years before they get a tax bill…. So that could be a very expensive claim to lose.

How do you protect against the risk?
The court has what it calls the “tests of justification”, and these are so broad that I could just about justify I was an employee of your company simply by having a conversation with you (I’m being slightly cheeky here, but they are very broad!).  So, how do you minimise your risk:

  1. Make sure you have a written agreement in place – HRtoolkit Independent Contractor agreement
  2. Make sure you issue it with a clear cover letter laying out that they are a contractor and what this means – HRtoolkit cover letter Contractor
  3. Make sure they provide you with invoices and are GST registered if earning over GST threshold (currently $60K per annum).  NB one mistake I have seen from companies being “helpful” is that they provide the invoice to the individual.  This is definitely not good practice.
  4. If they are starting to look like an employee rather than contractor, have the discussions up front and early and then confirm those discussions in writing i.e. “following on from our discussion, you are happy to remain as a contractor, and fully understand that this means you are not entitled to employee benefits such as paid leave, right to raise a PG etc, and you are responsible for paying your own taxes”
  5. Minimise the tax liability risk by deducting withholding tax/Scheduler payments.  The IRD does appear to be adjusting the rules around when you should/should not/have to deduct withholding tax/Schedular payments so I would recommend that you speak with your accountant about whether this is a requirement in your situation.

Free webinar
Click here to register for this month’s free webinar on Contractor V Employee on Friday 27th October at 10am.

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Lisa Mackay
Founder of HRtoolkit
021 741 544

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