Contractor or employee?

Do you remember the animated TV show Bob the Builder? What you may not recall is his young apprentice, Leo, a college student who works for Bob from time to time. While Bob appreciates the extra pair of hands, deciding whether to treat Leo as an employee or contractor gives him a headache

This is an important decision for any business owner, but is particularly relevant for builders given the nature of the construction industry. Determining the employment status of your staff will affect the statutory rights and protections afforded to them under the Employment Relations Act 2000 (the Act), so it’s important you get it right.

For example, employees are entitled to the minimum wage, annual holidays, public holidays, paid sick leave, bereavement leave and protection from unjustifiable actions and unjustifiable dismissal.

What’s the difference?

In New Zealand, Section 6 of the Act sets out the test for determining whether a worker is considered an employee. It states that an individual is an employee if they are employed to do any work for hire or reward under a ‘contract of service’ by the employer.

Section 6 also says that, in deciding whether a person is employed under a ‘contract of service’, the Court or Authority would look at the real nature of the relationship between the parties. This is a broad section, which provides the Court or Authority considerable scope to decide the matter in the event of a dispute. Over time, the courts have developed a number of tests to differentiate between employees and contractors. These tests are not determinative, but they provide a useful guide.

1. The intention test

If Leo entered into an agreement with Bob that expressly stated he was a contractor, this may indicate that the intention of the parties is for Leo to operate as a self-employed worker. While this is important when ascertaining the true nature of the parties’ relationship, it is not a conclusive test, as the agreement reflects only what the parties originally intended the work relationship to look like.

However, it does not necessarily reflect the real ongoing nature of the relationship. Occasionally, a working relationship that began as a principal-contractor relationship may morph into an employment relationship. Therefore, even if Leo is expressly named as a contractor in the agreement, if the nature of the relationship changes over time, Leo can become an employee.

2. Control vs independence test

The greater the control Leo has over his work and when he performs the work, the more likely it is that he is a contractor. On the other hand, if Bob largely controls what Leo does for the business and how he does it, he is more likely to be considered an employee.

Factors that may indicate a high level of independence include if Leo chooses:

• The type of work that he does.
• The amount of time he spends working.
• His hours.
• When he goes on holiday.

If, however, Bob had continuous and detailed control over Leo and required Leo to be at work for set hours on set days, apply for leave to go on holiday, and/or was always under the supervision of Bob or another while at work, this would indicate that Leo was an employee.

3. Integration test

If Leo and his work are highly integrated into Bob’s building company, it is more likely he would be considered an employee. For example, if the work Leo undertakes is integral to the running of Bob’s building business, this would suggest that Leo is an employee.

Work undertaken by a contractor is generally supplementary to the business, rather than an integral part. Other questions that should be asked as part of the integration test include:

• Does Leo work with his own equipment?
• Is he paid for what he produces rather than by the hour?

If the answer is yes to one or both of those questions, it would be more likely that Leo is a contractor.

4. Fundamental/economic reality test

When looking at the parties’ relationship as a whole, several factors may indicate the economic reality. For example, if Leo is paid a salary or a wage, and if Bob’s building company processes PAYE tax and ACC on Leo’s behalf, then this would weigh in favour of Leo being considered an employee.

If, however, Leo pays tax directly to Inland Revenue, is able to engage other workers to perform his work (through sub-contracting or employing his own staff), is entitled to the profits and is responsible for any losses from his work, this would suggest that Leo is a contractor

Why does it matter?

An employer must provide employees with the minimum standards set out in legislation, such as the Employment Relations Act 2000, Minimum Wage Act 1983 and the Holidays Act 2003. A contractor, however, is technically a self-employed individual and would not be covered by most employment laws and statutory entitlements.

This could affect Leo in several ways. For example, he would not be paid annual leave or sick leave, unless it was expressly provided for in his services agreement. Further, he would not be able to bring a personal grievance if he was dismissed and he may have to arrange to pay his own taxes.

If Bob’s building company wrongly treated Leo as a contractor rather than an employee, this could have adverse financial effects for Bob and his business. For example, they may be liable to pay costs such as unpaid PAYE tax, unpaid minimum wages and holidays and leave entitlements if they incorrectly treated Leo as a contractor.

Ultimately, the key message is to ensure that all parties accurately agree the nature of the working relationship between them from the outset of the relationship.

Anthony Harper is a leading New Zealand commercial law firm with offices in Auckland and Christchurch. Anthony Harper is also the exclusive New Zealand member of ALFA International, a global legal network of 150 prominent independent law firms located in 65 countries. This article was compiled by employment law specialists Jennifer Mills, Ethelred Chey and Elizabeth Thomas.