Defining your Employment Status
A common question we receive from clients is whether the person they are looking to hire should be treated as an employee or as an independent contractor. The distinction can be important for a number of reasons:
• if the person is an independent contractor and the value of the services they provide in a twelve month period exceeds $60,000 then they should be GST registered and charging GST on their fees,
• if the person is an employee, then the employer must deduct PAYE from any payment made to the employee and pay the PAYE to the Inland Revenue each month.
• if the person is an independent contractor, then they have the ability to claim expenses incurred in doing their work and thereby reduce the amount of income tax required to be paid on the income received.
• if the person is an independent contractor, then the employer has no obligation to pay the person any holiday pay or sick leave payments and the person is responsible for paying their own ACC levies.
To assist taxpayers with making a determination as to the correct employment status, Inland Revenue released Interpretation Guideline: IG 11/01 on 21st December 2011. The guideline is an updated version of the 1999 guideline that was released by the Commissioner, however it does not introduce any change in approach to be taken by taxpayers when determining whether a person is an employee or an independent contractor. Instead the guideline discusses a number of the more recent court decisions with a view to providing taxpayers a more up to date analysis of the principles being used by the court to assist in determining the correct nature of the relationship.
Common law decisions over the years have acknowledged that there are two types of contractual relationships – contracts of service (employees) and contracts for services (independent contractors). To assist in determining whether a contract of service or a contract for services exists, common law has also developed a number of tests:
Intention Test –
This test looks at the intentions of each party to the agreement regarding the nature of the relationship. While an expressed intention of the parties can be a strong indication of the true nature of the relationship, it is however by no means conclusive or the determining factor. This can be especially so where other factors of the relationship clearly point to an employment relationship even though the parties have expressly labeled themselves as being principal/independent contractor.
Lesson to be learned here therefore, is that you cannot just draft a contract which states that the relationship is that of principal/independent contractor, and expect that status to hold up under a challenge from the Inland Revenue (or the other party if there is a dispute), when your conduct in the relationship is something else.
Control Test –
This test looks at the degree of control you exert over the person who is doing the work as to what they do and how they do it. The greater the level of control you exert over specifying the work content, the hours of work, the work methods and whether you can supervise and regulate the person, the more likely an employment relationship exists and the person should be treated as an employee.
Independence test –
This test is effectively the inverse of the control test and looks to how much independence the person doing the work has. Factors indicating a high level of independence include the person working for multiple people, having their own premises which they can work out of and supplying their own tools and equipment, their level of business risk where doing a poor job can affect their profitability, having control over who they wish to help them on the job and advertising and invoicing for the work.
The greater the level of independence the person has in the relationship, the more likely they will be an independent contractor.
Fundamental test –
This test looks to whether the person performing the services does so as a person in business on their own account. Closely aligned to the independence test, it also looks at whether the person provides their own equipment, hires their own helpers and has a reasonable degree of financial risk.
However the test also examines whether the task justifies the use of an independent contractor, the behaviour of the parties pre and post entering into the contract, who is responsible for correcting sub-standard work/legally liable if things go wrong and whether the worker can be dismissed.
Where the person has agreed to be responsible for the work that they do, this will usually be an indication that the relationship is that of principal/independent contractor.
Integration test –
The final test looks to examine whether the person is part and parcel of the organization and whether the work is necessary for the running of the business. In this respect, a person is more likely to be an employee if the work is integral to the business organization, it is commonly done by “employees”, it is continuous and it is for the benefit of the business as opposed to the benefit of the worker.
Conclusion –
In my experience it is usually only those situations where the client is wanting to engage a person to do some work for them but does not want them to be an employee, that these five tests will need to be considered to ensure the arrangement is structured in such a way that the client achieves the outcome they were looking for.
A good start naturally is having both parties clearly agree that the relationship is that of principal/independent contractor however care must be taken that, when applied, the other four tests of control, integration, fundamental and independence will draw the same conclusion.
We can assist you with determining the employment status of the person you are looking to engage or alternatively if you are that person and are looking to retain a certain status under the new contract. We can also assist in making an application for a private ruling to the Commissioner, should that be the desired course of action.
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