Looking to hire a contractor but not sure whether they might be an employee instead? This article looks at the difference between employees and contractors and the tests that are used to help work out which is which.
It’s important to get it right as employees have minimum entitlements, such as the right to receive at least the Minimum Wage; leave entitlements and the right to only be terminated in certain circumstances and subject to a fair process.
What is the difference?
On the face of it, the definition of contractors and employees don’t seem too different.
An employee is a person employed by an employer to do any work for hire or reward under a contract of service (an employment agreement). It includes a homeworker or a person intending to work but excludes volunteers and certain persons engaged in film production.
A contractor is engaged by a principal to perform services under a contract for services (an independent contractor agreement), earning income by invoicing the principal for their services.
However, where there is a dispute as to whether someone is a contractor or an employee, several legal tests are used to determine the dispute. Each test on its own is not determinative, they all must be assessed together to reach a conclusion.
What the parties intended is relevant to deciding whether the relationship is an employment one.
Generally, intention involves looking at what the parties’ written agreement says. The title of an agreement and specific clauses within an agreement can suggest what the parties intended. Likewise, where an agreement does not have specific clauses is also relevant to intention. For example, an employee’s employment agreement would have clauses relating to leave including sick leave, annual leave, and bereavement leave, whereas this would not be present in a contractor’s agreement.
The greater control an employer has over the individual the more likely that individual is an employee. Control will be assessed in relation to work content, hours and methods. Thus, an individual who is set specific tasks to do which must be done in a particular way and whose start times and end times are controlled suggests that they are an employee. If an individual can control their own start times or work on a specific project using their own methods, this is more consistent with a person being a contractor, rather than an employee.
If the work performed by the individual is “fundamental” to the employer, this suggests that the person is an employee.
This is indicated by factors such as team integration, being reimbursed for work-related expenses and wearing a uniform. Conversely, an individual being paid by results and whose work is not fundamental to the business, but accessory to it, indicates they are a contractor, rather than an employee.
Economic Reality Test
This test involves looking at the whole working relationship to determine the economic reality.
In particular, a contractor is a person in business on their own account. This means that the individual is not engaged on a continuous basis by one business but is self-employed and contracts out their services to businesses that need them for a particular project or period of time.
A contractor usually charges a fee for their services, whereas an employee is paid a salary or a wage. Employees are entitled to at least the minimum wage, however a contractor can be paid whatever rate is agreed to. An employee’s employer pays PAYE tax and ACC on the employee’s behalf, whereas contractors generally issue invoices setting out their fees and pay their own tax directly to Inland Revenue.
Other factors relevant to the economic reality test include GST registration, the ability to subcontract work, who wears the financial risk in the relationship, and whether the person can work for more than one entity. All those factors are more consistent with a contractor relationship.
Industry practice can also inform whether an individual is an employee or contractor. While industry practice is not determinative, it can be considered by the Court especially when a custom or practice is well established. It could also help to show the intention of the parties.
Case Example – Employee
Southern Taxis Ltd v Labour Inspector
Southern Taxis Ltd (“STL”) operated a business in Dunedin and employed drivers described as “commission drivers”. The Labour Inspector alleged that four commission drivers were in fact employees and that in some instances they were not paid the minimum wage, holiday pay, sick leave or rest breaks.
The Court had to decide whether the commission drivers were employees or contractors.
Common Intention Test
There were no written agreements between the parties. There was also little evidence of discussions between the parties except that the drivers would be paid 40% of the takings.
Each of the drivers operated under a roster which was prepared by STL. The roster would let the drivers know in advance what days of the week they would work and broadly which shift that driver would work. The drivers would have to work the shifts that they were rostered for and their work patterns were similar every week. This suggests a degree of control was imposed over the drivers.
The drivers had to log on and off as well as maintain contact with the dispatcher. A dispatcher would assign work to the drivers and, although the drivers could theoretically decline work, in reality they had no choice if they wished to be paid.
The Court found that the working arrangements of the commission drivers was more controlled than those of independent contractors.
The drivers drove vehicles owned by STL and the company would meet the expenses for the vehicles. Particular clothing was worn by the drivers and the drivers would operate according to a roster.
The Court found that STL relied on the availability of the commission drivers for its business operation. The test supported the conclusion that the commission drivers were employees.
Economic Reality Test
The Court found it was clear that the commission drivers were not in business on their own account as they did not own their own vehicles or pay running costs. They could not subcontract their work.
STL deducted PAYE so the drivers did not make personal tax payments to IR. Furthermore, the drivers were not registered for GST and did not render invoices.
The economic reality test pointed towards the commission drivers being employees.
The Court found that the commission drivers were employees. The employees were paid varying amounts of approximately $13,000 to $32,000 for unpaid entitlements.
Case example – Contractor
Arachchige v Rasier New Zealand Ltd
This case concerned an uber driver, Mr Arachchige. He argued he was an employee of Uber after he was terminated.
Common Intention Test
There was a services agreement between Uber and Mr Arachchige. This suggests that the relationship was not an employment one. In the agreement it stated that the parties did not have an employment relationship. The services agreement did not require exclusivity of the drivers and there was an lack of clauses expected in an employment agreement, such as performance expectations.
Mr Arachchige had a lack of control over his client base and over determining what fare to charge. However, the Court stated Mr Arachchige could charge less than the quoted price but this would have been no value to him, as he had no ability to establish a relationship with the riders and thereby attract future work.
Mr Arachchige could decide to work in peak times and where he would work. He could also choose what car, phone, data plan, insurance and other business support he might use. Mr Arachchige also could share the vehicle with another person to reduce expenses.
Uber drivers carry out work integral to Uber. However, Uber had little control in the way in which drivers carried out their work. This was different from Southern Taxis Ltd where the drivers had little autonomy over the way in which they carried out their business activities.
Economic Reality Test/ Fundamental Test
Mr Arachchige could decide when he undertook his services. He provided all the necessary equipment needed including the vehicle. He was also responsible for his tax obligations.
Mr Arachchige was not an employee of Uber. Thus, he could not claim the rights of employees, such as the right to bring a claim of unjustified dismissal.
Conclusion – Employees vs Contractors
There are various factors to consider when determining whether an individual is an employee or contractor. The Court uses four tests, as well as industry practice, to help answer this question. It is important for employers to get it right because employees are entitled to broader legal rights than contractors, including minimum wage entitlements.
This article is not a substitute for legal advice, and you should consult your lawyer about your specific situation. Please feel free to contact us at Parry Field Lawyers: