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When your business needs help with a one-off project like migrating your email platform or periodic time-consuming tasks like payroll, you may want to explore contracting. As part of this process, you will engage a contractor to perform certain services for your business. Your legal employment obligations towards contractors are different from your obligations towards employees. For example, your business does not need to hold contractor records or make deductions from their earnings. The main difference is that employees have employment agreements with your business, while contractors are free to work for anyone. It is crucial to understand how employees and contractors differ because it affects the way you treat them. This article will help you understand your legal employment obligations when engaging a contractor in New Zealand and how this differs from hiring employees.

What Is a Contractor?

Contractors are self-employed workers. As a business owner, you may engage a contractor to perform services under a contract for services, or an independent contractor agreement. Contractors earn income by invoicing you, the principal, for the services performed and pay their own tax and ACC levies. They can choose to work as a sole trader or to incorporate a company.

Unlike employees, independent contractors do not have any rights under New Zealand employment laws. Instead, general civil law defines their rights and responsibilities. This means they are not entitled to sick leave or to get paid for not working on a public holiday. They cannot claim a personal grievance either. Depending on the industry, they may lack job security. If they register with Inland Revenue and meet the earnings criteria, they also have to pay GST on payments made to them. 

Tip: Health and safety laws apply equally to employees and contractors. 

Your Independent Contractor Agreement

When you engage a contractor, it is a good idea to provide them with an independent contractor agreement. However, in some instances, your contractor may ask you to sign their own services agreement. These are similar contracts, although an independent contractor agreement can be more beneficial for the party receiving the services (you). Ultimately, your choice will depend on the industry and the type of services that your contractor provides. 

Your independent contractor agreement should be tailored to the specific arrangement, and include these key terms: 

  • timeframe or key milestones of the project;
  • hours of work;
  • deliverables of the project; 
  • how the business will pay the contractor for their services;
  • the period of the arrangement; 
  • the contractor’s obligations, such as the requirement for specific licences or the need to provide equipment to perform tasks;
  • what happens to the intellectual property used or created by the contractor; and
  • specify the contractor’s obligation to take out personal liability and any other industry-relevant insurance.

What Are Your Responsibilities When Contracting?

As a business, you are not required to hold contractor records or deduct PAYE or KiwiSaver from their pay. One the main differences between employees and contractors is their working environments. Employees work for you, while contractors work for themselves. Employees will work where and when you tell them to, while contractors can decide how they work and even employ other people to help them. Therefore contractors pay their own income tax.

They use their own tools to carry out their work (separate property), unlike employees who use yours. Employees are required to work set weekly or monthly hours and may get paid overtime for working extra. Contractors agree with you their timeframes beforehand.

The Employment New Zealand website provides further information to help you understand how employees and contractors differ and your obligations under each arrangement. 

What Happens if You Get the Contracting-Employee Distinction Wrong?

Distinguishing between employees and contractors can be really challenging, but it is essential to get it right because it can have a significant legal and financial impact on your business. 

If you make a mistake, you will have to repay PAYE tax, minimum wages, holidays and leave entitlements. While if you deliberately try to avoid your responsibilities for employee entitlements by disguising an employment relationship as an independent contracting arrangement, you will enter into a sham contracting arrangement. Inland Revenue and The Employment Relations Authority in New Zealand penalise sham contracting severely. For example:

  • you may incur penalties that can be costly to your business and harm your reputation; 
  • they may prevent you from bringing in overseas workers; and
  • you may later be held liable for extra costs including unpaid PAYE tax, minimum wages, holidays and leave entitlements.

Key Takeaways 

As a business owner, you may engage a contractor, or self-employed worker, to perform a specific service for your business under a contract for services. Unlike employees, you do not have to provide contractors with an employment agreement. They can decide how they work, they use their own tools and pay their own tax. However, you should always agree to some key terms in writing, to make sure you protect your business from liability. For example, your independent contractor agreement should include:

  • the key milestones and deliverables of the project; 
  • your contractor’s hours of work;
  • obligations and other specific requirements, such as how to manage intellectual property and insurance; and
  • how you will pay them. 

Instead of drafting an independent contractor agreement, you could instead choose to sign your contractor’s own service agreement. However, this could be less advantageous for your business so you should get independent legal advice. Distinguishing between employees and contractors can be challenging, but it is essential to get it right because it can have a significant legal and financial impact on your business.

If you need help understanding your legal contracting obligations or reviewing your agreements, LegalVision’s employment lawyers can help. Call 0800 005 570 or fill out the form on this page.

Frequently Asked Questions

When is a contractor actually an employee?

Even if you label your worker as a contractor in your contractual documents, ultimately the nature of your working relationship is subject to many factors determined by law. Employment New Zealand provides some legal tests to help you differentiate an employer from a contractor, including the intention test, the control vs independence test, the integration test and the fundamental (economic reality) test. You need to think about your situation and apply all the tests to help you to decide. If you have any doubts, contact the Employment Mediation Services or seek legal advice.

What does it mean to hire someone as an independent contractor?

When you hire someone as an independent contractor, you agree to what, when and how they will provide their services in your independent contractor agreement. You should also specify whether they need to get their own insurance and what happens to the intellectual property they use or create. You do not have to deduct PAYE tax from their pay or accrue annual leave, and you do not have to keep records.

How much should I pay a contractor?

This will depend on the industry and type of service they provide, but typically your contractor’s rate will be higher because it needs to cover things you do not pay for as an employer, such as holidays and sick leave, KiwiSaver and insurance. A rule of thumb is to take the rate you would pay an employee for a similar job and add at least 20 per cent. A great way to get an idea of the market rate for the job is to use a wide range job sites like Seek or Trade Me, or by talking to a recruiter.

What are the benefits of hiring a contractor vs an employee?

Hiring contractors can have many advantages for your business, including reducing your payroll and employee benefits annual expenditure by twenty to fifty per cent. It improves your staffing flexibility because you can increase workers during busy periods and end their contract with a short notice period if you no longer need them. In some instances, hiring independent contractors can help you increase your profitability faster and reduce your training costs because they are highly skilled in certain areas and have their own licences and permits.

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