Employees vs contractors

Employees vs contractors

Under the mployment Relations Act the distinction between hiring an employee as opposed to engaging an independent contractor, is sometimes difficult to make.

Employees are covered by contracts of service whereas independent contractors enter into contracts for service to produce an agreed result.

An independent contractor agreement applies to situations where the parties want to set up a commercial arrangement. This is usually between a company (referred to as the principal) and a contractor (usually a company but could also be a partnership or a sole trader, which is a single person operating a business under their own name or with a registered business name). The payment basis for a contractor is usually a set price or formula for completion of a task. However in many cases, payment will be in regular instalments as progress payments depending on the amount of work completed in the period.

An independent contractor agreement is suited to situations where a contractor agrees to provide specified services for a period or undertakes to complete a project or specified parts of it. This is similar to situations where you eEngage a building contractor or electrical contractor to build a new home. A benefit of this type of arrangement is that it minimises the risk of legal action from the contractor when the contract is terminated.

However, therein lies the risk. If the contract in its operation is not a genuine contract arrangement, the principal is exposed to the risk that the contract was a sham and the contractor was in reality an employee. The principal may then be open to claims of personal grievance that he/she was denied entitlements properly due to him/her as an employee (such as annual holidays).

If the contractor is a company, the risk of that occurring is significantly reduced. Other factors that will mitigate the risk include:

  • The contractor being free to decide how the work will be performed and the hours to be worked.
  • The contractor being free to accept other work and not being tied exclusively to working for the principal.
  • The contractor being responsible for providing and maintaining the necessary tools and equipment.
  • The contractor being paid on submission of a GST invoice at the completion of the work or on achievement of agreed milestones.
  • The contractor being responsible for all employment obligations of its employees.
  • The written contract specifying the intention of the parties to enter into a relationship of principal and contractor.
  • The contractor being able to assign the contract to another party.

Under common law the courts have used a number of tests to distinguish between employees and contractors.

  • The Control Test – concerned with the nature and degree of detailed control over the person performing the work. This is the most durable however other tests are also important in coming to a decision.
  • The Fundamental Test – whether the person performing the work is in reality part of the organisation or in business on his or her own account.
  • The Intention Test – whether the parties intended the relationship to be an employer-employee relationship.
  • The Integration Test – whether in all the circumstances an employer-employee relationship is indicated.

Download a comprehensive checklist of indicators for each type of contract.