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Essential tax implications of employee and contractor agreements

The IRD’s recently updated guidelines on determining employment status for tax purposes serves as a timely reminder that establishing your tax status is essential.  Are you an employee or contractor?  Let’s discuss this in more detail. 

If you’re engaged to carry out work, your employment arrangement may have significant implications for tax purposes.  It’s essential to establish whether you are an employee or independent contractor and whether you have a “contract for services” or a “contract of service”.

IRD’s recent guideline identifies few changes in its approach and therefore those of you who are already familiar with previous interpretations will observe that many elements remain the same.

Why does it matter whether I have a “contract of service” or a “contract for services”? 

Will you be responsible for income tax, PAYE deductions & ACC payments?  Will you have to register for GST?  Before you can answer these you must establish your “employment” status.

A recent court case established some factors which may be help you determine your correct employment status for tax purposes.  In Bryson v Three Foot Six Ltd, the LOTR production firm was thrust in the spotlight as it highlighted some important distinctions between employee versus independent contractor statuses.  A number of “tests” were used to examine the relationship between the Three Foot Six and Bryson to form a clearer evaluation of the true status.  These tests can be used to establish your own status:

Intention:  This test analyses what was agreed between both parties and considers the true intention of the relationship’s nature.  For example:  If you’re paid regularly at set times and for set amounts and PAYE & ACC is deducted from you then this might indicate that an employer/employee relationship was intended.  Simply calling the relationship an independent contractor is unlikely to hide the true intended relationship.

Independence:  If you exercise high degrees of autonomy and independence then you are more likely to be labelled a contractor, rather than an employee.  If you’re free to work at home or your office and you supply your own tools & equipment, then this would strengthen your case as a contractor.  On the other hand, if you’re involved in recruiting & terminating staff or are significantly influencing how the organisation is managed, your case will weaken.

Control:  The control test establishes what control the employer exercises over you and how you perform your duties.  If you’re expected or asked to works set hours and are treated like an employee then you’re likely to be considered an employee.

Integration:  The primary question here is whether you’re simply an accessory to the organisation or whether you’re a fundamental part of it and “part of the furniture”.   As a contractor of service, you’re likely to be carrying out duties that are part and parcel of the business’ operations rather than carrying out ancillary duties over a short-term period

Fundamental:  This test establishes whether you are operating as a business and is often referred to as the economic reality test or business test.  If you have other business clients and cannot be dismissed (like an employee) but can have your contract terminated then you may satisfy this criterion and be deemed a contractor.

If you’re an employee, employment law will apply to you and should offer you the same benefits as any other employee – minimum wage rates, annual leave, parental leave, etc.  Your employer will have to deduct PAYE from your salary or wages.  But if you’re a contractor you won’t be entitled to these benefits, although you are likely to claim tax deductible business expenses and enjoy more flexibility.  Your employment status should reflect the relationship’s intended nature and getting it wrong may have disastrous consequences.

For further help and advice on establishing your employment status, please contact your Business Advisory Services adviser.


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