Independent contractor vs. Employee – A dynamic distinction
When a person is engaged to perform services, their employment status can be defined in one of two ways: a ‘contract for services’ or a ‘contract of service’. That is, an independent contractor or an employee. The distinction between these two terms is set out in the Inland Revenue’s recently updated interpretation guideline: ‘Determining employment status for tax purposes (employee or independent contractor?)’.
The category into which a person falls has substantial consequences for tax purposes. Who bears the burden of accounting for ACC? Does PAYE need to be deducted at source by the employer? Does the worker need to register for GST? None of these questions can be answered without first establishing the person’s employment status. The new interpretation guideline signals no change in approach by the Inland Revenue, so those familiar with the previous guideline will note that a substantial part of the document remains the same. However, the incorporation of recent case law establishes additional factors which can be indicative.
The most notable inclusion is the 2005 Supreme Court case Bryson v Three Foot Six Ltd. The Lord of the Rings production company involved attracted plenty of attention and so the spotlight was put on the distinction. The purpose of these proceedings, which started in the Employment Court, was to establish whether Mr Bryson was an “employee” of Three Foot Six Ltd. If so, he could consequently bring an unjustified dismissal claim under the Employment Relations Act 2000. This required an analysis of section 6 of the Employment Relations Act, with particular emphasis on determining ‘the real nature of the relationship’. While this relates to employment legislation, the new interpretation guideline states section 6 decisions can be relevant when determining employment status for tax purposes to the extent that those decisions concern the common law tests.
As a result of Bryson, industry practice has emerged as a new factor to consider in determining employment status. In situations where custom or practice is sufficiently well established, industry practice may point to a person being either an employee or an independent contractor. In Bryson, witnesses assumed that Mr Bryson was an independent contractor because “that was the invariable practice at Three Foot Six [and] across the film industry”. Despite the fact that this ultimately worked against the defendant, industry practice can now be used to shed light on the parties’ intention as to employment status.
This new indicator now accompanies the more well-known tests. We explain these tests with reference to the Bryson case:
- Intention of the parties test: This test gives consideration to the intentions of each party to the agreement regarding the nature of the relationship, which involves an analysis of the agreement between the parties. Important to note is that if actual circumstances point to an employment relationship, then simply labelling it an independent contract relationship will not modify the true position. In Bryson it was established that “tax status can be an indicator of what a person intends his contractual relationship to be”. Thus if a person is paid a set-rate at regular intervals and PAYE is deducted, this may support the view that the parties intended the relationship to be one of employer-employee. Mr Bryson was paid a regular wage based on an hourly rate, with the invoices being generated by Three Foot Six; all indicative of an employer-employee relationship.
- Control test: This test looks at the degree of control the employer or principal exerts over the work the person is doing and the manner in which it is to be done. Mr Bryson had his work closely controlled by Three Foot Six – he was expected to work regular hours and was treated as an employee, being paid for his downtime. This supported the conclusion that Mr Bryson was in fact an employee.
- Independence test: Essentially the inverse of the control test, a high level of autonomy on the part of an employee or contractor is inconsistent with a high level of control by an employer or principal. This test was not mentioned in Bryson however has been discussed in several Taxation Review Authority cases. Examples of factors which indicate a high level of independence include a person supplying their own equipment, working from their own premises, having direct responsibility for profits and risk of the business and being able to hire or fire who they wish to help them do the job. fire who they wish to help them do the job.
- Fundamental test: As referred to in Bryson, the question for this test is whether the person engaged to perform services is performing them as a person in business on his own account? Also known as the ‘economic reality test’ or the ‘business test’, a key factor in this test is that an independent contractor typically agrees to be responsible for their work. Further, they are unable to be “dismissed” but rather will have their contract terminated should it be broken. The Supreme Court, in concurring with the judgement of the Employment Court, found that there was no evidence at all of Mr Bryson operating a business on his own account.
- Integration test: Is the person performing services part and parcel of the organisation? Is their work necessary for the running of the business? In Bryson, reference was made to Lord Denning’s ‘classic description test’ which states that: “Under a contract of service, a man is employed as part of the business, and his work is done as an integral part of the business; whereas, under a contract for services, his work, although done for the business, is not integrated into it but is only accessory to it.” Mr Bryson, as a model maker, was an integral part of Three Foot Six’s business.
The Supreme Court held that Mr Bryson was in fact in the position of employee. This case serves as a reminder to employers that their intentions for the employment status of a person engaged to perform services must be reflected in the real nature of the relationship. For further advice on the new interpretation guideline and establishing the employment status of a person, please contact your usual Deloitte adviser.