Employment Court delivers courier decision – tax consequences part and parcel
The recent Employment Court case Leota v Parcel Express Limited  NZEmp 61 is the latest New Zealand judgment on the distinction between the employer-employee relationship and the principal-independent contractor relationship. While the decision in Leota does not discuss tax issues, the nature of the case means that these are part and parcel of the judgment delivered by the Employment Court. From a tax perspective the case highlights the risk of wrongly classifying workers – a mistake that can have very significant tax consequences for both parties. This article discusses the Leota case and its tax implications.
This case was brought by Mr Leota, a courier driver for Parcel Express Limited (the ‘Company’). The Company had classified Mr Leota as a contractor, and sought to terminate his contract for services on that basis. Mr Leota sought a declaration from the Court that would set aside his contractor’s agreement and confirm his status as an employee. He was successful. Our Employment team’s summary of the Leota case can be viewed here.
This case is a useful re-statement of the relevant legal test, the courts will look beyond the relevant documentation and determine the nature of the relationship between the parties with reference to various factors, in particular, the relevant factors are:
1) whether a hirer has the right to exercise detailed control over the way in which work is performed; and
2) whether the worker must supply and maintain any equipment or tools; and
3) whether the worker is paid according to task completion rather than receiving wages based on time worked; and
4) whether the worker can subcontract the work or delegate performance to others; and
5) whether the worker is required to wear a uniform and/or display material that associates them with the hirer’s business; and
6) whether the worker is free to work for others while working for the hirer; and
7) whether the worker is integrated into the hirer’s organisation; and
8) whether the worker receives holiday pay or sick leave.
In Leota, the Employment Court held that despite the contractual arrangements which existed stating otherwise, the worker was an employee rather than a contractor because it found that, after testing the above factors, the plaintiff was serving someone else’s business rather than their own. The fact that the working relationship was described in a particular way in the contract, was not determinative of the actual legal status of that working relationship.
From a tax perspective there is generally an incentive for businesses to engage their workers on a contractor basis, so that the contractors are responsible for tax on the contract payments they receive. By contrast, if the workers are engaged as employees, then the business would be responsible for the tax under New Zealand’s PAYE rules.
Neither the Income Tax Act 2007 or the Goods and Services Tax Act 1985 prescribe how to classify workers as employees or contractors. The employment law tests are, for this reason, relied upon when determining a worker’s status for tax purposes.
The Leota case is significant because it highlights the importance of analysing the real nature of the relationship when determining whether a worker is an employee or a contractor. It is not enough to simply document an arrangement as a contractor arrangement – the Courts are willing to look beyond the contractual terms and conclude that the worker is an employee based on the surrounding circumstances.
Mistakes in classifications can be very costly from a tax perspective. In general terms, if a worker who has been treated as a contractor is later found to be an employee, then we expect that:
- their employer would need to deduct PAYE from future payments to them and account for this tax to Inland Revenue; and
- the employee would lose the ability to deduct their employment-related costs; and
- the employee would no longer be able to register for GST or charge GST for services that they supply as employees; and
- the employee would no longer have to account to Inland Revenue for tax and accident compensation earner and employee premiums.
In addition, there would also be a question mark over the tax treatment adopted by the parties to date. In particular:
- Will the employer have to recharacterise past payments to the worker as salary and wages subject to payroll taxes? From a policy perspective this would seem unnecessary where the worker has correctly accounted for tax themselves, but it is potentially an issue if they have not.
- Will the worker have to amend prior year returns to reverse employment-related deductions they have claimed?
While there is a tax incentive for businesses to classify workers as contractors, Leota highlights the risk of getting this classification wrong. Prudent businesses should seek to document their arrangements with workers in a manner that is consistent with the real nature of the relationship, and account for tax accordingly.
Businesses should also be alert to changes in the real nature of employment relationships over time, as it is possible that an independent contractor relationship may later evolve into an employment relationship as a result of the parties’ continued dealings.
If you wish to discuss the tax consequences of employment status issues, please contact one of our experts.