How Is A Contractor Different From An Employee?

Small Business Tips
Jan 13, 2023

Running a small business is often tough. If you’ve been doing everything yourself, it might be time to consider getting help. Many small businesses rely on employees, contractors, or a mixture of the two to keep their operations going. But what’s the difference between a contractor and an employee?

An employee is employed directly by a business, and a contractor is self-employed but provides services to other businesses. However, it’s not always that clear cut and getting it wrong can be costly.

Let’s discuss the main differences between contractors and employees, so you can choose the right assistance for your small business.

Contractors vs. Employees – The Key Differences

There are several key differences between contractors and employees. These include:

Employment law

Employees are covered by employment law, specifically the Minimum Wage Act 1983, Employment Relations Act 2000, and Holidays Act 2003. This means they are entitled to holiday and sick pay and a minimum hourly rate. Businesses must deduct taxes from an employee’s pay to submit to the Inland Revenue Department (IRD).

Contractors are not covered by employment law. They are not entitled to holiday or sick pay from the businesses they work with. Contractors may need to set aside money from each payment to ensure they can cover their tax bill each financial year.

There may be penalties if a contractor is ruled by the courts to be an employee. You may owe them back pay, holiday and sick pay, and a minimum wage.

Contracts

Employees have an employment contract. It defines their work hours, rates of pay, and holiday pay. It may also contain other key clauses about how and where they may work.

Contractors have independent contractor agreements or a “contract for services”. It defines them as contractors and sets expectations for their work, pay, and other obligations. In this way, these agreements protect the contractor and the business hiring them.

Employment contracts and independent contractor agreements should be drafted and accepted before work begins. That way, there is less likely to be confusion over what is expected from both parties.

Work control

Employees largely have their work controlled by the business they work for. You might expect your employees to work certain hours or in a specific location.

Contractors generally have more freedom. They may be able to set their own hours so long as the agreed-upon work is delivered on time. A contractor might work from any location. Though COVID-19 has given many employees more flexibility, contractors may be more likely to work from home or remote locations.

Payment for services

Employees are paid via a business’ payroll. PAYE tax is deducted by the business and submitted to IRD on the employee’s behalf.

Contractors must submit an invoice to the business to get paid. The business typically pays the full amount, and tax is not deducted. It’s the contractor’s responsibility to pay their own taxes each financial year.

Still unsure if they’re a contractor or employee?

Hopefully, it’s now clear whether the person you’re about to hire is an employee or a contractor. But what if you’re still unsure? It may help to think about the person in terms of money and risk and how they’ll fit into your business structure.

Economic Reality Test
Simply put, is the worker reliant on your business, or are they a business themselves? Consider the following question:

Who sets the rate of pay? Contractors typically set their fees, but an employee’s salary is largely set by their employer.
Can they work for more than one business at a time? Contractors may work with different clients at the same time (though you may negotiate this with them).
Do they hold their own liability insurance? Contractors typically have their own business insurance policies, as they may not be fully protected by your small business insurance.
Do they advertise for work? Contractors will advertise their servicesto find clients.

Integration Test
Now think about how the worker will fit into your business. There are often very different expectations for employees and contractors. It may help to ask yourself these questions:

Will they be a permanent part of your operations? A contractor may only work for a short period of time (such as a single project).
Will you supply them with equipment to do their job? Employees are typically given equipment to use on the job, but contractors usually provide their own.
Will they be expected to wear a uniform? Employees may be required to follow a strict dress code or wear a provided uniform while they work. This isn’t usually expected of contractors.

Protecting your small business

Whether you work with contractors, hire employees, or do both, protecting your small business is vital. Small business insurance can help you create a safety net that shields your business and finances from many unexpected events.

BizCover makes it simple to compare and buy liability insurance, like Public Liability and Professional Indemnity. Plus, you can also sort out other popular types of business insurance, such as Cyber Liability and Employer Liability, at the same time!

Start comparing quotes and save today!

This information is general only and does not take into account your objectives, financial situation or needs. It should not be relied upon as advice. As with any insurance, cover will be subject to the terms, conditions and exclusions contained in the policy wording.