The Contractor Who Looks Like an Employee
Kiri owns a small web-design studio and has engaged Ravi for 14 months. Ravi works 30 hours a week, mostly from Kiri's office using her equipment, and invoices her monthly as a sole trader with no GST registration. Kiri sets his start time, requires him to attend Monday planning meetings, and he cannot send a substitute without her approval. He earns $6,500 a month and has no other clients. Kiri has not withheld PAYE, has not filed an employer monthly schedule, and treats the payments as deductible contractor expenses. Ravi has filed GST returns showing no output tax on the invoices, believing he is below the $60,000 threshold. Inland Revenue has begun a review after a former employee raised concerns.
1. Determine whether Ravi is an employee or an independent contractor for tax purposes, and explain the consequences for Kiri if the arrangement is reclassified.
Read the worked answer
The label 'contractor' does not decide the matter; the substance of the relationship does. The key tests are control, integration into the business, whether the person is in business on their own account, and the intention of the parties. Here the control indicators point strongly to employment: Kiri sets hours, requires attendance at meetings, controls the premises and equipment, and restricts substitution. Ravi works only for Kiri and has no independent business presence, which points to integration rather than genuine independence.
If reclassified, Kiri is the employer and should have withheld PAYE and ACC earners' levy, filed employer monthly schedules, and paid employer contributions such as KiwiSaver if applicable. The payments are still deductible, but as employment income rather than contractor expenses. Kiri faces PAYE arrears, late payment penalties, and possibly shortfall penalties for not taking reasonable care. Ravi's gross income is unchanged, but his tax is now withheld at source and he may be owed a refund or face a shortfall depending on his marginal rate. Kiri should consider a voluntary disclosure to reduce penalties.
2. Assess the GST position for both parties and identify the compliance failures.
Read the worked answer
Ravi's supplies are made in the course of a taxable activity. The $60,000 registration threshold is tested on a rolling 12-month basis, not per invoice. At $6,500 a month, Ravi's turnover is $78,000 a year, so he exceeded the threshold and should have registered once he became liable, and should have charged output tax on his invoices. His belief that he was under the threshold is mistaken because he appears to have tested it against a shorter period or against net rather than gross amounts.
If Ravi should have been registered, he owes output tax on supplies made after registration was required, though input credits may be available for expenses incurred. Kiri, if registered, may have claimed input tax on invoices that did not include GST, which would create an overclaim. The reclassification to employment does not remove the GST issue for Ravi, but wages are not consideration for a taxable supply, so once he is an employee his remuneration is outside GST. Both parties should correct returns, and Kiri should review whether input tax was validly claimed.