Due Process

a column by Geoff Hardy

What type of contractor are you?

There is often confusion about the difference between an independent contractor, a labour-only contractor, and a subcontractor, and consequently some doubt as to which contract to use in any given case. This article explains the difference and provides some guidance on the issue.

Independent Contractors

Geoff Hardy has 45 years’ experience as a commercial lawyer and is a partner in the Auckland firm “Martelli McKegg”. He guarantees personal attention to new clients at competitive rates. His phone number is (09) 379 0700 and email geoff@ martellimckegg.co.nz.

These are people who would normally be your employees, but for the fact that one or both of you prefer that they be treated as independent contractors instead. There are certain advantages and disadvantages for both parties in doing so.

The main advantages for the independent contractor is that they can generally charge a higher rate, they pay income tax four times a year rather than PAYE out of every pay packet, and they can deduct certain expenses from their income for tax purposes.

The main advantages for you the joinery business owner is that they are not covered by employment law so they are not entitled to be paid when they are on leave and they don’t enjoy the normal protections against dismissal and unfair treatment.

From the independent contractor’s perspective the main disadvantages are that they have to prepare financial statements, file GST and income tax returns, and pay their tax when the time comes, and they aren’t entitled to all the protections that employment law would otherwise give them. The main disadvantages from the joinery business owner’s point of view is that independent contractors are supposed to have a greater degree of freedom than employees do, in terms of how and when they carry out their work.

Independent contractors typically only work on your projects and under your supervision, just as your employees do. So they are effectively your staff members. However it is important not to treat them in exactly the same way as your employees, because if they are employees in reality, then the law will treat them as employees regardless of what label you put on the relationship. That means in the event of a falling-out between the two of you, the independent contractor may claim that he was in fact an employee, and insist on all the paid leave and protections that he was entitled to, right back to the day he started.

There are certain tests that tax law and employment law use to differentiate between true employees and true independent contractors, and it pays to get some professional guidance on those tests so you don’t stray across the line. Using a formal independent contractor agreement certainly helps to achieve that, but it may not be enough to get you home.

Labour-Only Contractors

These are tradespeople who genuinely are the bosses of their own businesses and work directly for arms-length clients, rather than independent contractors who have all their work fed to them by one “boss” and who very rarely deal with the clients direct. Typically labour-only contractors work for many different clients over their careers, although they may do repeat work for certain clients and in some cases may get all their work from one or more developers or volume building companies.

So they tend to be the more mature tradespeople who have served their time and have “gone out on their own”, but at the same time they either don’t want, or aren’t given, the responsibility for managing the project. That means that they usually don’t engage the subcontractors or procure the building materials, and they are just one of a number of skilled tradespeople working on the project under the direction of the project manager – whether that is the property owner, or the volume building company which has contracted with the property owner.

Consequently, the labour-only contractor is generally given much more autonomy and freedom than an independent contractor, consistent with his greater knowledge and experience. He is one step closer to the true head contractor, in that he is largely left to his own devices to carry out the work as he sees fit, rather than being closely supervised by the project manager. His primary responsibility is to provide skilled labour in his specialist area of expertise, using the building materials supplied to him by the building manager.

Of course there are always exceptions to the rule, in that some labour–only contractors are expected to procure some of the building materials and occasionally engage some of the specialist trades. In fact on residential projects where the property owners have taken it upon themselves to manage the project, but clearly don’t have the expertise to do so, the labouronly contractor may end up as the unpaid project manager by default.

The important point is that there is no clear delineation between an independent contractor and a labour-only contractor, and there will always be some overlap between them. A labour-only contractor is somewhere between an independent contractor and a head contractor, and the main factors to look out for are that he needs less tuition and he doesn’t take instruction from a “boss” to quite the same extent, but he still doesn’t fully manage the project.

Subcontractors

Once again these are tradespeople who genuinely are bosses of their own businesses and work directly for arms-length clients. However they differ from labour-only contractors in two main respects. First, they may well supply their own materials and they may well engage sub-subcontractors, if that is what their job calls for, so in that sense they provide more than just labour and they do fully manage their part of the project. Secondly, their clients are never the property owners. That is because to be a “sub” contractor you have to be serving or working for another contractor who is above you in the chain of command. Usually that will be a head contractor who has contracted with the property owners direct, and has overall responsibility for the project.

Typically subcontractors are specialised tradespeople like plumbers, electricians, gasfitters, roofers, brick and block layers, foundation experts, painters, landscapers, and installers of complex joinery, HVAC or waterproofing systems. They are engaged by head contractors because the head contractors don’t have the expertise or qualifications required to perform their function, but nonetheless the head contractors have undertaken to the property owners to supply the full package required to complete the project.

There are very few standard-form subcontracts in common use in New Zealand, and those that do exist are normally used in the large commercial or infrastructure projects. In the smaller projects there is usually some resistance by the head contractor and subcontractors to sign a “book” of terms and conditions, so the terms of the subcontract are recorded in the plans and specifications the head contractor gives to the subcontractor, and the quote or proposal the subcontractor gives in return. Consequently most smaller subcontracts are a bit deficient when it comes to providing guidance in the event of a dispute, so it is always preferable to sign the ‘book” if you can get away with it.

Once again there is no clear delineation between a subcontractor and the other two categories of contractor described above, and someone could conceivably meet the criteria for all three at the same time. However the main differentiating factors are that the subcontractor never contracts with the owner direct, he usually has qualifications or expertise in a specialist area, and he is given a lot of autonomy to carry out his work as he sees fit.