As a small business owner, you've probably wondered whether that person you're hiring should be classified as an employee or a contractor. It's one of the most common questions we hear, and for good reason. Getting it wrong can be expensive and stressful. We've heard some absolute horror stories from well-meaning business owners who got stung badly when contractor relationships soured.

The consequences of misclassification aren't just paperwork headaches. You could face penalties, backdated holiday pay claims, KiwiSaver obligations, and even Employment Relations Authority disputes. The good news? Understanding the rules doesn't have to be overwhelming.

Why does the distinction matter?

The classification of your workers affects everything from tax obligations to employment rights. Employees are entitled to minimum wage, holiday pay, sick leave, KiwiSaver contributions, and protection under employment law. Contractors, on the other hand, are responsible for their own tax (though you may have withholding tax obligations), don't receive employment benefits, and operate under commercial law rather than employment law.

For your business, this means different:

• Tax obligations: Employees require PAYE deductions, while contractors may need withholding tax (as covered in our [schedular payments guide])
• Insurance requirements: Different ACC obligations and liability considerations
• Legal protections: Different dispute resolution processes and termination procedures
• Ongoing costs: No holiday pay, sick leave, or KiwiSaver contributions for genuine contractors

The gateway test: the new starting point

As of 21 February 2026, the government introduced a gateway test that gives businesses and workers a clear, upfront way to confirm whether someone is properly engaged as a contractor.

This is a big deal. Previously, the only way to determine someone's status was the "real nature of the relationship" test, which involved courts weighing up multiple factors after the fact. That meant uncertainty for everyone, and plenty of cases where businesses thought they had a legitimate contractor arrangement only to have it overturned.

The gateway test changes that. If a working arrangement meets all four criteria, the worker is considered a "specified contractor" and that classification can't be challenged through the Employment Relations Authority or Employment Court. It's definitive.

The gateway test criteria

All four of the following must be met:

1. A written agreement that specifies the worker is an independent contractor (or specifies they are not an employee)
2. Freedom to work for others: The worker is not restricted from working for other businesses, including competitors. They just can't do that work at the same time as working for you. Worth noting: contracting someone for the equivalent of full-time hours doesn't in itself count as a restriction on working for others
3. Flexibility in when they work, or the ability to subcontract: Either the worker isn't required to work at specific times, on specific days, or for a minimum number of hours, or they're allowed to subcontract the work to someone else. Businesses can vet subcontractors where it's justified for the nature of the work, and the contractor can decline additional work without the arrangement ending
4. Reasonable opportunity to get advice: The worker must have had a reasonable opportunity to seek independent advice on the arrangement before signing

What if the criteria aren't all met?

If any of the four criteria aren't met, the gateway test doesn't apply and the existing common law test kicks in. That's the one that looks at the "real nature of the relationship" across four factors: intention, control, integration, and economic reality.

The gateway test is not retrospective. If you had a contractor arrangement in place before 21 February 2026 and it's disputed, the common law test applies for the period before that date. From 21 February onwards, both tests can be considered. That could result in a split decision, where someone is found to have been an employee before the law changed and a specified contractor after it.

The common law test: still relevant

Even with the gateway test in place, you should understand the common law test. It applies whenever the gateway test criteria aren't fully met, and it's the test that's been used in New Zealand for years.

The four factors

Intention of the parties: What did both parties intend when they entered the relationship? Written agreements matter, but they're not conclusive if the reality tells a different story.

Control: How much control does the business have over how, when, and where the work is done? Greater control typically points towards employment.

Integration: How integrated is the worker into the business? Are they part of the business structure or genuinely operating independently?

Economic reality: Who bears the financial risk? Does the worker have their own business, multiple clients, and responsibility for profit and loss?

Signs that point towards employment

• Fixed hours or a requirement to work set times
• You provide equipment, tools, or workspace
• You pay a regular wage or salary rather than invoiced amounts
• The worker needs permission for time off
• You control how the work is done, not just the end result
• The worker doesn't have other clients or business activities
• You deduct tax like you would for an employee

Signs that point towards a genuine contractor relationship

• The worker invoices you for services
• They have their own business registration or GST number
• They provide their own tools and equipment
• They work for multiple clients
• They set their own hours (within project requirements)
• They bear financial risk for their work
• They can subcontract or delegate work

What this means for your business

If all gateway test criteria are met: The worker is definitively a contractor. This can't be challenged. That's the certainty the new test was designed to provide.

If any criteria aren't met: The common law test applies, and the courts or ERA will look at the full picture of the working relationship.

Either way, it's worth reviewing your current arrangements to make sure they stack up.

Practical steps for small business owners

Before hiring anyone

• Clarify the relationship upfront: Determine whether you need someone integrated into your business (employee) or someone to deliver specific outcomes independently (contractor)
• Document everything: Whether employee or contractor, have clear written agreements that reflect the reality of the working relationship
• Review your current arrangements: If you have existing contractors, check whether those arrangements would meet the gateway test criteria. If not, consider whether the common law test would still support a contractor classification

For contractor relationships

• Make sure your written agreement clearly states they're an independent contractor (or not an employee)
• Don't restrict them from working for competitors or other businesses
• Allow flexibility in when they work, or ensure they can subcontract
• Give them a reasonable opportunity to get independent advice before signing
• Pay based on invoices, not regular salary or wage payments
• Don't provide employment benefits like annual leave or sick pay

For employee relationships

• Use employment agreements that comply with employment law
• Provide minimum employment entitlements
• Deduct PAYE, not withholding tax
• Consider KiwiSaver, ACC, and other employment obligations
• Follow employment law for any disciplinary or termination processes

Common mistakes to avoid

Hybrid arrangements: Don't create relationships that have characteristics of both. Pick one and structure the arrangement consistently.

Control creep: Starting as a contractor relationship but gradually imposing more control and integration without changing the legal structure. This is one of the most common ways businesses end up in trouble.

Written vs reality mismatch: Having a contractor agreement but treating the person like an employee in practice. The gateway test has made the written agreement more important than ever, but the arrangement still needs to reflect reality if the common law test applies.

One-size-fits-all approach: Different types of work and workers may need different approaches. A graphic designer working on a one-off project is very different from someone providing ongoing administrative support.

Being led by the worker: We often hear from employers who have workers that asked to be a contractor because they feel it benefits them. If this is the case, make sure the rest of the arrangement actually supports a contractor classification. If something goes wrong, the fact that they asked to be a contractor won't be enough to protect you.

Thinking the gateway test is a loophole: The gateway test provides certainty for genuine contractor arrangements. It's not a way to avoid employment obligations by restructuring the paperwork while keeping everything else the same. If the reality of the relationship looks like employment, and the gateway criteria aren't genuinely met, you're still exposed.

Getting professional advice

The employee vs contractor distinction involves both employment law and tax law. Consider getting professional advice when:

• You're unsure about a specific working arrangement
• You have workers who could potentially be classified either way
• You want to restructure existing relationships
• You want to make sure your agreements meet the gateway test criteria

Employment lawyers, HR consultants, and accountants can provide guidance tailored to your specific situation.

The bottom line

Getting the employee vs contractor distinction right isn't just about avoiding penalties. It's about creating clear, fair working relationships that work for everyone involved. The gateway test has made things significantly clearer for genuine contractor arrangements, but it's important to understand both the new test and the common law test that still applies when the gateway criteria aren't met.

Take time to review your current arrangements, make sure your agreements match the reality of how you work together, and don't hesitate to get professional advice when you're unsure. Your workers and your business will benefit from getting it right from the start.

And remember: when in doubt, it's often safer to assume an employment relationship and provide appropriate protections and benefits. The costs of misclassification typically far exceed the costs of proper compliance.

This guide covers the essentials based on current law as at February 2026. Every business situation is unique, so always consult with employment law professionals and check the latest requirements with Employment New Zealand for your specific circumstances.

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