Employee or contractor? It is not just a label. PAYE and schedular payments are taxed differently, carry different obligations, and getting the classification wrong creates problems for both the worker and the business that pays them.
Quick answer
PAYE applies to employees. The employer deducts income tax and ACC earner levy from each pay, handles KiwiSaver and leave, and the employee's tax is largely sorted at source. Schedular payments apply to certain contractors. Tax is withheld from the payment, but the contractor runs their own business, files an IR3, claims expenses, and handles their own ACC and (often) provisional tax.
The dividing line is the nature of the relationship, not what the contract calls it. Calling someone a contractor does not make them one if they work like an employee, and misclassification can be unwound by IRD with back-tax consequences.
The detail, in plain English
The practical differences run deep:
| Feature | PAYE employee | Schedular-payment contractor |
|---|---|---|
| Who deducts tax | Employer, each pay | Payer withholds, but you reconcile |
| Expenses | Generally none claimable | Business expenses deductible |
| ACC | Earner levy via PAYE | Own ACC levies invoiced |
| Leave / KiwiSaver | Employer obligations apply | Your own responsibility |
| Year-end | Usually squared up automatically | File an IR3, may owe top-up |
Whether a worker is truly an employee or a contractor is decided on the substance of the arrangement: how much control the business has, whether the worker can profit from doing the job well or carry the risk of doing it badly, whether they can send a substitute, and how integrated they are into the business. A written “contractor agreement” helps but does not override the reality.
Schedular payments only apply to certain types of work listed in the rules (for example particular contracting and labour-only activities). A contractor outside that list is not on schedular payments at all and simply manages their own tax in full.
It is worth being clear that schedular payments are a subset of contracting, not a synonym for it. Only specific kinds of work — certain labour-only building work, some agricultural and forestry contracting, commission-based roles and a handful of others — are listed as schedular. A genuine contractor doing work that is not on the list has no tax withheld at all and simply manages their full tax themselves, expenses and provisional tax included.
A simple example
Two people do similar work for the same firm:
| Worker | Treatment |
|---|---|
| Fixed hours, firm's tools, paid weekly, told how to work | Likely an employee — PAYE, leave, KiwiSaver |
| Own tools, invoices per job, can subcontract, sets own method | Likely a contractor — schedular withholding, files IR3 |
If the firm pays the first worker as a contractor to avoid PAYE obligations, IRD can reclassify them as an employee and seek the PAYE, leave and KiwiSaver that should have applied. The cost of getting it wrong falls mainly on the business, which is why classification deserves care up front.
Common mistakes to avoid
- Letting the label decide. “Contractor” on paper does not beat an employee-like reality.
- Assuming all contractors have schedular payments. Only listed work types do; others manage tax in full themselves.
- Forgetting the contractor's other obligations. ACC, expenses and provisional tax are all on the contractor.
- Ignoring the business risk of misclassification. Back PAYE, leave and KiwiSaver can be reassessed.
For the worker, the move from PAYE to contracting is easy to under-prepare for. PAYE quietly handled tax, ACC and KiwiSaver; as a contractor all three become your job, and the first year-end is where an unplanned-for bill tends to appear if nothing has been set aside.
Where this fits in your return
For an employee, PAYE largely settles the year and there may be no IR3 at all. For a schedular contractor, the withheld tax is a credit on the IR3, expenses reduce the taxable amount, and a shortfall can trigger provisional tax next year. ACC levies sit on top either way, just collected differently.
If you are the contractor, this connects with schedular payments and withholding tax and how to set your rate.
How Fernway can help
We help you read a working arrangement correctly, set it up the right way from the start, and — if you are the contractor — handle your IR3, expenses, ACC and provisional tax so the move out of PAYE does not catch you out. For businesses, we flag classification risk before it becomes a back-tax bill.
Book a free 20-minute review and we will sort out which side of the line you are on.
This is general information only, not personalised tax advice. Your situation may differ, so confirm it with us or check ird.govt.nz.
In plain English: PAYE is for employees and is settled at source; schedular payments are for certain contractors who file their own return and run their own ACC and provisional tax — and the real test is how the work is done, not what the contract calls it.
This is general information, not personalised tax advice.See our full disclaimer.