Managing A Mixed Workforce – A Practical Guide To Converting Employees To Independent Contractors

As economic pressures mount in Hong Kong, many organisations are exploring ways to streamline operations and reduce costs. One increasingly popular strategy is converting employees into independent contractors, who do not have the same statutory rights and protections as employees.

While this approach can offer significant cost savings, such as avoiding mandatory leave entitlements and MPF contributions, intentionally reclassifying employees solely to avoid statutory payments may be ethically questionable and fraught with legal and practical risks if not managed carefully. Misclassification can lead to costly disputes, tax liabilities, and reputational damage. Below is a comprehensive guide for employers considering this transition.

Understanding the distinction: employee vs. independent contractor

The distinction between employees and independent contractors is not always clear-cut. In 2007, the Court of Final Appeal in Poon Chau Nam v Yim Siu Cheung (2007) 10 HKCFAR 156 identified factors, now known as the "11 indicia", for determining employee status. These include:

1. Level of control: The degree to which the purported employer exercises control over how, when, and where the work is performed.
2. Provision of equipment: Whether the worker uses their own equipment or if the purported employer provides the necessary tools and resources.
3. Ability to delegate work: Whether the worker can delegate or subcontract their duties to others or must perform the work personally.
4. Financial risk: The extent to which the worker bears financial risk in the performance of their duties, such as incurring expenses or suffering losses.
5. Opportunity for profit: Whether the worker has the opportunity to profit from sound management or efficiency in performing their work.
6. Investment and management responsibility: The level of investment the worker makes in their own business and the degree of management responsibility they assume.
7. Integration into the business: Whether the worker is an integral part of the employer's business or operates independently.
8. Ability to engage in other work: Whether the worker is free to work for other organisations simultaneously.
9. Mutuality of obligation: The existence of mutual obligations between the parties, such as the obligation to provide and accept work.
10. Tax and insurance arrangements: Who is responsible for tax and insurance arrangements, such as whether the purported employer completes tax filings for the worker, provides medical insurance or makes MPF contributions.
11. Industry practice and structure: The usual structure and practices within the relevant trade or industry, and whether the arrangement aligns with industry standards.

In recent years, many employers have reclassified employees as independent contractors to address budget concerns. These individuals are often labeled as “consultants,” yet in practice, they work alongside regular employees, maintain similar hours, and receive company email accounts, IT equipment, stationery, and business cards. Companies which continue to treat these “consultants” much as they did employees risk undermining their worker classifications, potentially defeating the intended cost savings and exposing the organisation to legal challenges.

As more of these disputes escalate to the courts, we are observing evolving patterns and criteria now being applied to distinguish between employees and independent contractors:

• Control: The degree of control the organisation exercises over how, when, and where the work is performed remains an important factor. Employees are typically subject to more direct supervision and set schedules, while contractors should have autonomy over their work methods and hours.
• Provision of equipment: While traditionally a strong indicator, the provision of equipment (such as laptops) is now less decisive, especially as security concerns have prompted organisations to supply devices to all workers.
• Ability to hire helpers: Whether the worker can hire their own assistants or helpers is still highly indicative, as employees do not typically have that power.
• Financial risk and profit: The extent to which the worker bears financial risk or can profit from efficient management is less significant than it once was.
• Integration: Whether the worker is integrated into the business (e.g. has a company email address or works alongside employees) is less determinative, but clear differentiation is still advisable.
• Adhering to policies of the organisation: it only used to be employees who were required to abide by company policies. However, it has now become the norm even for third party contractors to agree to abide by an organisation's policies including non-discrimination and harassment and anti-bribery and corruption policies.

Other tests that may better indicate whether a worker is an employee or an independent contractor include the following: Must the worker perform the services personally?

1. Can the worker provide services to other parties, and do they need permission to do so?
2. How did the worker apply for the consultancy work?
3. On what basis is the consultancy fee calculated?
4. Is the worker required to attend work at regular hours, and must they observe company regulations?
5. What is the designation of the officer to whom the worker reports, and is an appraisal report prepared on the worker?
6. Does the worker need to obtain approval to take time off, and if so, from whom should he seek approval? What is the designation of the officer whom he needs approval from?
7. What is the manner in which the consultancy can be terminated?
   It is clear that courts focus on substance over form when determining a worker's status. Therefore, it is crucial that a contractor is not treated like an employee in practice.

Practical steps to minimise misclassification risks

What can organisations do to ensure that independent contractors and employees are classified as intended?

1. Draft distinct contracts

• Service contracts for independent contractors should be clearly different from employment contracts. Avoid simply amending existing employment agreements with minimal changes.
• Contractor agreements should not include probation periods, references to duties owed to the company, fixed working hours or locations, summary dismissal, or payment in lieu of notice (PILON).

2. Payment and use of HR service providers

• Payment should be based on invoices issued by the contractor rather than payroll.
• Engaging a third party, such as an employer of record, can help, as the provider acts as the employer of the workers, assigns them to jobs at the organisation, and pays them. However, such service providers can be expensive and may sometimes cost more than employing the workers directly and providing the requisite employee benefits.

3. Differentiate application and termination processes

• The process for engaging contractors should differ from the employee recruitment process. For example, procurement rather than HR should handle contractor onboarding and payments.
• Termination procedures should also be distinct, reflecting the independent nature of the contractor relationship. As mentioned, summary dismissal and PILON should not apply to contractors.

4. Maintain clear operational distinctions

• If contractors work alongside employees, ensure they are clearly identified as such (e.g. janedoe@company.com should appear as janedoe(contractor)@company.com).
• Contractors should not be subject to the same internal policies as employees, except where necessary (e.g. anti-bribery or anti-discrimination).
• Allow contractors flexibility to accept or reject assignments and to determine their own work schedules.

5. Consistency across documentation

• Ensure all documentation, policies, and communications relating to the contractor consistently reflect the independent contractor relationship. This clarity can help avoid disputes and support the organisation's position if challenged.

Conclusion: proceed with caution

While converting employees to independent contractors can sometimes offer cost savings and flexibility, it is essential to approach this transition with care. Each case must be assessed on its own facts, and the overall relationship should be structured to reflect genuine independence. By taking the steps outlined above, employers can better manage the risks associated with a mixed workforce and ensure compliance with Hong Kong's legal and tax obligations. Proper planning and clear differentiation are key to avoiding the possibility of contractors being regarded as employees.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.