This recent decision by the Employment Court confirmed a $52,800 penalty against an employment advocate. Under the Employment Relations Act 2000, parties to an employment dispute can choose to be represented by a non-lawyer advocate, which is usually cheaper.
This case was unusual because the advocate agreed to sign a clause in a settlement agreement in mediation. The employer later said this meant he had agreed to abide with the employee’s “non-disclosure” clause but that was disputed.
One of the issues was whether an employment settlement agreement can affect third parties and the judge relied on an obscure 2010 precedent, Musa v Whanganui DHB, as we reported two weeks ago, to find that it did, although in the Musa case no order was actually made.
Paragraph 8 of the decision says:
 “... RPW insisted upon the clause being incorporated and H signing so that he and C became parties to the agreed terms of settlement then certified by the Mediator pursuant to s 149 of the Act. It was based on the representation by H agreeing to be bound that H and C were able to procure a settlement for their employee client. The agreed terms of settlement required RPW to contribute to the employee’s costs of representation by H and C in the sum of $4,000 plus GST. The payment was clearly to be made directly to H and C because the payment was to be made within five days of RPW’s receipt of a GST invoice sent by H and C...”
This contorted explanation of why C and H might be bound by a settlement between two other parties touches on several areas of law but does not explain how the judge thought C and H might be liable. It does appear to depend partly on RPW having paid the employee’s expenses associated with the mediation.
But this is actually commonplace and this has nothing to do with making the employees’ lawyer or representative liable if anything goes wrong (such as a party being unable to pay a penalty). It is simply for tax reasons that that the lawyer or advocate invoices the employer for their fee.
Almost always the employer and the law firm or advocacy business are registered for Goods and Services Tax (GST) and the employee is not.
Any wages of salary or severance packages paid by the employer to the employee are taxed at source; in New Zealand this is currently 17.5% if the employee earns $14k-48k in the financial year, 30% for $48k-70k and 33% for anything above $70k. But to simplify the calculations we’ll use 20%.
From Paragraph 8 it appears the judge thought that because RPW paid H’s company C the amount of $4,000+GST, and that is written into the settlement between RPW and their employee, then C is a party to the settlement agreement. But the advocate was not employed by RPW and wasn’t making a settlement between RPW and the advocate.
Judge Perkins seems to have overlooked a quirk around standard industry practice that we suspect ERA Members seem to understand better than judges, in that the legal fees are treated as a legitimate tax-deductible work related expense as far as the employee is concerned (I run a small business and know about this stuff too).
The above pie charts show that based on a hypothetical $10,000 settlement, and an advocate’s fee of $4,000 plus GST, there are two ways this can break down:
The employee has 20% income tax (PAYE) deducted from $10,000. That leaves $8,000 after tax, but then the advocate’s fee including GST has to be paid by the employee. Once the employee has paid that fee, $8,000 less $4,600 leaves the employee with $3,400.
The employer pays the employee $6,000 and deducts income tax of $1,200, leaving the employee with $4,800. The employer pays the remaining $4,000 plus $600 GST to the advocate. But the employer can claim the GST back when it does its next GST return. The advocate and the employer are the same financial position either way.
Using these figures the second option has the employee $1,400, or 41% better off, at no extra cost to the employer. If the employee’s total income for the financial year exceeds $48,000 including the settlement, the marginal tax rate would be 30% and the benefit of splitting the payment would be even more significant.
Of course the taxman is $1,400 worse off but we have no reason to believe that the IRD disapprove, because other allowances such as mileage reimbursement (currently $0.72 per km up to a maximum of $5,000) are allowed to be paid without deduction to employees who use their own vehicle for work.
The direct payment of the advocate was an ordinary agreement that didn’t make the advocate an employee of RPW or a party to an employment settlement, so it’s very hard for us to see why this should be something an Employment Court judge wanted to get mixed up in.