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Employee or contractor – what’s the difference?

Many businesses struggle with the distinction between employees and contractors. We explore the difference and the importance of getting it right for your business.

Does it really matter if I confuse the two?

Engaging contractors to get things done is appealing. Pricing can be more outcomes based, work can start and stop more flexibly, and there’s no payroll, PAYG or super to worry about. In some cases payroll tax is also not payable (see for example the Victorian payroll tax contract exclusions). And people often prefer to work as contractors for their own tax reasons.

But if in fact the law would say it’s an employment relationship, businesses that get caught face some serious trouble.

The ATO penalises businesses for not withholding PAYG, and imposes heavy fines for not meeting the superannuation guarantee obligations, as well as requiring super plus interest to be back-paid. In addition to the ATO, under the Fair Work Act, courts can impose penalties of up to $54,000 per contravention.

The difference between employees and contractors

So, how can a business be sure it has the correct arrangements in place?

There’s a lot of info out there but the most concise and easy to understand is on the Australian Taxation Office (ATO) website. Unfortunately, it’s sometimes not straight forward to determine if a person is an employee or contractor. It’s a question of weighing up the particular circumstances of the relationship against the various factors identified by the courts.

The ATO has summarised the case law and focuses on six key factors that need to be considered:

  • Whether the worker can sub-contract or delegate the work
  • How the worker is paid, either as a fixed price for an outcome or result or by time, commission or piece rate
  • Whether the person is providing their own tools and equipment
  • Whether the worker takes on the commercial risk of fixing mistakes for no additional fee
  • The extent to which the worker has control over when and how the work is done
  • The general independence of the worker and their freedom to accept and refuse additional work.

The ATO also has an Employee/contractor decision tool to help businesses work it out. But note that some experts believe the tool is skewed towards assessing workers as employees, so seek legal advice if you want to question the outcome it gives you.

For more information, visit the ATOs difference between employees and contractors web page. For an in-depth understanding, Taxation Ruling TR 2005/16External Link and Superannuation Guarantee Ruling SGR 2005/1 explore the issues in more detail.

The Fair Work Ombudsman provides its own guidance on the question as it pertains to the Fair Work Act. Thankfully it also looks to the same common law cases as the ATO so the guidance and tests are very similar, see here.

Myths and mistakes to avoid

Despite the guidance available, confusion on the contractor / employee question is common. So much so the ATO has compiled a page of mistakes to avoid with information on common contractor myths, including:

  • Having an ABN makes you a contractor
  • Having a registered business name makes you a contractor
  • Being engaged for only short term work makes you a contractor
  • That working for less than 80% of your time in a business can make you a contractor
  • Businesses should treat people as contractors if the worker would prefer it
  • Submitting an invoice makes a worker a contractor.

If you’re still in doubt, or need some help setting up your systems to easily manage payroll and employee obligations, contact us for further guidance. Modern accounting software makes complying with employment obligations simpler than ever before.

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