Over the past couple of decades there has been a clear shift away from ‘traditional employment’, and towards people acting as independent contractors or ‘freelancing’.
But working out when you are genuinely a contractor, and when you are still seen by the law as an employee, is not an easy task. Whether the law sees you as an employee or an independent contractor has an impact on a number of important aspects of your working life.
On the flip-side, if you are an employer, understanding who are your ‘employees’ is equally important – as it will dictate the extent of your responsibilities.
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Who is an employee?
Generally an employee is someone who is employed by a business to provide their labour. Employees can be employed on a permanent, casual or fixed-term basis, working either full-time or part-time hours. Employees owe duties of fidelity and good faith to their employer.
Different government rules have expanded the categories of people who fall within the definition of an ’employee’. For example, people providing services ‘principally for their labour’, even on a very short-term basis, are considered employees for workers’ compensation purposes.
Who is an independent contractor, and how is it different to being an employee?
An independent contractor is a person who contracts to others to provide services and to achieve a particular result or complete a particular project.
A contractor is different to an employee because the contractor must run their own independent business, separate from the person who engages them. For that reason, a contractor can service many different clients (often at once), and can advertise their services to the public at large.
The question to be asked when determining whether someone is an independent contractor is: ‘in performing work, is that person working in and for their own business, rather than as part of someone else’s business?’
What are the benefits of being an employee?
There are a number of benefits to being an employee, primarily under a range of State and Federal legislation designed to protect workers and their safety. These include:
- Unfair dismissal and unlawful termination protection;
- Minimum pay rates;
- Minimum working conditions;
- Leave entitlements;
- No personal liability if there is a defect in your work; and
- Cover by a relevant workers’ compensation scheme if injured or ill while at work.
What are the benefits of being a contractor?
There are both economic as well as ‘personal’ benefits to being an independent contractor. A lot of people enjoy the sense of freedom and personal responsibility. Productivity often increases, and stress can be decreased (at least initially). At law:
- By default, you own your own intellectual property (‘IP’) (unless the contract says otherwise);
- Potential tax benefits (although the ‘personal services income’ rules under the tax legislation may negate these benefits);
- Potential to be paid more on a per project basis, plus you get the benefit of your own efficiency;
- Flexibility of work hours and work location; and
- Creation of your own business and branding, which may later be sold (as ‘goodwill’)
I run a business, and want to engage someone to provide services to me. How do I know if that person is an employee or a contractor?
There is no fixed ‘test’ to decide whether a worker is properly classifiable as an employee or a contractor.
All the elements of the relationship and features of the worker need to be considered. Even if you call them an ‘independent contractor’, they may still be an employee (and vice versa).
Factors to take into consideration include:
- Control of performance of work – employees are subject to the ‘ultimate authority’ of their employers about how they perform their work, whereas contractors get to make their own decisions about how they do the work to achieve the relevant outcome.
- Control of working conditions – employees have to perform the work when and where the employer requires, whereas contractors have much greater flexibility (i.e. working from home, working outside of business hours, etc).
- Risk – employees bear no risk for any defect in their work (because the risk lies with the employer), whereas contractors will generally bear the risk of their work (and should generally take out professional insurances as a result).
- Separate business – employees perform work in the course of and as part of their employer’s business, whereas contractors are running their own independent business (with their own accounts and expenses) and can accrue ‘goodwill’ towards their own business name and branding.
- Contract for a fixed project – employees are employed on an ongoing basis, whereas contractors are often engaged to achieve a particular result or work on a particular project.
- Delegation of work – employees may delegate work to colleagues in certain instances but are not responsible for payment of those colleagues for the delegated work, whereas contractors who delegate or sub-contract work will have to attend to payment of the third-party who undertook the work.
- Provision of equipment to perform work – employees will be provided with the tools and equipment necessary to perform their work (or receive an allowance to pay for them), whereas contractors will have to provide their own equipment at their own cost.
- Exclusivity of service – employees are usually required (at common law) to exclusively serve their employer, whereas contractors have no obligation of exclusivity and can market their services to the public.
- Invoicing and payment for services – employees are usually paid regularly on an ongoing basis, whereas contractors must invoice for work performed (often including timesheets or evidence of work undertaken). Contractors should therefore have their own ABN and may need to charge GST if their turnover exceeds the threshold.
- Requirement to wear a uniform – employees are commonly required to wear uniforms branded with their employer’s name or logo, whereas contractors cannot be made to wear a uniform of another business because it is inconsistent with the contractor running their own business.
I am a business owner. Is there a difference for me if someone is an employee or a contractor?
Yes, there are a number of differences:
- PAYG withholding – you must withhold and remit tax on behalf of employees under the PAYG withholding scheme, but no similar obligation exists for payment of contractors.
- Payroll tax – if you pay wages which are liable to payroll tax over the relevant State monthly threshold you must register for payroll tax. If you then have an annual wages bill of over the annual threshold, then you must actually pay payroll tax. The amounts paid to a true independent contractor are generally not included as wages for payroll tax purposes.
- Superannuation – you must pay the Superannuation Guarantee (which is currently 11% of the employee’s annual pay) to your employees’ superannuation funds on their behalf. Contractors must make their own superannuation contributions.
- Payment for leave – your employees are entitled to receive payment for leave, including sick leave, annual leave and long service leave. Contractors do not have an entitlement to leave.
- Workers’ compensation cover – you are responsible for taking out insurance against loss caused by injuries sustained by your employees in the course of their employment. Contractors are required to take out their own insurances.
I’m worried about getting it wrong – is there any free advice available to me?
The ATO provides an online tool for businesses to determine whether they ought to pay someone as an employee (with PAYG withholding) or as a contractor. Businesses can rely on the results of this tool (meaning that the ATO will not enforce any penalties), provided that the questions are answered accurately.
The ATO website also provides a Superannuation Guarantee Decision Tool that businesses can use to determine whether they need to pay the SGC for a particular worker.
In relation to payroll tax liability, the relevant State revenue office website will provide a questionnaire for you to determine whether a worker is an employee or a contractor for the purposes of assessing payroll tax. For example, in South Australia the RevenueSA website provides a Relevant Contracts Decision Tool. If you rely on the results of this tool and still get it wrong, you won’t be charged the penalties or interest that would ordinarily be imposed, provided that the questions are answered accurately.
You should also speak to the relevant workers’ compensation scheme to determine if you must register to cover your employees.
My boss has terminated me as an employee so that he can re-hire me as a contractor. Can he do this?
No. This is known as a ‘sham contracting arrangement’, because you should actually be treated as an employee. You are entitled to bring an unfair dismissal claim against your employer through the Fair Work Commission (formerly Fair Work Australia).
We covered this issue on a previous ABC 891 Drive segment.
I provide work to a business through a labour-hire agency. Am I an employee of that business?
No. No employment relationship is taken to exist if your services are not directly engaged (i.e. if you are ‘temping’ through a labour-hire agency). However, it is possible that you are employed by the agency itself.
As a business owner, what are the potential penalties for me if I fail to properly classify someone?
If you treat someone as a contractor when they are properly classifiable as an employee, there are a number of consequences (most of which are expensive):
- Taxation – if you have failed to withhold PAYG for a worker, the Commissioner of Taxation has strong powers to seek recovery of the amount that should have been withheld and remitted. The Commissioner must first notify you in writing of their reasonable estimate of the amount that should have been remitted, and can then commence recovery proceedings. You will also be charged interest on the amounts that should have been remitted.
- Superannuation – you will have to pay any unpaid SGC for a worker that ought to have been classified as an employee. There will also be interest and penalties imposed.
- Pay and leave entitlements – you will be liable to pay the worker an amount equal to what they would have received under the NES or the relevant modern award, including back pay for leave entitlements that would ordinarily have accrued during the period of employment.
- Workers compensation – if you fail to register for the relevant state workers’ compensation scheme, their can be significant financial penalties per worker. For late payment of premiums you may also be subject to significant fines as well as interest charges.
- Payroll tax – any payroll tax liability that would have otherwise been incurred will be payable, together with any interest and penalties assessed.
- Fair Work prosecution – Fair Work Inspectors can seek the imposition of penalties for sham contracting arrangements. You could also be exposed to unfair dismissal claims through the Fair Work Tribunal.
The information contained in this post is current at the date of editing – 28 September 2023.
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