When hiring workers, it is critical to classify if a worker is an employee or contractor. If an employer classifies them incorrectly, they may face fines and penalties. However, classifying workers is not as simple as one may think as there are multiple factors to consider when determining whether a worker should be classified as an employee or as a contractor. An employer should learn the difference between the two and determine which type of employment arrangement is the best for their business.
What is the difference between an employee and a contractor?
An employee is defined as an individual who works under the supervision of an employer as a representative of their business receiving in return wages or other remuneration. While an employee might have some freedom such as flexible hours, the employer has the right to manage and direct them.
On the other hand, a contractor is defined as an individual who provides services to a business and who is not an employee of that business. They are the ones who make their own work arrangements and run their own business. Even though the employer specifies the results of their work, they have more control over how the work is done.
What are the factors to consider in determining whether a worker is an employee or a contractor?
If a worker is engaged just for their labour, then they are considered an employee rather than a contractor, from a tax point of view.
This may sound simple, but it quickly becomes quite complicated. Although some people may believe that having an ABN is sufficient to classify someone as a contractor, the table below shows that there is much more to it than that.
Here is a summary of contractor vs employee differences:
|Control over how work is performed
|Performs work under the control of their employer. The work is being controlled by the employer including hours, work location and how work is done.
|Has a high level of control over the work they perform, including their hours, work location and how they do the work.
|Usually works exclusively for the employer.
|Free to provide services to multiple clients.
|Faces no commercial or financial risk over their work as the employer is the one who bears the responsibility. Employers also have the obligations regarding the safety of their employees and will be responsible if there will be any injury that occurs during the course of their employment.
|Assume the risk of making and losing money as they will be responsible for any liability and defects that is why it is common for contractors to have their own insurance policies.
|Tools and equipment
|Generally, performs work using tools and equipment provided by the employer (at employer’s place of work). An employee is generally reimbursed for expenses personally incurred by them to perform their work (as long as they are authorised by their employer).
|Typically provides their own tools and equipment and they are not usually reimbursed for expenses they incur in providing the services.
|Ability to delegate or subcontract work
|Personally engaged to perform the work and has no right to delegate or subcontract the work to another person unless authorised by the employer.
|Can delegate all or some of the tasks to another person and may employ other persons to perform the work (although this can be subject to the agreement with the employer).
|Hours of work
|Generally has a standard or set hours which are determined by the employer. It also applies to casuals even though their hours tend to vary every week.
|Can set their own hour of work as long as they are able to perform the task. An agreement may deem a certain amount of hours’ worth of work be completed but it is entirely at the discretion of the contractor for when these hours will take place.
|Status of Business
|Part of the business and is working in the employer’s business.
|Own and run their own business and their services are different from the employer’s business. The work performed is specified by a contract and it’s up to them to accept or reject additional work.
|Expectation of work
|Can expect regular and systematic work.
|Usually hired for specific tasks and will not generally engage them for further work beyond this.
|Method of Engagement
|Normally engaged personally through an interview process.
|Can be engaged through a trust, partnership or company.
|Entitled to have super contributions paid by their employer into their nominated super fund.
|Pays their own super but in some circumstances, contractors may be entitled to be paid super contributions (see below for more information).
|Withholding tax (PAYGW) deducted by their employer and then the latter remit it to the Australian Tax Office (ATO).
|Pays their own tax to the Australian Tax Office (ATO).
|Entitled to annual leave, long service leave and sick leave and this is usually provided by a written contract.
|Not entitled to leave and a written contractor agreement would not usually provide for these things.
|Method of Payment
|Paid on a regular basis such as weekly, fortnightly, or monthly. They are paid for the time worked, a price per item or activity and commission.
|Will invoice the employer for work completed or is paid once the agreed work is finished. The amount that will be paid is determined by the result achieved as per the quote provided that is calculated based on an hourly rate or price per item.
The employer must pay superannuation for contractors who are deemed to be employees for superannuation purposes in some circumstances such as:
- If the worker works under a contract that is wholly or principally for their labour.
- If the worker performs work that is wholly or principally of a domestic nature for more than 30 hours per week.
- A sportsperson, artist or entertainer who is paid to perform, present, or participate in any music, play, dance, entertainment, sport, display or promotional activity, or similar activity.
- A person paid to provide services in connection with any performance, presentation, or participation in these activities.
- A person who is paid to perform services related to the making of a film, tape, disc, television, or radio broadcast.
What will happen if an employer misclassifies an employee as contractor?
It is critical for an employer to not misclassify a worker because there are differences between the entitlements an employer owes to employee versus contractor. Penalties and charges will apply if you misclassify an employee as a contractor.
Penalties and charges include:
- Penalties for failing to meet the PAYG withholding requirements.
- A super guarantee charge – which includes of super guarantee shortfall amounts (the amount of super contributions that should have been paid into a complying super fund), interest charges and administration fee.
- Additional fines up to twice the amount of the super charge
What is Sham Contracting?
Sometimes an employer may tell a worker that they are an independent contractor, when in fact they are an employee of the business. If the employer knew that the worker was an employee, there may be a sham contracting arrangement.
A sham contracting arrangement is when an employer attempts to disguise an employment relationship as a contractor relationship. They may do this to avoid certain taxes and their responsibility for employee entitlements like superannuation and leaves.
Sham contracting is prohibited under the Fair Work Act 2009 and if the employer is found to have engaged in sham contracting, they will be required to compensate the employee for any unpaid entitlements plus interest.
What is the difference between an employment contract and a contractor agreement?
An employment contract is a contact between an employer and an employee that sets out the terms and conditions of the employment arrangement. This may be written, verbal, or a combination of the two. It is highly recommended that a written agreement is made in order to specify all the obligations of the employer.
On the other hand, a contractor’s agreement is a contract between a company or employer and the contractor who provides the service. This agreement sets out the services to be provided, the price for the services, dates, or timelines for the provision of the services and any other conditions or obligations between the employer and the contractor.
What are the pros and cons of hiring an employee vs a contractor?
Some employers may choose to hire a full-time employee for stability and availability while others may choose to hire a contractor due to flexibility and specialty. If an employer is unsure about which is the better option, the below pros and cons may help to decide which is more beneficial to the business.
Pros of hiring an employee
- An employer can build a consistent team to work on projects when needed. It means that the employer does not have to continuously negotiate contracts with new talent and think about if they have the capabilities to complete the tasks that the employer hired them for.
- Employees can be treated as long term investments because as the employer spend money on training them and developing their skill sets, they will understand the process within the company, and they will be more willing to put in extra effort which can be beneficial on the business in the long run.
- Since an employer has more control over an employee, they can adjust an employee’s workload that best fit the needs of their business.
Cons of hiring an employee
- It can be more expensive to have an employee as a worker for the business as the employer needs to invest in their staff, and this cost can quickly add up, especially if they need to purchase specialised equipment and tools.
- It is always possible that an employer may hire someone that is not fit for the business. This may cause issues within the business that are hard and may take some time to be fixed.
Pros of hiring a contractor
- It might be that the cost per hour is higher but the overall costs of hiring a contractor may work out to save you money because unlike an employee, an employer does not need to consider things like providing training, annual and personal leave, and purchasing the required tools and equipment.
- Some businesses may need the flexibility to hire more workers during a busier period and this is where independent contractors can help ease the load.
- The employer does not have to be as involved with the management process as the employer can just give the contractor a briefing and then let them get on with the job at hand. This saves them a lot of time to get on with other aspects of running their business.
Cons of hiring a contractor
- A contractor can sometimes be working for multiple clients at the same time, so there is not always going to be the same kind of loyalty that an employer would experience with an employee.
- Contractors have more flexibility when it comes to the hours they work, what jobs they accept/reject. This can sometimes make it difficult when it comes to communications and managing projects.
In determining whether to hire a contractor or an employee, it can be a crucial decision for the business to make as both have their pros and cons. Whether an employer decides to hire a contractor or an employee, it will be best if they hire someone that will be valuable and beneficial to their business.
This article is for general information only. It does not make recommendations nor does it provide advice to address your personal circumstances. To make an informed decision, always contact a registered tax professional.