WHETHER YOU are working for someone or running a business it is crucial to establish who is a contractor and who is an employee. Ursula Hogben, co-founder and Managing Director of LegalVision, discusses the topical issue of staff contracting arrangements.
ARE YOU hiring new staff or checking your current staff arrangements? If so, congratulations on the growth in your business and your attention to the relevant law.
It is crucial to establish whether a worker is a contractor or an employee. Why? Your tax, superannuation and other government obligations vary depending on the answer.
It’s illegal to incorrectly characterise an employee as a contractor, due to taxation and superannuation requirements. Just because a worker is engaged as a contractor (reasonably common in real estate), does not mean
that they will be treated by law as one.
RISKS TO AVOID
Businesses that fail to recognise this important distinction are at risk of being penalised. These penalties may include:
- A monetary penalty for failing to meet PAYG withholding requirements
- A super guarantee charge for failing to make the correct superannuation contributions, which consists of the shortfall (up-to-date payments), the interest on the shortfall, and an administrative fee.
For example, you may hire someone as a contractor, at $50 an hour, for 35 hours per week for six months. If they are actually an employee by law, then you may be required to pay the minimum superannuation guarantee of 9.5 per cent, in addition to the contracting fee that you have paid. This would be over $4,000, plus interest, penalties and fees.
THE ATO TEST
When engaging a new worker, you need to check whether they are an employee or a contractor before entering into the agreement. An employee typically works as part of a larger organisation. A contractor is running their own business under their own Australian Business Number.
Once you’ve decided their employment status, you need to keep records to support your decision and the factors you relied on.
WHAT ARE THE KEY DIFFERENCES BETWEEN AN EMPLOYEE AND A CONTRACTOR?
- ABILITY TO SUB-CONTRACT OR DELEGATE
Employees are not allowed to sub-contract or delegate their work and cannot pay someone else to do their work for them. Contractors are allowed to delegate or sub-contract and pay someone else to do the work.
- BASIS OF PAYMENT
Employees are paid in salaries, hourly rates and/or on commission-based structures. Contractors have varying arrangements, including to be paid once they have completed a piece of work.
In an employer-employee relationship, the employer usually pays for the business equipment. Contractors usually provide and maintain their own equipment and tools.
Employees are generally not at commercial risk while employed, as the employer has legal responsibility for the actions of its employees while at work. Contractors, however, are responsible for their own conduct and the commercial risks of the work.
- CONTROL OVER WORK
Employers are expected to give employees direction in terms of the type of work that is required and how the work is performed. Contractors are able to perform the work as they choose, provided they adhere to the terms and conditions of the agreement.
An employee and employer are working for the same business and the same goals. Contractors are running their own business, independent of the hirer. They can elect whether or not they will do extra work (depending on the terms of the contract) and are allowed to enter contracts with a third party.
WHAT IS THE DIFFERENCE BETWEEN AN EMPLOYMENT CONTRACT AND A CONTRACTOR’S CONTRACT?
An employment contract is an agreement between employer and employee, and establishes the terms and conditions of the employment. It can be verbal or written. A contractor’s contract is an agreement between a company (known as the ‘principal’) and a service entity (known as the ‘contractor’).
The agreements address the different legal requirements of the employee or contractor relationship, including:
- Term and payment
- Insurance, taxation, superannuation and reporting
- Subcontracting, exclusivity and restraint and termination provisions.
WHAT ARE THE DIFFERENT TAX REQUIREMENTS?
Employers are required by the Australian Tax Office (ATO) to make compulsory superannuation guarantee contributions to the employee’s chosen superannuation fund, or the employer’s fund. On top of this, employers are required to withhold Pay As You Go (PAYG) tax from any income paid out to employees.
The taxation obligations are different for contractors. Unlike employers, they are responsible for organising their own taxation and superannuation. Employers are generally not required to make tax deductions from any amount that the contractors have been paid.
The ATO test on who is an employee or a contractor is strict. Even if you employ someone as a contractor, the ATO can rule that the worker is actually an employee, and require you to pay superannuation penalties and fines. We recommend taking the test on the ATO website, and checking that your legal contracts correctly reflect the contractor or employee arrangement.
To determine whether your worker is an employee or contractor, use the ATO online tool available at https://www.ato.gov.au/Calculators-and-tools/Employee-or-contractor.