Do you run a business and have or are thinking about hiring workers? If so, it’s important to understand the difference between contractors and employees, as you have different tax and superannuation responsibilities depending on the status of the worker.

What’s the difference between contractors and employees?

Generally speaking, an employee works in your business and is part of your business. A contractor is a person who is typically running their own business and the business engaging their services has little direction or control in respect of how that service is supplied.

The table below provides six key factors that determine whether a worker is an employee or contractor for tax and superannuation purposes.

Factor If worker is an employee If worker is a contractor
1. Ability to subcontract/delegate The worker can’t subcontract/delegate the work – they can’t pay someone else to do the work. They must do the work themselves. The worker can subcontract/delegate the work – they can pay someone else to do the work.
2. Basis of payment The worker is paid either:

  • For the time worked
  • A price per item or activity
  • A commission.
The worker is paid for a result achieved based on the quote they provided.

A quote can be calculated using hourly rates or price per item to work out the total cost of the work.

3. Equipment, tools and other assets
  • Your business provides all or most of the equipment, tools and other assets required to complete the work, or
  • The worker provides all or most of the equipment, tools and other assets required to complete the work, but your business provides them with an allowance or reimburses them for the cost of the equipment, tools and other assets.
  • The worker provides all or most of the equipment, tools and other assets required to complete the work
  • The worker does not receive an allowance or reimbursement for the cost of this equipment, tools and other assets.
4. Commercial risks The worker takes no commercial risks. Your business is legally responsible for the work done by the worker and liable for the cost of rectifying any defect in the work. The worker takes commercial risks, with the worker being legally responsible for their work and liable for the cost of rectifying any defect in their work.
5. Control over the work Your business has the right to direct the way in which the worker does their work. The worker has freedom in the way the work is done, subject to the specific terms in any contract or agreement.
6. Independence The worker is not operating independently of your business. They work within and are considered part of your business. The worker is operating their own business independently of your business. The worker performs services as specified in their contract or agreement and is free to accept or refuse additional work.

 

Your tax and super obligations

Your tax, superannuation and other obligations will vary depending on whether your worker is an employee or contractor. The table below summarises the key considerations.

 Tax/Obligation If worker is an employee If worker is a contractor
Income You’ll need to withhold tax (PAYG withholding) from their wages and report and pay the withheld amounts to the ATO. Contractors generally look after their own tax obligations, so you don’t have to withhold from payments to them unless they don’t quote their ABN to you, or you have a voluntary agreement with them to withhold tax from their payments.
Superannuation You’ll need to pay superannuation, at least quarterly, for eligible employees. You may still have to pay superannuation for individual contractors if the contract is wholly or principally for their labour.
Fringe benefits tax (FBT) You’ll need to report and pay FBT if you provide your employee with fringe benefits. You’ll need to report and pay FBT if you provide your employee with fringe benefits.

The High Court’s new employee/contractor test

The High Court has delivered several decisions which confirm that when determining whether a person is an employee or contractor, it is necessary to look to the legal rights and obligations agreed under the relevant contract, rather than what happened in the working relationship as it unfolded.

This is in contrast to the previous practice adopted by courts and tribunals whereby the actual circumstances of how the arrangement played out in real life (on the facts, not the contract terms) was decisive. In other words, the written agreement (the contract) will determine the nature of the relationship, rather than examining the subjective circumstances. This is unless the contract is a sham and does not reflect the circumstances of the arrangement.

Review your contracts with your workers

It is important that business owners understand the difference between employees and contractors. Businesses should review their written contracts with employees and contractors to ensure that the contracts correctly give effect to the arrangement the parties understood was being entered into when the contract was formed. If you have any questions or would like to discuss the content of this article further, please contact us.

 

Content in partnership with Tax & Super Australia.