Difference Between Employees and Contractors

September 12, 2013

Attention Business Owners – Do You Know Who Your Employees Are?
Do you know who your employees are?  The ATO certainly believe that many businesses don’t, as they believe that many businesses are wrongly treating their employees as contractors.  So what’s wrong with this?  The answer is lots of things.  A business who engages an employee is required to meet Pay As You Go Withholding obligations, Superannuation Guarantee obligations and Fringe Benefits Tax obligations.  These obligations do not generally apply if you engage a contractor (although a business will have to pay superannuation for a contractor under a contract that is wholly or principally for the labour of the person).    Penalties, interest and charges may apply if you fail to meet these obligations by wrongly classifying your employees as contractors.  In this article we examine some of the key differences between an employee and contractor as identified by the ATO.

An employee works in your business and is a part of your business.  Some of the key characteristics of an employee are:

The employee cannot subcontract the work.

The worker is paid for the time worked, a price per item or activity, or a commission.

Your business provides all or most of the tools.  If the employees have to provide for tools, they are generally reimbursed by the employer.

Your business is liable for any defective work done by the employee.

Your business has control over the work and can direct the employee how to perform the work.

The employee is not working independently and is considered part of your business.

A contractor is running their own business and provides services to your business.  Some of the key characteristics of a contractor are:

The contractor can subcontract the work.

The contractor is paid for a achieving a result based on the quote they provided.

The contractor has to supply their own tools.

The contractor is legally responsible for their work and is required to rectify any defects in their work.

The contractor has freedom in the way the work is done subject to the terms of the contract.

The contractor is working independently from your business and is free to accept or refuse additional work.

Some Common Myths
The ATO has recently released a publication entitled Common myths about the employee / contractor decision.  In the publication they share some of the facts which have been wrongly relied upon by businesses to classify an employee as a contractor.  The ATO emphasise that the classification of a worker as an employee or contractor is dependent on the working arrangement as a whole and the specific terms and conditions under which the work is performed.

The myths which should NOT be used to determine the correct classification of a worker is summarised below:

Having an ABN or Business Name – This does not automatically mean a worker is a contractor.

Common industry practice – Just because everyone in the industry uses contractors does not necessarily mean that they correctly classified a worker as a contractor.  Likewise, just because your business has always used contractors in the past does not necessarily mean that the new worker is a contractor.

Short term work – the length of a job makes no difference to whether a worker is an employee or contractor.

80% rule – Just because a worker spends less than 80% of their time working for one business does not necessarily make them a contractor.  The 80% rule relates to the personal services income rules and how a contractor reports their income and expenses in their tax return.  It does not make someone a contractor or employee.

Contracting on different jobs – A worker who is treated as a contractor for one job may not necessarily be a contractor for all jobs.

Paying super – A business cannot decide to treat a worker as a contractor if their actual working arrangement is indicative of an employment relationship.  Additionally, businesses are required to pay super for their contractors where the contract is wholly or principally for the labour of the person.

Worker wants to be contractor – whether a worker is a contractor or employee is not a matter of choice, but instead is dependent on the working arrangement under which the work is done.  A contract which specifies the worker to be a contractor will not necessarily make him a contractor if the actual working arrangement is indicative of an employment relationship.

Using invoices – submitting an invoice does not change an employee into a contractor.