“Is a worker a contractor or employee?”
This is one of the most common questions asked by employers. And it’s one you need to get right for payroll tax and obligation purposes. Otherwise, misclassifying workers can leave you liable for employment taxes, and you may get hit with costly penalties.
In this post, we’ll discuss the key differences between contractors and employees, so you get it right 100% of the time.
To give you an idea of how costly incorrect reporting can be, let’s look to a 2017 example.
“Recently, the Federal Circuit Court of Australia found that an employer had failed to correctly treat a contractor as an employee,” writes accounting firm Crowe Horwath Australasia. “The employee, therefore, did not receive his correct rate of pay and accrued leave payments and superannuation amounting to over $230,000, plus fines and penalties.”
This is one of the more extreme cases of what can happen when misclassifying. Granted, it took place over the course of 20 years. But it shows the trouble employers can get into.
Even with the best of intentions, it can put a huge financial strain on your business and even hurt your reputation.
Factors That Differentiate Between Contractors And Employees
There’s no single factor that determines how a person is classified. Instead, there are a variety of factors that decide whether they’re a contractor or employee.
Here’s are some specific ones to look at.
Level Of Overall Control
One of the main factors to consider is how much control a person has over the tasks they perform.
A contractor has a high level of control and does much of the decision-making. They may decide the direction of a project, how to best utilise resources and have a say in the deadlines.
An employee has far less control. They’re under the direction of the employer and won’t be key decision-makers. The employer will usually control an employee’s day-to-day tasks, when the employee is paid and the medium in which they’re paid.
The amount of independence varies as well.
When an employee works for a company, they do not operate independently. They’re employed by the company and work within it. In other words, an employee isn’t a separate entity.
A relationship with a contractor differs because they do operate independently. The contractor is essentially running their own business, and therefore, is a separate entity. As a result, they’re able to pick and choose the projects they participate in.
In other words, a contractor has much more freedom than an employee does.
In a standard employer-employee relationship, a worker will typically have set hours. For example, they may work 9 to 5, Monday through Friday. Although some employers offer flexible scheduling and telecommuting options, there’s a predictable schedule, where an employee is responsible for sticking to.
A contractor, on the other hand, can usually choose the hours they work. They decide the days they want to work, the specific time they want to work, how many hours they work, and so on. It doesn’t really matter as long as deadlines are met.
Duration Of Work
In most cases, an employee is hired on permanently with the expectation of ongoing work. Although some positions under labour hire are only temporary or temp-to-hire, most working arrangements are indefinite.
But this isn’t always the case with contractors. These workers may be brought on to complete one specific project and that’s it. There’s no guarantee that the relationship will continue once a particular project is over, making it more temporal in nature.
Access To Supplies And Equipment
The employer will usually provide an employee with supplies and equipment to complete tasks. For example, they may receive a laptop and mobile device to use while in the workplace.
Other times, the employer won’t directly provide the supplies and equipment but will instead offer an allowance to pay for it. The bottom line is the employer is responsible for supplying the necessary tools for an employee to perform their tasks.
But this isn’t usually the case when it comes to contractors. The employer isn’t required to provide them with supplies and equipment. Instead, they’ll be responsible for obtaining and maintaining their own items.
In the case of laptop and mobile device, a contractor would need to purchase these items themselves.
Basis of payment is another major differentiating factor.
There’s a set payment amount per period with an employee, where they earn money for 1of the 3:
The amount of time they worked (e.g. 40 hours per week)
The amount per period (e.g. a weekly or monthly rate)
On a commission basis (e.g. the number of products they sell within a given period)
A contractor is paid by delivering the results based on a quote they provided. For instance, they may be paid for completing a particular project. Quotes are usually given by calculating hourly rates or on a price per item basis.
A contractor will have an Australian Business Number (ABN) and submit an invoice to the company.
Option To Subcontract
An employee doesn’t have the option of subcontracting tasks to another party. They’re not allowed to pay another person to complete a task under this working arrangement.
A contractor, however, does have the option of subcontracting. They’re allowed to delegate tasks and can pay another person to do it for them.
Income And GST
An employee has their income tax deducted by their employer. They’re not directly responsible for keeping up with how much they’ve earned, how much they owe, and so on. The employer assumes responsibility for that.
Working as a contractor comes with more responsibility from a tax standpoint. A contractor must keep up with how much they’ve earned, how much they owe and pay their own income and goods and services (GST) tax.
Say that a task wasn’t properly completed or didn’t meet an employer’s expectations.
An employee wouldn’t assume any financial risk and would still be paid regardless. Their employer is the one ultimately responsible.
However, a contractor assumes responsibility for earning a profit and taking a loss for any task they complete. Whenever, there’s poor work on their end, there’s no guarantee they’ll be paid. They may also need to obtain their own insurance because of this risk.
Full-time employees are often entitled to certain benefits that contractors are not.
“Unlike full-time employment, the fee of a contractor will not include employee insurance, holiday pay, sick leave, equipment, office space or employee benefits,” Robert Half International writes.
If a worker receives benefits, they’re likely an employee rather than a contractor.
There’s a lot that goes into determining whether a worker should be classified as a contractor or an employee.
Here’s a quick summary for clarification:
- Contractors have a lot of control with their working arrangement.
- Employees have minimal control, and their employer does most of the decision-making.
- Contractors aren’t directly employed by a business and work independently.
- Employees are directly employed by a business and don’t work independently.
- Employees have set hours.
- Contractors don’t have set hours and are deadline oriented.
- Employees operate on the basis of ongoing work.
- Contractors work on a per project basis without the guarantee of ongoing work.
- An employer provides employees with supplies and equipment.
- An employer isn’t responsible for providing contractors with supplies and equipment, and the contractor must purchase these items.
- Employees earn a set amount of money per period.
- Contractors operate on a price per item basis.
- Contractors are allowed to subcontract and pay other people to complete tasks.
- Employees aren’t allowed to subcontract.
- An employer is responsible for employee tax deductions.
- An employer isn’t responsible for contractor tax deductions, and the contractor must handle this themselves.
The Employee/contractor Decision Tool
Still a little confused?
There’s a simple way to determine whether someone is an employee or contractor. Just use the employee/contractor decision tool from the Australian Taxation Office.
Here’s how it works.
Simply click on the fields that best describe a worker.
Fill in all fields, and click on “Show result” at the bottom.
This will let you know whether they’re a contractor or an employee, as well as provide you with information on your obligations like superannuation, pay as you go (PAYG) withholding and fringe benefits tax (FBT).
Getting It Right
There are numerous factors that differentiate contractors from employees. So it’s understandably a little confusing for some employers.
But you need to get it right.
Understanding the key differences between the two and using the Australian Taxation Office’s free tool should help you know for sure. This ensures all workers are correctly classified, which can spare you some major headaches in the long run.
Based on this information, are the majority of your workers employees or contractors? Feel free to get in touch here and discuss how our solutions might help with managing funding for your headcount. Or call us on 1300 207 345 today.