Correctly working out whether you are hiring an employee or simply engaging an independent contractor isn’t always straightforward and getting it wrong can be costly.

Employers need to ensure their working arrangements are correct as some industries are seeing a rise in claims by former contractors seeking compensation for not being paid their full entitlements as an ‘employee’.

What’s the distinction?

A key difference is an employee works in the business and is part of it, while independent contractors and subcontractors run their own businesses and are only supplying a service. They can choose their own hours of work and must pay for their own insurance, sick leave, holidays and super contributions.

Before bringing any new worker or contractor on board, always check whether the working arrangement is legally deemed to be employment or a contract. To help you decide, the Australian Tax Office (ATO) has resources on its website.

Common law test

The common law test for determining whether a relationship is one of independent contract or employment is known as the ‘multi-factor’ test. This involves identifying and weighing up various features of the relationship to see where the balance lies. This table extracts some common features that courts have considered:

Feature	Employee	Independent contractor
Measure of control exercised by the principal/employer	Employer usually has the right to control how, when and where a worker performs their duties. Tasks are usually performed at request of employer.	Contractor works at own initiative to achieve a stated result. Contractor maintains discretion and flexibility as to how work is completed, although contract may specify some terms as to materials used and methods of performance.
Exclusivity	Employee usually works exclusively for employer.	Contractor is free to provide services to multiple clients
Right to delegate	Employee is personally engaged to perform the role and has no inherent right to delegate performance of the role to another employee, unless authorised by employer.	Contractor may delegate all, or some, tasks to another person and may employ other persons to perform the services (although this may be subject to the principal’s consent).
Risk, rectification of faults	Employee bears little or no responsibility to rectify poor work. Employer is responsible to others for poor work of employee.	Contractor must rectify poor work at own cost and effort and bears commercial risk of loss incurred by principal due to contractor’s poor work.
Tools and equipment	Employee generally performs work using tools and equipment provided by employer, at employer’s place of work. Employee is generally reimbursed for expenses personally incurred by them in performing work, as long as they are authorised by the employer.	Contractor generally provides their own tools and equipment. Contractors are not usually reimbursed for expenses they incur in providing the services.
Hours of work	Employee has hours of work set by employer.	Contractor can set their own hours of work, as long as they perform the services.
Leave entitlements	Employee is entitled to annual leave, long service leave and sick leave, and this is usually provided for in written contract.	Contractor is not entitled to leave, and a written contractor agreement would not usually provide for these things.
Payment	Employee is generally paid for their time, e.g. hourly, weekly, annual salary	Contractor is generally paid for providing services or completing units of work. Contractor usually issues tax invoices.
Method of engagement	Employees are always personally engaged.	If an individual is engaged through a trust, partnership or company, this usually indicates a contractor relationship.
Part of the business	The work of an employee is usually essential to the business carried on by the employer. Employee is working in the business of the employer.	Contractor carries on their own business, independently of the employer and as distinct from the employer’s business.

Source: https://www.cpaaustralia.com.au/-/media/project/cpa/corporate/documents/achivies/deciding-between-an-employee-or-contractor.pdf

Myths about contractors

There are many misconceptions about hiring an independent contractor, according to the ATO.

• Having an Australian Business Number (ABN) or a registered business name
  A common myth is that this automatically makes a person a contractor. In fact, having an ABN or being paid after submitting an invoice makes no difference to whether an employment arrangement is a contract or employment.
• The length of a job 
  Another widespread myth is that the length of a job, or how regular the work is, determines whether someone is an employee or a contractor. Both employees and contractors can be used for casual, temporary, on call or infrequent work.
• The percentage of annual income paid
  Businesses sometimes think if they pay less than 80% of an employee’s annual income they’re not their employer. This ‘80% rule’ is only relevant for the ATO’s assessment of personal services income (PSI) and whether or not a contractor can claim business tax deductions.
• Personal preference Legally, it’s not a matter of choice as employment status is determined by the working arrangement and specific terms and conditions of the job. Signing a work contract stating an individual is a contractor does not override the true employment relationship and relevant legislation. It also doesn’t remove Pay-As-You-Go tax withholding and super obligations.

Dangers of ‘sham contracting’

Sham contracts are usually offered by employers trying to disguise an employment relationship as a contract to avoid paying the required employee entitlements.

Both the ATO and Fair Work Ombudsman can impose significant penalties if they determine the worker is an employee. Businesses also run the risk that they will have to foot the bill for back pay to cover the employee’s unpaid leave and employment entitlements.

Protecting your employment rights

It’s also in the interests of employees and individual contractors to check their work status is correct. Otherwise they risk missing out on significant financial benefits and the employment protections they are entitled to.

Under current legislation, it is illegal for employers to misrepresent a current or proposed employment relationship as an independent contracting arrangement, or to dismiss or threaten to dismiss an employee so they can be re-hired as a contractor. It is also illegal to make misleading statements to an employee to try to persuade them to take on a contract arrangement for similar work they performed as an employee.

Employees and contractors can request assistance from the Fair Work Ombudsman if they believe their rights have been breached.

Individual contractor and superannuation

If a contractor operates as a sole trader structure, they may be eligible for superannuation if:

• The individual works under a contract that is wholly or principally for their labour or personal skills
• The individual must perform the contractual work personally (there is no right of delegation)
• The individual is not paid to achieve a result.

If you would like to discuss your employment status, or to check whether you are meeting all of your tax and superannuation obligations for someone who works for you, give AFS a call today on 03 5443 0344.