Employee or contractor? What’s the difference?

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 an Employee or contractor decision tool on its website.

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.

 

Dennis Barnett, Partner, AFS & Associates

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 Dennis Barnett, Business Services Partner a call today on 03 5443 0344.