What’s the difference between an employee and a contractor, and why does it matter?

Nobody expects you, an employer, to be an expert in tax laws. That’s why we’re here to help! However, your legal and tax responsibilities to your employees are very different from your obligations to your contractors. The penalties for wrongly classifying employees as contractors can be severe (e.g. unfair dismissal claims, Australian Taxation Office penalties on employers/directors, Fair Work Act penalties and more). So it’s vital that you:

  1. Understand the basic differences between an employee and a contractor; and
  2. Correctly classify all your workers as employees or contractors.

Note these two key Australian Taxation Office (ATO) comments:

“An independent contractor typically contracts to achieve a result, whereas an employee contracts to provide their labour (typically to enable the employer to achieve a result).”

“A key factor in deciding if a worker is an employee is the degree of control that can be exercised over the worker. If the payer has the right to direct how, when, where and who is to perform the work, the worker is likely to be an employee. These directions may be verbal or in writing, or simply understood between the parties.”

There are other key factors to consider in establishing if a worker is an employee or a contractor. This issue can be complex, so if you’re in doubt about any of your staff, we strongly recommend you speak to your professional adviser.

5 Common Misconceptions

  1. “I pay my worker’s family trust/company for their work, so she can’t be an employee.”

No, if your work agreement is with an individual worker, and you pay their family trust/company for their employment services, then the payment would be viewed as a mere redirection of their salary/wages. Take care when answering the ATO employee/contractor decision tool. You need to know accurately if you have entered into an agreement with an individual, or with a trust or company or partnership.

  1. “My worker and I have signed a detailed legal ‘contractor’s agreement’, so he must be a contractor.”

False. You cannot change the true substance of the work relationship by giving it a different label. All the terms of an agreement, and the actual reality of work performed, need to be considered.

  1. “My worker gives me her ABN and a weekly invoice, so she must be a contractor. “

Not necessarily. Many employees have an ABN, which may relate to their separate business activity. If a worker has an ABN, this does not automatically mean that they are a contractor in relation to the work they do for you. You still need to consider the above key factors as discussed in the above ATO decision tool.

  1. “I only have to pay super contributions for my employees, not my contractors.”

Be careful. You need to pay the required super contributions for all individual contractors employed under a contract that is wholly or principally for the contractor’s labour, even if they quote an ABN.

  1. “My worker and I agree that he’ll be a contractor, so I’m not at risk.”

Not always the case. Not only are you at risk if your employee changes their mind but, more importantly, you’re still at risk of a review or audit from the ATO, Fair Work Australia, and other government agencies. Even though the employer payroll obligations for employees can be quite heavy, it’s always far better and safer to correctly identify all employees from the beginning of their employment.

See our infographic for a summary of the key differences between employees and contractors. With employers providing increased flexibility at workplaces and more employees being able to work from home and perform freelance work on the side, the line between employee and contractor is becoming increasingly blurred so it can be difficult to establish what category your staff fall into. As always, seek professional advice if you have any concerns.