Businesses need clear systems to determine whether workers are employees or independent contractors. Tax, superannuation and other government obligations differ depending on the type of working arrangement.
Employees generally have PAYG withholding, superannuation and fringe benefits tax obligations managed by their employer. Contractors generally manage their own tax obligations.
If you incorrectly classify a worker and fail to meet your obligations, you may face penalties, charges and additional costs.
What Factors Determine Whether a Worker Is an Employee or Contractor?
Several factors can help determine whether a worker is an employee or an independent contractor.
No single factor determines the correct classification. Instead, you need to consider the entire working arrangement and the relationship between the parties.
A worker is not automatically a contractor because they have an ABN, specialist skills or only work during busy periods.
When determining whether someone is an employee or contractor, courts will consider the overall relationship between the parties.
The Fair Work Ombudsman provides a table of common indicators that may help determine whether a person is an employee or independent contractor:
| Indicator | Employee | Independent Contractor |
| Degree of control over how work is performed | Works under the direction and control of their employer on an ongoing basis. | Has a high level of control over how the work is completed. |
| Hours of work | Generally works standard or set hours (although casual employees may have varying hours). | Agrees on the hours required to complete a specific task. |
| Expectation of work | Usually has an ongoing expectation of work, although some employees may work for a specific task or period. | Usually works on a specific task or project. |
| Risk | Does not carry financial risk because the employer takes responsibility. | Carries the risk of making a profit or loss and is usually responsible for poor work or injuries. Contractors generally hold their own insurance. |
| Superannuation | Receives superannuation contributions from their employer into a nominated superannuation fund. | Generally pays their own superannuation, although some contractors may qualify for superannuation contributions in certain circumstances. |
| Tools and equipment | The employer generally provides tools and equipment or provides a tool allowance. | Uses their own tools and equipment, unless the contract states otherwise. |
| Tax | The employer deducts income tax from their pay. | Manages their own tax and GST obligations with the Australian Taxation Office. |
| Method of payment | Receives regular payments, such as weekly, fortnightly or monthly wages. | Usually submits invoices for completed work or receives payment at the end of a contract or project. |
| Leave | Receives paid leave entitlements, such as annual leave, personal leave and long service leave, or receives casual loading instead of leave. | Does not receive paid leave entitlements. |
A Simple Way to Tell the Difference
The Australian Taxation Office uses the following simple descriptions:
- Employees work in your business and form part of your business.
- Contractors operate their own business and provide services to your business.
Why Does the Distinction Matter?
Employment relationships are governed by workplace laws, awards and employment agreements. These rules generally provide employees with greater protections than the commercial laws that apply to contractors.
Employee protections include minimum workplace conditions such as:
- Leave entitlements
- Public holiday entitlements
- Notice of termination
- Redundancy pay
Adopt Good Business Processes
Business owners should keep records explaining why they classified a worker as an employee or contractor and the factors they considered when making that decision.
The relevant information should appear in the appropriate agreement, such as a service contract for contractors or an employment contract for employees. These documents should accurately reflect the actual working arrangement.
All contracts should:
- Be in writing
- Specify whether the agreement is a contract for services or an employment contract
- Set out the engagement period and remuneration
- Include dispute resolution provisions
- Explain how the relationship can be terminated
Penalties
Employers must not misrepresent an employment relationship as an independent contracting arrangement. It is also unlawful to knowingly provide false information to influence an employee to become a contractor.
Under the Fair Work Act, inspectors can:
- Seek penalties for breaches involving sham contracting arrangements.
- Apply to courts for an injunction where an employer attempts to dismiss an employee to engage them as an independent contractor. Courts may also order reinstatement or compensation.
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