Is Your Worker an Employee or Contractor?
There are many factors involved in deciding whether a worker is an employee or contractor. It’s vital to get the classification right so you can rest easy knowing that you won’t be penalised by the ATO or the Fair Work Ombudsman.
- Do you know the differences between contractors and employees and your obligations as a business owner?
- Do you know what kinds of risks you expose yourself to if you misclassify a worker as a contractor when they’re actually an employee?
- Do you have written agreements with all workers?
At On The Money Bookkeeping Melbourne, we work closely with business owners to ensure your payroll is accurate and compliant. Our payroll services can assist in classifying workers correctly and setting up your Xero bookkeeping and payroll to pay employees and contractors correctly.
Key Differences Between a Contractor and an Employee
No single principle will decide whether your employee is a contractor or an employee. Instead, it’s a multi-factor test. You need to consider the situation with each worker. The tests are based on several key factors, although many other factors could be considered depending on the situation.
- Control – does the employer control the service provided?
Employee: the business controls the work, including how they perform it, when they do it, and the hours worked.
Contractor: the worker has the right to delegate the work, quote for the job and determine exactly what work needs to be done. - Integration – does the worker have other clients?
Employee: they’re an integral part of the employer’s business.
Contractor: the worker has other clients and advertises their services to the public as a business and is an accessory to the business. - Results – is the worker hired for a specific outcome?
Employee: the worker is hired to work specific hours, even if they’re variable (casual).
Contractor: the worker is hired to produce a result and complete specific tasks. - Risk – who is responsible for the commercial risk?
Employee: the worker is immune from risks related to their work as the employer takes responsibility for work done by the employee. An employee is paid for time worked regardless of errors or defects.
Contractor: the worker is responsible for fixing errors and problems and is liable for the cost of rectifying errors or defects in the work. A contractor has the potential for a profit or a loss on the job. - Intention – is it the business owner’s intention to create an employment relationship or engage an independent worker?
Employee: the business will provide a superannuation choice form, a tax file declaration, the Fair Work Information sheet and an employment agreement outlining the applicable modern award and entitlements.
Contractor: the business requires invoices from the contractor that show the contractor’s ABN and business details. The contractor is generally responsible for their own licenses, insurance, tax and super.
Other Tests
A person is not classified as an employee or contractor based solely on the type of work they do. The relationship and intention of the arrangement are important deciding factors.
Other factors that may be relevant in deciding between a contractor and employee classification include the place of work, who provides the equipment needed for the work, whether the work is ongoing or project-based within specific timeframes, tax and entitlements, and the right to refuse work.
Get it in Writing
Whether you engage an employee or contractor, you need to have a written agreement in place once you have determined the correct classification.
Recent court cases have highlighted the importance of worker agreements. A lawful agreement clarifies the terms of engagement and addresses all aspects of the working relationship so that there is no room for misinterpretation of the conditions of the relationship. This protects both the business and the worker so that a court can assess all rights and obligations in the event of a dispute.
Determining if Your Worker is an Employee or a Contractor
The Fair Work Ombudsman has information that covers the tests mentioned above as well as penalties and sham contracting arrangements (attempts by an employer to disguise an employee relationship, usually to avoid responsibility for employee entitlements). Visit FWO Independent Contractors for more detail.
If you’re still unsure, you can check out the ATO’s employee/contractor decision tool. It asks questions based on what the courts consider when deciding whether a worker is an employee or a contractor. Once you’ve answered all of the questions, it will provide you with a report indicating whether you are more likely to have an employee or contractor relationship with your worker. Be aware, however, that even if this tool suggests that the worker is a contractor, this does not automatically absolve you of responsibility for paying tax, superannuation, workers’ compensation insurance or payroll tax. There are other tests for this again! More on this shortly.
Remember, you can engage a worker as a casual employee. You don’t have to put someone on as a permanent employee on day one. Sometimes this is a better option than a contractor where there is uncertainty about hours or the length of a project and the contractor in question is a sole trader.
Bookkeeping and payroll go hand in hand and OTM Melbourne Bookkeeping is expert in both. Xero’s payroll function is transitioning to Single Touch Payroll Phase 2 and easily copes with both employee and contractor payments. Contact us if you’d like a review of your Xero payroll setup.
Your Worker is an Employee
If the ATO tool says that your worker is an employee, this already answers the question about withholding tax, paying superannuation, accruing leave, workers’ compensation insurance and payroll tax. You need to pay and/or accrue them all. (Payroll tax only applies if you pay wages over the state or territory threshold.)
Your Worker is a Contractor
If the tool says that your worker is a contractor, then a further decision tool needs to be run to determine if superannuation obligations apply.
If the ATO tool says that your worker is a contractor, you are not responsible for paying leave entitlements or withholding any tax. However, the contractor can voluntarily request that you withhold and pay the ATO on their behalf. You’re also not required to provide notice on termination or redundancy.
If the ATO contractor decision tool says that they’re an employee for superannuation purposes, you must pay them superannuation. This is the most often overlooked obligation of business owners who engage contractors. Superannuation does not apply if the worker supplies services via a trust, company or partnership. However, if they’re a sole trader, there’s a high likelihood that you need to pay.
Workers Compensation and Payroll Tax
Workers’ compensation insurance and payroll tax have their own rules and vary according to each state’s guidelines. Employees are always included. Some contractors are included, and some are excluded. You’ll need to check each state or territory’s information on whether you need to include contractors or not.
Employer Obligations
Responsibility for getting worker classification correct falls on the business engaging the worker. Just because a worker is called a contractor, has an agreement that states that they are a contractor, or submits an invoice with an ABN, does not mean they are classified as contractors for entitlement, super or tax purposes.
Should you mistakenly classify a worker as a contractor instead of an employee, then the employee has the right to seek back-payment of leave, public holidays, superannuation and potentially even unfair dismissal or redundancy. It is worth noting that business owners are personally liable for unpaid superannuation. Shutting your business will not protect you from your obligation to pay this. Given that interest will apply and that the super will be paid late, you will also lose the tax deduction you could otherwise have claimed if you’d paid the superannuation by the due date.
At a company tax rate of 25%, $5,000 of late superannuation will cost you $1,250 in extra tax due to the lost deduction, on top of the penalties and interest.
Possible Penalties for Employers
The Independent Contractors Act 2006 provides severe penalties for contravention of these provisions. The Fair Work Ombudsman can provide assistance where workers feel their employer has engaged in questionable or prohibited conduct. Current penalties are up to $66,000 for each sham contracting arrangement.
If you get the classification wrong, penalties could apply separately for ATO PAYGW and super, Fair Work Ombudsman, state payroll tax and WorkCover.
Next Steps
If you’re a business that engages workers as contractors, it’s best to get professional assistance to determine their correct classification. There are a few options available, but it depends on your budget and the level of complexity of the working relationships.
Check the ATO employee contractor tools and the Fair Work Ombudsman information first. If you’re still not sure, talk to us. On The Money Bookkeeping Melbourne payroll services experts have a lot of experience with payroll and HR matters, and we work with enableHR for expert employment law advice when needed.
ATO – Employee/contractor decision tool
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