In Short
- It is crucial to correctly identify whether workers are employees or contractors.
- Misclassification can lead to penalties, including unpaid superannuation and tax issues.
- Use the Australian Tax Office's test to determine the correct status of a worker.
Tips for Businesses
When hiring, always clarify whether a worker is an employee or contractor to avoid tax and superannuation issues. Contractors are generally responsible for their own equipment and taxes, while employees are entitled to more benefits. Consider using the ATO's tool to help with classification.
Have you reviewed your current employment contracts or are you taking on new staff? Congratulations on the growth in your business and your attention to the relevant law. Understanding whether a worker is a contractor or an employee is vital for many reasons. Why? Your tax, superannuation and other government obligations vary depending on whether your worker is an employee or contractor.
It is against the law to categorise an employee as a contractor due to varying taxation and superannuation implications.
This article will explain the differences between employees and contractors, helping you avoid tax and legal risks.
How Can I Minimise Risk?
Businesses that fail to acknowledge this very real distinction are at risk of being penalised. These penalties include:
- a monetary penalty for failing to meet Pay As You Go ("PAYG") withholding requirements;
- a super guarantee charge for failing to make the correct
superannuation contributions, which consists of:
- the shortfall (up-to-date payments);
- the interest on the shortfall; and
- an administrative fee.
For instance, you may take on a contractor, at $100 an hour, for 25 hours per week, for 10 months. If they turn out to be an employee by law, then you may be required to pay the minimum superannuation guarantee of 12%, in addition to the contracting fee that you have paid.
What is the Australian Tax Office Test for Determining This?
When taking a new employee, you need to confirm whether he or she is an employee or contractor before entering into the agreement. An employee typically works as part of a larger organisation. A contractor is running their own business under their own Australian Business Number. To determine whether your worker is an employee or contractor, use the ATO online tool.
Should I Keep Records?
You need to keep records to support your decision on whether your worker is an employee or contractor, and the factors you relied on.
What are the Main Points of Difference Between an Employee and a Contractor?
Ability to Sub-Contract or Delegate
Employees cannot sub-contract or delegate their work and cannot pay someone else to do their work for them. Contractors, however, can delegate or sub-contract and pay someone else to do the job.
Basis of Payment
Employees are paid in salaries, hourly rates and on commission-based structures. Contractors are paid on varying bases, including a one-off payment due after the job.
Equipment
In an employer-employee relationship, the employer usually pays for the business equipment. Contractors typically provide and maintain their equipment and tools.
Risk
Employees are generally not at commercial risk while employed, as the employer has legal responsibility for the actions of its employees while at work. Contractors, however, are responsible for their conduct and the commercial risks of the work.
Control Over Work
Employers are expected to give employees direction regarding the type of work required and how the work is performed. Contractors can perform the job as they choose, provided they adhere to the terms and conditions of the agreement.
Independence
An employee and employer are working for the same business and the same goals. Contractors run their businesses independently of the hirer. They can elect whether or not they will do extra work (depending on the terms of the contract) and are allowed to enter agreements with third parties.
What is the Difference Between an Employment Contract and a Contractor's Contract?
A contractor's contract is an agreement between a company (known as the "principal") and a service entity (known as the "contractor").
An employment contract is an agreement between employer and employee and establishes the terms and conditions of the employment. It can be verbal or written.
The agreements address the different legal requirements of the employee or contractor relationship, including:
- term and payment;
- insurance, taxation, superannuation and reporting; and
- subcontracting, exclusivity and restraint and termination provisions.
What are Different Tax Requirements?
Employers are required by the ATO to make compulsory superannuation guarantee contributions to the superannuation fund chosen by the employee, or, alternatively the employer's fund. On top of this, employers withhold PAYG tax from any income paid out to employees as required by law.
Contractors have very different taxation requirements. In contrast to employers, they themselves are responsible for meeting their taxation and superannuation obligations. Employers are generally not required to make tax deductions from any amount that the contractors have been paid.
Employment Essentials Factsheet
As an employer, understand your essential employment obligations with this free LegalVision factsheet.
Key Takeaways
The ATO test used to determine whether a worker is an employee or a contractor is quite stringent. Even if someone seems like they're working in a contractor's capacity, the test may determine otherwise. Instead of guessing, take the test yourself and avoid paying superannuation penalties and fines.
If you need assistance with the ATO test, our experienced tax lawyers can assist as part of our LegalVision membership. For a low monthly fee, you will have unlimited access to lawyers to answer your questions and draft and review your documents. Call us today on 1300 544 755 or visit our membership page.
Frequently Asked Questions
What are the key differences between employees and contractors?
Employees cannot sub-contract work, are paid on salaries or hourly rates, and the employer provides their equipment. Contractors, however, can sub-contract, manage their own business, and provide their own equipment.
How do tax obligations differ between employees and contractors?
Employers withhold PAYG tax and make superannuation contributions for employees, while contractors handle their own tax and superannuation obligations.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.
