Do you engage contractors in your business? Do you know the differences between contractors and employees and the obligations that this places on you as the business owner? Do you know what kinds of risks you are exposing yourself to if you misclassify a worker as a contractor when they’re actually an employee?
When a Worker is Deemed to be a Contractor Instead of an Employee
There is no single criteria that will decide whether your employee is a contractor or an employee. It’s a multi-factor test. The situation of each worker needs to be considered. The tests are based on four key factors. Brief examples are provided below.
- Control – does the employer control the service provided?
Employee: the business controls the worker’s services such as how they do 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 presents their services to the public as a business, (with associated profits or losses).
- Results – is the worker hired for a result?
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 wears the risk?
Employee: the worker is immune from risks related to their work.
Contractor: the worker needs to be responsible for fixing errors and problems and is exposed to a possible profit or loss on the job.
How Do I Determine if My Worker is an Employee or a Contractor?
The Fair Work Ombudsman has a 3-page document 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). This document may provide additional insights.
If you’re still unsure, you can check out the Australian Government’s independent contractors’ decision tool. It asks 16 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.
My Worker is an Employee
If the Australian Government tool says that your worker is an employee, then 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 threshold.)
My Worker is a Contractor, Maybe
If the tool says that your worker is a contractor, then a further decision tool needs to be run to determine if superannuation and possible tax obligations exist. Workers’ compensation insurance and payroll tax have their own set of rules and can even be state dependent. We won’t be covering these in detail here. There are two ATO decision tools: one for the construction industry and one for everyone else.
If the Australian Government tool says that your worker is a contractor, then you are not responsible for paying leave entitlements or withholding any tax, unless the worker voluntarily requests that you withhold tax. You’re also not required to provide notice on termination or redundancy. The contractor can send you an invoice quoting their ABN.
However, if the ATO contractor decision tool says that they’re an employee, then you need to pay superannuation for them. This is the single largest overlooked obligation of business owners engaging contractors. Superannuation does not apply if the worker is supplying services via a trust, company or partnership. If they’re a sole trader, however, there’s a high likelihood that you need to pay.
Responsibility for getting this right falls on the employer or engager. 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 a contractor.
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 here that business owners are personally liable for unpaid superannuation. Shutting down your business will not protect you from your obligation to pay this. Given that interest will be applied and that the payment will be paid late, you will also lose the tax deduction that you could otherwise have claimed if you’d paid the superannuation as and when it was due. At a company tax rate of 28.5%, this means that $5,000 of late superannuation will cost you $1,425 in extra tax due to the lost deduction.
Possible Penalties for Employers
The Independent Contractors Act 2006 provides serious penalties for contravention of these provisions. The Fair Work Ombudsman can provide assistance where workers feel that their employer has engaged in prohibited conduct. Current penalties are up to $51,000 for each sham contracting arrangement.
What Should I Do Next?
If you’re a business that engages workers as contractors, it would be advisable 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. You could engage a lawyer, an HR specialist or a BAS Agent with high-level payroll and HR skills. Both the HR specialist and the BAS Agent may not be able to answer all of your questions, but they may be able to assist you in conjunction with another specialist.