Contractor Vs Employee – What You Need to Know
What is the difference between a contractor and an employee and whose responsibility is it to get right? While employees and contractors might seem similar, there are distinct differences between the two working arrangements. Recent updates to legislation have further clarified these distinctions.
What is an employee?
Employees work in the business and are integral to that organisation. Employees:
- Have legal rights and employee entitlements under the Fair Work Act 2009.
- Have a reasonable expectation of ongoing work, agreed hours and duties.
- Are covered by the employer's workers compensation insurance.
- Must be paid the superannuation guarantee by their employer.
- Are not exposed to any financial risk associated with the business.
What is a contractor?
Contractors differ from employees in several key ways. They:
- Actively run and advertise their own business — they're essentially their own boss.
- May work for more than one client and dictate their own fees — which might be an agreed price for a project rather than hourly rate. (Is the person paid according to piece completion, rather than receiving wages based on time worked? This alone does not mean they are a contractor).
- Are responsible for their own insurance, equipment, licenses, and tax.
- Have a high level of independence, discretion, and control over how and when the work is performed.
- Can delegate work to their own employees or contractors.
- Are liable to fix mistakes at their own cost.
- Likely use their own tools for the job and manage their own tax withholding with the Australian Taxation Office (ATO).
- May or may not receive superannuation, depending on the engagement.
- May have less job security than a permanent employee.
The business owner is legally responsible for determining whether someone is an employee or contractor — but don't worry, we can help you get it right.
Multi Factor Test
Deciding if someone is an employee or a contractor depends on many factors, and each situation needs to be looked at individually. There isn’t one single factor that decides it — instead, the whole working relationship and the type of work being done are considered.
New Definition of Employment
Effective 26 August 2024, a new definition of employment has been added to the Fair Work Act to help determine whether a worker is an independent contractor or they have an employment relationship. Key factors include:
- The real substance, practical reality, and true nature of the working relationship.
- The totality of the working relationship, including both the contract terms and how the contract is performed in practice.
This new definition may result in some existing working relationships being characterised differently, and may lead to different rights and obligations for businesses and workers.
Whole of Relationship Test
The whole of relationship test is generally used by proprietary limited companies (Pty Ltd or Ltd entities) to determine if a worker is an employee or contractor. Factors include:
- Control over how work is performed.
- Financial responsibility and risk.
- Supply of tools and equipment.
- Ability to delegate or subcontract work.
- Hours of work.
- Expectation of ongoing work.
Start of Relationship Test
Partnerships, sole traders or other unincorporated entities will generally be required to use the start of relationship test, which also considers the above factors but focuses on the initial terms of the engagement.
Workers earning above the contractor high-income threshold ($175,000 from 1 July 2024) can opt out of the whole of relationship test.
Whole of Relationship vs Start of Relationship
The whole of relationship test looks at the entire working relationship, considering how the job is actually performed and the practical realities — like who controls the work, supplies tools, and carries risks — to decide if someone is a contractor or an employee. This test is used by constitutionally covered businesses (like companies). In contrast, the start of relationship test focuses on what was agreed at the start of the arrangement, usually based on the contract, and is used by state-referred businesses (like partnerships or sole traders).
Sole Trader as a Contractor May Not be Right
When sole traders are engaged as independent contractors, business owners must ensure they meet the criteria for being contractors. Many sole traders engaged as contractors are not actively carrying on a business, even if they have an ABN, and may lack the independence required to be considered contractors. When this happens, the contractor misses out on their employment entitlements, and there could be penalties for the employing business. If an employment dispute arises, you may need to seek independent legal advice.
Key points to assess:
- Are they engaged to provide services or their labour?
- Can they delegate work?
- Do they work under the direction of the business?
If sole traders do not meet contractor criteria, they may need to be engaged as employees to avoid penalties and disputes.
Sham Contracting Changes
From 27 February 2024, the defence against sham contracting claims has changed from a "recklessness" test to a "reasonableness" test. Employers must now prove they reasonably believed a worker was a contractor at the time of engagement to defend against claims.
Sham contracting occurs when employment arrangements are misrepresented as independent contractor arrangements. Employers can face penalties for this practice. This may occur when a business owner needs extra workers, but they want to avoid the responsibility of having to pay superannuation contributions, PAYG withholding, annual leave or sick leave. It's a good idea to have a written contract when any sort of working arrangement you're looking at entering with someone.
Unfair Terms in Contracts
From 26 August 2024, contractors can apply to the Fair Work Commission if they believe their services contract contains unfair terms. The Commission can:
- Determine whether a term is unfair.
- Set aside, amend, or vary all or part of a contract.
This only applies to contractors earning below the contractor high-income threshold and where there is a constitutional connection. A constitutional connection refers to the legal basis under the Australian Constitution that determines whether a business is subject to federal workplace laws. It primarily applies to constitutionally covered businesses, which are businesses that fall under the jurisdiction of the national workplace relations system.
A business has a constitutional connection if it is:
- A constitutional corporation: A business incorporated under the Corporations Act 2001 (usually identified by "Pty Ltd" or "Ltd" in its name), which engages in trading or financial activities.
- Located in a Commonwealth territory: For example, businesses operating in the Australian Capital Territory or Northern Territory.
- A Commonwealth entity: Such as a federal government agency or department.
- Involved in interstate or overseas trade or commerce.
This connection determines whether federal laws, like the Fair Work Act, apply to a business or whether it is governed by state workplace laws.
Regulated Workers
A new category of contractors, regulated workers, has been introduced from 26 August 2024. These workers have additional protections and include:
- Digital labour platform workers.
- Contractors in the road transport industry.
- Contractors in road transport contractual chains.
Independent Contractor or Casual Employee?
If you are unsure whether a worker is an employee or independent contractor, it's a good idea to seek professional guidance. If you're unsure or the worker does not meet the definition of a contractor, another option might be to engage the worker as a casual employee if they do not meet contractor criteria but flexibility is still needed. Casual employees receive superannuation, accrue leave entitlements, and have income tax obligations managed by the employer.
This approach helps avoid being accused of having a sham contracting arrangement and ensures compliance with tax, superannuation, and employment laws.
Get it Right to Avoid Penalties
Misclassifying a worker as an employee can leave your business liable for costly back-payments, including entitlements like paid annual leave, overtime, allowances, and superannuation.
While some situations are clear-cut, many aren’t. Don’t leave it to chance—reach out to us for expert guidance. We’ll help you navigate the complexities and ensure your tax and super obligations are fully compliant for every worker, whether they’re contractors or employees.
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