Employee or Contractor: What’s the Difference?
So what’s the difference?
There are a number of differences but, basically, it comes down to the fact that a contractor is an independent person providing a service to the business on set terms and conditions, whereas an employee is hired to do what the employer directs them to.
It can be a fine line, but according to the Tax Office an employee is someone who is part of the employer’s business, whereas a contractor runs their own business.
An employee, for example, is under the control of the employer. They can be directed how to work, they can’t delegate their job to someone else, they are paid for what they do, and the employer generally provides the equipment they need to do the job and takes the commercial risks.
Contractors have more freedom in how they work. They are contracted to provide specific services but they have more freedom in how they achieve the contracted result.
Contractors, according to the Tax Office, generally provide most of their own equipment and are legally responsible for their own work and for rectifying any defects. They tend to be paid for results rather than hours worked or commissions.
Why does it matter?
Being an employee carries with it a wide range of employment entitlements such as annual leave, long service leave and parenting leave, and may result in the application of award conditions of employment. The employer will have the primary responsibility for taking out insurance and paying tax. The employer is much more likely to be liable for the acts of an employee than a contractor.
Significant obligations therefore depend on whether the person is correctly categorised as an employee or contractor.
If someone you regard as a contractor subsequently claims to have been an employee over many years, with substantial accrued employment entitlements, the financial consequences and possible flow-on to other similar “contractors” can be disastrous.
Or the tax authorities may dispute your classification and argue that your business is liable for extra group tax or payroll tax, as the person you treated as a contractor was “really” an employee.
What is the test?
Court cases have identified a grab bag of factual matters which help to decide whether someone is a contractor or an employee. These include:
- whether the person provides tax invoices;
- whether the person takes responsibility for their own tax deductions and arranges their work-related insurance;
- whether there are any paid leave arrangements;
- the extent to which the person has other business activities and is free to organise his or her time and work arrangements as he or she wishes;
- the degree of control which the business exercises over the person’s activities (the greater the control, the more likely the person is an employee);
- whether the business or the person are responsible for the supply of equipment (supply by the person rather than the business suggests the person is a contractor, at least if the equipment is substantial);
- whether the person is building up marketable goodwill in their own name;
- whether the person appears to outsiders as an independent person or as part of the business (eg business cards, uniforms, stationery);
- whether the person was transformed from an employee into a contractor (willingly or under coercion) at some time;
- whether the contractor is an individual, or a company supplying the services of an individual (and perhaps other employees).
Isn’t there something called the 80 per cent rule?
This rule relates to how you report personal-services income (income that is at least 50 per cent derived from your skills, knowledge, expertise or efforts) in your tax return and what deductions you can claim.
If you derive 80 per cent or more of your income from one client, you fail this test and must report your income as personal-services income.
However, the Tax Office says passing this test is irrelevant to whether or not you should be treated as a contractor.
Even if I am a contractor, is there any way I can get super from my employer?
Even if you are a bona fide contractor, your employer must make super contributions for you if you are contracted wholly or principally for your labour.
Employee or contractor common myths
There are many myths about what makes a worker an employee or contractor. Often businesses rely on these myths and get the employee or contractor decision wrong.
To ensure you know fact from fiction when determining whether your worker is an employee or contractor, read more ……….
To get an answer about whether your worker is an employee or contractor, use our Employee/contractor decision tool. It is free, anonymous and easy to use.