Employee or Contractor?
One of the most frequently asked questions I hear from my business clients is: “What is the difference between an employee and a contractor?”.
This question comes generally from those people who are considering taking on someone to do some work for them and whether they should be engaged as an employee or as a contractor. Alternatively, from an individual who is going to do some work for someone and they’re wondering if they can work as a contractor or an employee.
So what’s the difference?
Very simply: a contractor is someone who performs work, provides an invoice for the work and gets paid on that invoice. They receive no other payments. An employee is entitled to other payments like superannuation, annual leave, PAYG and Return to Wok (previously known as Workcover).
So there’s quite a difference in the way they get paid and it is very important that we get it right. If, for example, a person you take on as a contractor is later deemed to be an employee and you have not been paying them their entitlements, then you (the employer) may be required to pay them up, even though they actually would have been payed a higher rate as a contractor.
How do we make sure to get it right?
The ATO provides six key factors to determine if someone should be considered a contractor or an employee.
- Ability to delegate: If you engage someone to do some work, do they actually have to do it themselves or can they get someone else (or an outside organisation) to do it for them? If they have to do it themselves, then that would indicate they’re an employee. Whereas, if they can go to another organisation and get someone else to do it for them, then they would be considered a contractor.
- Basis of payment: If they were charging an hourly or daily rate, then this would indicate that they’re an employee, versus if they were given a certain amount for completion or stages along the job which would indicate they’re a contractor. If a contractor finishes a job early, or they take longer, they still get paid the same amount – so the contractor is taking on the risk.
- Tools of the trade: If the person is only supplying simple tools (like drills, hammers, etc) then they could be considered an employee because the tools don’t have significant value. If they provide tools like an excavator, for example, that would indicate that they are a contractor because the ‘tool’ has significantly higher value.
- Risk: Who is bearing the risk? If an employee goes on the job and ‘stuffs up’ they’ll actually get paid additional hours to fix it up. If a contractor ‘stuffs up’ they won’t receive any additional pay to make good and it will be at their cost.
- Control: Who is exercising the control as to when and where the work is done? An employee will be told that they need to turn up at 9am and they will be there for the week, whereas the contractor will be told that they need to complete the job within a certain timeframe but they can choose when they turn up, as long as it’s completed within the timeframe.
- Independence: Do they actually HAVE to do the work? For example if the task is to paint a house, the employee has to do it as it is part of their job. Whereas the contractor can say “No, I don’t want to do that job”, or “I have other work on and therefore you’ll have to find someone else”. In other words, a contractor has the right to refuse or accept work.
That’s the basic summary of how the ATO determines the difference between employees and contractors.
It is vital that you get this right as there can be significant penalties if you get it wrong. This is particularly true for an employer; if you engage someone as a contractor, don’t pay super and leave, you could be forced to back-pay it if it’s ever reviewed. And that can be costly!
I have sat through several reviews by the ATO and Fair Work where they have looked at the contractor and employer relationship. Where people come unstuck with this is, initially, they’ll bring someone on as a contractor (correctly) for a short term project, but that project is extended or additional work added to it – this indicates that the relationship has changed from a contractor to an employee.
So, check your relationship at the start and then review contractor relationships after three months. If it’s looking like turning into a long-term relationship, you’re going to need to look at changing the relationship to an employee.
If you have any questions about the difference between a contractor and an employee, please do not hesitate to ask!