Employee or Contractor – Why Does it Matter?
We are hearing a lot more from the Fair Work Ombudsman these days about employers being penalised for not classifying a worker correctly as an employee or contractor, and therefore not paying them correctly. A worker in your business can be either an employee or a contractor, depending on the circumstances involved. Above all, it is the employer’s obligation to get the classification correct—it is not up to the worker to decide whether they should be a contractor or not. There are many factors involved in deciding whether a worker is a contractor or an employee, which means that often it is not a black and white decision. There is no single or overriding deciding factor that covers all the requirements a business has in meeting their obligations with regard to workers and how they are classified for different agencies and different legal obligations. Different criteria apply for deciding whether a contractor is a contractor depending on the government agency involved. There are slightly different definitions of a contractor for tax, superannuation, payroll tax and workers compensation purposes. This article focuses on tax and super. Despite some grey areas, it is important to get it right for both the employer and worker—the employee is paid and taxed correctly, and therefore the employer is protected from claims and penalties. Penalties can be significant for businesses that do not classify workers correctly. For example, if a contractor should have been engaged as an employee, the business may have to pay annual leave and other entitlements such as allowances or overtime, in addition to the Fair Work penalties and possibly superannuation guarantee charge penalties.
Always a Contractor
Companies, trusts and partnerships are always contractors. An employee must be a person, not an entity.
Always an Employee
Apprentices, trainees, labourers and trades assistants are always employees.
Sometimes a Contractor, Sometimes an Employee
It’s all about the sole trader, or individual. It can be tricky to decide whether a sole trader should really be engaged as an employee, and that could be casual, part-time or full-time. Having an ABN and being GST registered does not automatically make the sole trader worker a contractor. Assess contractors every 6-12 months to decide whether they should still be considered a contractor or if they should now be engaged as an employee. The nature of the work and the engagement may have changed over time. Another important factor is that even if a contractor has signed an agreement with the business owner, they can still appeal to the Fair Work Ombudsman (FWO) to have their work engagement audited, and the FWO can apply penalties, regardless of what the worker agreed to earlier.
Contractor or Employee – How do you Decide What is Right?
This is a multi-factor test; consequently there are many aspects to the relationship that need to be considered, and it is often not ‘black and white’ but grey. There are several key tests:
- Control – who controls how, where and when the work is performed?
- Risk – who carries the financial risk of correcting errors, fixing defects or paying for workers compensation?
- Integration in the business – is the worker engaged in activities that are integral to the nature of the business, or are the activities accessory to the business?
- Result expected – is a specific result expected or is labour required which is governed by the business?
Other factors considered:
- The nature of the work performed and the contract
- Hours of work
- Place of work
- Quotes, fees, remuneration and invoicing
- Expenses—reimbursed or worker responsible
- Engaged by recruitment or advertisement
- Equipment provided by worker or business
- Scheduling of work
- Delegation of work
- Expectation of work—ongoing vs. set period or project
- Right to refuse work
- Ability to accept other work
Tax and Super Obligations
Employees are paid according to a modern award or other industrial instrument; tax is withheld and superannuation guarantee is paid at least quarterly. Contractors are generally required to manage their own tax and super; however, there are exceptions to this rule. Contractors may enter into a voluntary withholding arrangement whereby the business withholds an agreed amount from their invoices on their behalf. These contractors will be given a payment summary at financial year end detailing the amount withheld. If a worker is engaged as a contractor and no ABN is quoted, the business must withhold 47% and remit to the ATO. These contractors will also receive a payment summary from the business at year end. Some contractors must have super paid, depending on the industry and the nature of the work performed. It’s important to be clear in any contractor agreements about superannuation – whether it is paid, and if so, the rate it will be paid at. Super is paid on the GST exclusive amount of the contractor invoice. The default position is that a contractor rate is inclusive of superannuation unless otherwise agreed in writing between the parties. The business owner must pay the super directly to the super fund at least quarterly; they cannot pay it to the contractor.
ATO Information and Tools
The ATO has recently updated and clarified a lot of their employee and contractor information, so that it is now much more easy to understand and rely on the information. There is now a useful Employee/contractor decision tool to assist in making the right decision. There is also a separate tool to assist in superannuation guarantee eligibility.
Do You Need Help Assessing Your Contractors?
If you engaged contractors some time ago and have not reassessed the basis of the engagement, it could be time to look into all the factors surrounding the work engagement. It is best practice to assess contractors every year. Talk to me if you need help with this and if you also need to set up your payroll for contractors changing to employees. Read more about the basics of employing people in my Quick and Easy Guide to Employing People for Small Business.