Updated: 30 April 2024.
Employee or independent contractor? Here's a practical guide to approaching this common question which can cause significant issues for your business if you get it wrong.
At MyHR, we're regularly asked to give an opinion on the difference between contractors and employees. Usually, this is because the parties want to set up a contractor relationship and all too often the relationship is better defined as employment.
Sometimes, the individual is seeking a contracting relationship for perceived tax benefits. They might tell an employer that they “choose” to be a contractor and they’re “okay waiving their employment rights” in favour of an independent contractor relationship.
However, this choice is not theirs to make. In Australia, the day-to-day nature of the employment relationship helps define whether somebody is an independent contractor or an actual employee. People cannot choose to opt out of employment entitlements and they cannot opt out of their statutory tax requirements.
Getting this wrong can cause significant issues. You could be liable for extra costs like unpaid tax and minimum wages. You might also be fined or receive other penalties from the Fair Work Commission or Fair Work Ombudsman.
So how do you know the difference?
The difference between an employee and a contractor
There is plenty of advice online to help with differentiating between an employee and a contractor. The Australian Tax Office (ATO) provides a handy decision tool and there is also lots of useful information at Business.gov.au.
For a less formal, common sense assessment, remember: If it looks like a duck, swims like a duck, and quacks like a duck, then it probably is a duck. No amount of convincing yourself (or others) that it’s a golden swan will make it not a duck!
Employees
Employees are in a contract “of service”, serving the employer under a relevant award, agreement, or an employment contract.
They are considered part of the business and (generally speaking) told what to do. Hours are generally fixed and they dedicate their time and effort primarily to one organisation. They are provided tools to complete the work. They must apply for time off.
This means they’re paid by a payroll system, with PAYG and any fringe benefits deducted. They’re eligible for superannuation and have all minimum rights under the Fair Work Act.
Contractors
Contractors are working in a contract “for service”, serving themselves by delivering outcomes to their clients. This is a commercial relationship, not an employment relationship.
Contractors are self-employed and can work freely for a number of organisations (or sub-contract the work out). They dictate their own time-off and may or may not be available for work. They provide their own equipment and tools.
They invoice for their work and look after their own tax obligations, and if their turnover is at least $75,000 a year (or they claim fuel tax credits or provide taxi travel), they must be GST registered.
Note that any contractor who is paid wholly or principally for their labour is considered an employee for superannuation purposes.
The nature of the employment situation is usually obvious, although project work of fixed duration or finite funding could be debated. In most cases, the same rules above can be applied and a position and fixed-term employment could apply.
New definition of employment
From 26 August 2024, the Fair Work Act will include a new statutory definition of employment to help determine the meaning of ‘employer’ and ‘employee’ (rather than independent contractor).
This includes factoring in “real substance, practical reality and true nature of the working relationship”, and both the terms of any written contract and how the relationship works in practice after the contract is entered into.
This is a change from the current common law test, which focuses mainly on the terms of the contract.
Contractors who earn more than a new (yet-to-be-set) high-income threshold will be able to opt out of having the new definition apply to their work arrangements.
Contractors who earn less than the high-income threshold will be able to take a dispute about unfair contract terms to the Fair Work Commission (FWC) and the FWC will have power to set contracts aside.
New sham contracting laws
The rules in the Fair Work Act around defending a claim of “sham contracting” (misrepresenting an employment contract as an independent contracting arrangement) have also changed.
From 27 February 2024, the onus is on the employer to prove they reasonably believed they engaged a person as an independent contractor.
Previously, employers could prove that they did not know and were not reckless as to whether the contract was an employment contract rather than a contract for services.
In determining whether the employer's belief was “reasonable”, a court will consider the size and nature of the employer's business and other relevant matters (e.g. the employer’s skills, experience, and time operating, the industry they operate in, whether there is a dedicated HR resource in the business, and whether the employer sought and followed professional advice).
The maximum penalty for sham contracting is $93,900 for corporations and $18,780 for individuals, per contravention.
Practical tests
There are a couple of practical tests that are very useful in highlighting the true nature of an employment relationship.
Termination
If both parties are comfortable with the understanding that the work may cease at short notice and without any official process, then it is likely a contractor relationship.
However, if the individual would feel aggrieved and being told “don’t come to work on Monday”, then they may have an expectation of fixed hours and ongoing work, which means they are more likely an employee.
Leave
If both parties are comfortable with the individual “booking themselves out” for periods of time at their own discretion, then it is likely a contractor relationship.
But if the employer would feel upset at the individual announcing their intention to go away for a couple of months, then there is an expectation that the person is available at the employer’s requirement and should apply for leave. This person is an employee.
Our advice
The new legal definition of employment and sham contracting laws will shine a brighter light on employers’ use of independent contractors.
Where before the written agreement between the parties was the primary factor in determining whether a worker is an employee or a contractor, the courts will now also consider the nature and reality of the relationship as it operates on a daily basis.
Employers will have to be able to prove they “reasonably believed” they engaged a worker as an independent contractor rather than using the contract as a way to avoid providing the relevant minimum workplace entitlements and protections to an employee.
So it’s crucial for every employer to assess their independent contractor arrangements to ensure they are legitimate. Make sure that any contractor arrangement is set out in writing, clearly defining the terms of the agreement as that of a principal and contractor.
You should also regularly review the relationship to ensure it continues to meet the definition of contracting. If you have expectations around the person always being available when you want them, or you want to take formal disciplinary action because of their conduct or performance, the arrangement might be more akin to actual employment.
Remember, you can only terminate the contract if you aren't happy with the agreement or the other party isn’t meeting the agreed terms.
If you still don’t have a clear view of the differences between employees and independent contractors, get in touch with MyHR for expert help.
