Employee or contractor: the rules on using contractors

This article was current at the time of publication.

As the gig economy continues to expand, many SMEs are taking advantage of the services of contractors.

But while it may seem appealing to hand over to an independent operator the responsibility for things like superannuation, holiday pay or sick pay, businesses need to clearly define the relationship and understand their obligations. If they don’t, they risk costly penalties.

Both the Fair Work Ombudsman (FWO) and the Australian Taxation Office (ATO) are striving for clarity around the roles, as well as business compliance with the Fair Work Act 2009.

Amy Zhang, Executive Counsel & Team Leader at Harmers Workplace Lawyers, says understanding the differences between an independent contractor and an employee is critical. She says the distinction between the two, in practice, can be grey and complex and some businesses do get it wrong.

Employee or contractor?

Small businesses must confirm whether their worker is an employee or independent contractor as it affects their tax, super and other obligations, says an ATO spokesperson.

The employee or independent contractor – what's the difference guide can help distinguish an employee from an independent contractor. The ATO has also busted common myths that have caused small businesses to slip up.

As well as considering things like payment and who supplies the work tools, an overarching consideration in defining the relationship involves how much control the worker has, such as who has the right to tell the worker how, when and where they do their work.

This goes towards the “totality of the relationship” – not just the terms of the contract but how the contract is performed – something which has been brought back into focus with the recent amendment of the Fair Work Act 2009, as part of “Closing Loophholes” laws.

Zhang explains: “The contract is not the be all and end all of the relationship, or an employer’s obligations. In practice, there are circumstances in which a worker could perform the work that could result in a finding that the worker is actually an employee. 

“The rationale for the Labor Government bringing back a test that looks at the totality of the relationship and how a relationship works in practice, is that it is not necessarily fair to workers if they work like an employee but do not have the benefits of an employee; and it could allow businesses to have sham contracting arrangements and workers to be worse off.”

New uncertainties for SMEs

She adds: “There are obvious or clear-cut examples of when a worker may actually be an employee. ‘For example, if you work for someone five days a week for 10 years, that tends to suggests an employment relationship, even though you may have been hired as a contractor.

“If you are doing the same thing other workers are doing in the business, but being paid as a contractor, this may also be problematic.”

Zhang says the amendment does introduce more uncertainty for small business, compared to the outgoing test that emphasises the importance of the written contract between the parties. She says it is always best practice to obtain employment law advice.

The ATO has published additional guidance to help businesses in relation to employees and independent contractors: Taxation Ruling TR 2023/4 Income tax: pay as you go withholding – who is an employee? and Practical Compliance Guideline PCG 2023/2 Classifying workers as employees or independent contractors – ATO compliance approach.

Checking business practices

Small businesses looking for a contractor/subcontractor need to check the person pays their employees correctly, including covering employment costs like worker’s compensation, payroll tax, insurance and licences. Checking minimum pay rates and National Employment Standards are being adhered to are two ways to reduce risk. 

Businesses that make payments to contractors in the building and construction, cleaning, courier and road freight, information technology (IT), security, investigation or surveillance industries, may need to report payments made to the ATO via the Taxable payments annual report (TPAR), due by 28 August annually. 

Contractors, according to the ATO, can either be sole traders or working in their own company, partnership or trust and need an ABN and possibly other business tax registrations, such as GST. In most cases, they also take care of their own tax and super, as well as sick leave and holiday pay.

Accountants need to be proactive

As well as assisting clients with their financial reports, accountants whose clients hire contractors need to be very careful they do not facilitate underpayment, says Zhang. 

If this is the case, they can be held responsible for breaches as an accessory, through something called accessorial liability, and ordered to pay significant penalties and potentially an employees’ entitlements. 

“Accountants are seen as advisers and are privy to records and information including payroll or work arrangement information,” she says.

“Accordingly, if their client is breaching employment obligations and the accountant is knowingly concerned in the breaches, they could be personally pursued for their involvement (including lack of action to stop the breaches). 

“Accountants, therefore, have a proactive role to play in ensuring their clients get good employment law advice and follow the law.” 

Payroll tax and superannuation

Laws differ between states and territories with regards to payroll tax. However, generally, payments to contractors are liable to payroll tax if contractors are engaged under a relevant contract, agreement or arrangement to provide an employer or another contractor with a service. 

As for superannuation, while many SMEs assume they do not have to pay this to contractors, this may not be the case.

An ATO spokesperson says that in certain circumstances, small businesses must pay superannuation for contractors deemed employees for superannuation purposes.