Defining Employees and Contractors: The Key Areas to Avoid Future Liabilities

Contracting has emerged as an alternative to the traditional employment relationship. However telling the difference between an employee and an independent contractor can be complex. There is no single rule that determines the question rather consideration is given to multi-factor tests.

Determining the Nature of Engagement

A contractor can be engaged directly as a natural person, through a trust, partnership or company, or through a labour hire agency. In determining whether the engagement is one of employment or contractual, it is important to look at the full circumstances of the engagement and consider all factors that led to the relationship:

  • Degree of control over how and when the work is done

  • Expectation of ongoing work

  • Financial risk

  • Whether superannuation contributions are needed

  • Who provides tools and equipment

  • Income tax deductions

  • Method of payment

  • Leave entitlements

  • Ability to work for other companies

  • Right to delegate or subcontract

Does a Written Agreement eliminate the confusion?

It is not unusual for a business to engage an individual to perform work and fail to record the terms of the engagement in a written contract. This means that, if there is later a dispute there may be significant disagreement between the parties and – ultimately – litigation.

For this reason, it is always prudent to record the terms of engagement in a written contract before the engagement commences, and have both parties sign it. Even if you have already engaged the individual, it is not too late to enter a written contract, and acknowledge that the contract has already commenced.

However, you should be aware that simply calling an individual a ‘contractor’ on paper, or the fact that they have an Australian Business Number (ABN) or a registered business name, does not mean that this is determinative of the relationship. Courts can still look behind a contract to define the true relationship between the parties. Also, having a contract in place does not mean that you can contract out of your obligations under legislation.

What liabilities arise if we get it wrong?

Generally, the employment relationship is more heavily regulated than a contractor relationship. So, if you incorrectly classify an individual as a contractor, you may be liable for:

  • superannuation charges, where you have failed to make superannuation contributions for the benefit of the individual either because they are an employee at common law or because they are an ‘employee’ under the extended definition in the SG Act.

  • additional payroll tax (including penalties and interest) where you have incorrectly claimed contractor exemptions on payments made to common law employees.

  • back pay under a modern award, where you have incorrectly classified an individual as a contractor. Most non-management employees are covered by a modern award and will have entitlements under the award to a minimum wage, overtime, penalty rates, allowances and leave loading.

  • unpaid annual and long service leave, where you have incorrectly classified an individual as a contractor. All employees are entitled to paid annual leave, and may be entitled to long service leave upon reaching the required number of years’ service.

  • compensation for unfair dismissal or for other prohibited conduct. Many employees have access to an unfair dismissal regime, and to other remedies where their employer acts to the detriment of the employee.


    What additional liabilities could arise for a Contractor: Deeming Super obligations?

    While in most cases, a Contractor will be responsible for their own superannuation obligations, there are circumstances where the relationship will be “deemed” to be one of employment. Under the Superannuation Guarantee (Administration) Act 1992 (Cth) a contractor is entitled to superannuation contributions if they work under a contract that is “wholly or principally for the labour of the person”. Below is some criteria the Australian Taxation Office looks at in determining whether a contractor should be paid super contributions:

  • Contractor is an individual: The agreement must be between an individual who provides the service and a customer who receives the service. If the individual works on behalf of another company, that company is responsible for paying the contractor’s super. Not you, the customer.

  • Contractor performs their own work: This means the written contract stipulates that work must not be delegated to a subcontractor. But if the arrangement does not prohibit delegation or subcontracting, this means delegation is possible and the contractor is not required to the work by themselves.

  • Contractor is paid for hours worked, rather than paid to achieve a result: Most independent contractors are paid to perform a specific task, as opposed to employees who are paid for their time. However, if the contractor is being paid an hourly rate this means they are being paid for their time and labour. If the arrangement makes it clear the contractor is being paid to achieve a result, regardless of how much time is spent, then the contractor is typically not entitled to superannuation.

If a contractor meets all of the above criteria they may be entitled to be paid superannuation contributions. At the rate of 9.5% of their ordinary time earnings, as long as they earn $450 or more before tax per calendar month.
Where to for advice?

The Australian Taxation Office provides a Contract Decision Tool to help determine the nature of an engagement relationship. This link to the tool is provided below:
https://www.ato.gov.au/Calculators-and-tools/Host/?anchor=ECDTSGET&anchor=ECDTSGET/questions/ECDT#ECDTSGET/questions/ECDT

If you are unsure of your obligations when engaging for services, please contact our office and talk to one of our experienced accountants who can walk you through the process of determining the nature of the relationship and your obligations.

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