When hiring, employers need to understand the differences between an employee and a contractor to avoid costly consequences.
Many businesses get it wrong when determining if a worker is an employee or contractor because they are not ensuring the arrangements have been set up correctly.
It is essential to get the decision right because businesses will face different tax and super obligations depending on whether the workers are employees or contractors.
A number of recent case decisions have challenged the traditional view on the determination of common law employees and independent contractors for superannuation guarantee contribution (SGC) and PAYG withholding purposes.
Traditionally, the difference between an employee and a contractor was almost exclusively determined under the control test. That means an employee is controlled to the extent that they are told, not only what work is to be done, but also how and when it is to be done.
A decision in the Federal Court established that there is not a singular factor that determines what a contractor is. Each case needs to be considered on its own. The case raised a number of factors that should be considered before deciding whether a worker is considered to be an employee or contractor.
As a guideline, the following factors should be considered in determining whether an individual worker is a common law employee or a contractor for SGC and PAYG purposes.
Control test
The employer directs the employee in relation to what to do and also how and when it is to be done.
Contractors maintain a high level of discretion and flexibility as to how the work is to be done.
Delegation test
An employee is unable to delegate duties to others except for delegating to other employees.
A contractor has the power of delegation and can delegate to other employees or subcontractors.
Integration test
An employee generally performs the work on the employer’s premises and using equipments provided by the employer. A contractor carries on a business on in his or her own right. The contractor provides their own equipment and incurs their own expenses to complete the work, and meets their own tax and superannuation obligations.
Risk test
The employer, not the employee, that is responsible for all the commercial risk including poor workmanship or injury sustained in the performance of work.
The contractor, not the employer, that is responsible for all the commercial risk including poor workmanship or injury sustained in the performance of work.
Results test
An employee is generally paid based on an hourly rate, piece rates or award rates.
A contractor is paid to produce a given result based on satisfactory completion of the contract.
If the employees are incorrectly treated as contractors by the employer, the financial implications can be significant. The business will be required to pay nine per cent superannuation guarantee contributions. That is in addition to the contracting fees it has already paid.
All the future payments to the contractor will also be subject to PAYG withholding tax. The business is required to remit the withholding tax to the ATO and prepare PAYG payment summaries for payments made to the workers.
