With COVID-19 having a significant impact on traditional employment, many people are finding themselves working as a contractor for the first time either by choice or necessity. It’s not just a lifestyle decision; from the tax and superannuation perspective, there are important differences between being an employee and a contractor.
For employers, you also need to recognise the potential for the ATO to impose significant penalties for failing to meet your obligations for tax and super payments if you incorrectly categorise an employee as a contractor.
Whether you are contracting for the first time, or hiring someone as a contractor for your business, it’s important to understand the differences between the two work arrangements.
Contractor or employee?
Deciding if you are a contractor or an employee can be complex, but a key distinction is that an employee works in the business and is part of it, while an independent contractor runs his or her own business.
Contractors are self-employed and are engaged to undertake a specific task at an agreed price, usually over a set period. They can choose their own hours of work and must pay for their own insurance, sick leave, holidays and super contributions.
Although COVID-19 has seen many employees working from home and claiming tax deductions for their home office running expenses, they remain an employee and are part of their employer’s business – even though they are working remotely.
On the other hand, if you’ve been made redundant and have begun offering services to a range of businesses from your home office, you are more likely to be a contractor.
How to tell an employee from a contractor
The table below outlines six factors that, taken together, determine whether a worker is an employee or contractor for tax and super purposes.
| Employee |
Contractor |
| The worker can’t delegate the work or pay someone else to do it. |
The worker can delegate the work or pay someone else to do the work. |
| The worker is paid for the time worked, at a price per item or activity, or via commission. |
The worker is paid for a result based on a quote, calculated using hourly rates or price per item to work out the total cost of the work. |
| The business provides all or most of the equipment, tools and other assets required to complete the work; or the worker provides them but the business provides an allowance or reimburses the cost. |
The worker provides all or most of the equipment, tools and other assets required to complete the work and doesn’t receive an allowance or reimbursement for this. |
| The worker takes no commercial risks; the business is legally responsible for the work and liable for the cost of rectifying any defects. |
The worker takes commercial risks, is legally responsible for their work and liable for the cost of rectifying any defects. |
| The business has the right to direct the way in which the worker does the work. |
The worker has freedom in the way the work is done, subject to the specific terms in any contract or agreement. |
| The worker is not operating independently of the business and is considered part of the business. |
The worker operates their business independently, performs services as specified in the agreement and is free to accept or refuse additional work. |
Source: ATO website
Recognising a contracting arrangement
Even if you hold an Australian Business Number (ABN) or a registered business name, you are not automatically a contractor. Being paid after submitting an invoice makes no difference either.
The length of a project or how regular the work is are also immaterial to your employment status. Both employees and contractors can be used for casual, temporary, on-call or infrequent work.
Even your personal preference or the percentage of your annual income received from a particular employer is irrelevant, as your employment status is determined by the work arrangement and its specific terms and conditions. The so-called '
80 per cent rule' is only relevant for the ATO’s assessment of personal services income (PSI) and whether or not a contractor can claim business tax deductions.
Both employers and contractors can check whether a proposed work arrangement is legally deemed to be employment or a contract using the ATO’s
Employee or contractor decision tool.
Avoiding tax and super responsibilities
With some employers finding their bottom line under continuing pressure due to COVID-19, it’s important to remember that under current legislation it’s illegal to make a misleading statement to an employee to try to persuade them to take on a contract arrangement. You are also not permitted to dismiss or threaten to dismiss an employee so you can re-hire them as a contractor.
Arranging for an employee to sign a formal document stating they are a contractor will not override the true employment relationship – or your tax and super obligations for them.
If you attempt to classify an employee as a contractor, it could be considered a ‘sham contract’ by the ATO and could result in you being prosecuted for tax evasion. You could also face penalties for not complying with your workers’ compensation responsibilities and you may be required to reimburse the employee for unpaid leave and other employee entitlements over the period they worked for you.
Late super payments are expensive
Not meeting your obligations to make super contributions for someone who should have been classified as an employee can be costly.
The base salary used to calculate their unpaid super contributions is higher than for on time payments and you are also required to pay the Superannuation Guarantee Charge (SGC), which includes interest and other fees.
The Fair Work Ombudsman has the power to impose significant penalties on employers, while in some industries former contractors have begun seeking compensation for not being paid their full entitlements as an employee.
If you would like help understanding and complying with your tax and super obligations as either a contractor or employer, contact us today.
