Sometimes a person engaged as a contractor may in law be an employee. The line that divides employees from contractors is grey and shifting. Application of Awards and unjust dismissal laws, pay and leave entitlements, and tax and insurance issues all depend on which status applies. This Plain English Guide answers some of the commonly asked questions about the distinction between an employee and a contractor.
What is the difference?
An employee is someone engaged by an employer to provide their labour in return for a wage or salary and is commonly referred to as “a contract of service” i.e. to carry out tasks as required under the employer’s supervision, direction and control.
A contractor, on the other hand, is a sole trader or incorporated business engaged by a Principal to provide “services” i.e. to perform specific work under a commercial services agreement.
Why does it matter?
The relationship between employer and employee is heavily regulated by statute and employees are entitled to receive a wide range of entitlements such as superannuation, annual and personal leave, long service leave, parenting leave, redundancy pay and penalties and loadings under any applicable Award. Employees who earn less than the high-income threshold (currently $167,500 per annum) are also protected from unfair dismissal.
Employers are also responsible for PAYG tax withholding and paying payroll tax, having adequate workers compensation and public liability insurance, ensuring employee entitlements are paid, making and maintaining recordings relating to employee payments and are generally liable to third parties for acts by an employee, such as if an employee damages property of a third-party during work, the employer will be liable to compensate the injured party.
A contractor’s entitlements are typically governed solely by the terms of their contractor agreement and are responsible for providing their own tools and equipment, paying their own tax and superannuation, preparing quarterly BAS, maintaining their own insurance and are liable for any harm to third parties caused by them. Contractors also typically earn higher fees than employees performing comparable work to compensate for their loss of entitlements and may have different tax obligations and benefits.
Significant rights and obligations are therefore triggered by a person’s characterisation as an employee or contractor. If the parties get it wrong, and a company incorrectly engages an employee as a contractor, the consequences can be disastrous and may lead to litigation and orders for the company to pay accrued employment entitlements and superannuation and may also lead to significant financial penalties being imposed against the company and against directors and officers personally. The problem is then compounded if more than one person has incorrectly been engaged as a contractor.
Contractors are not immune from financial loss either and can be penalised by the ATO if they are subsequently found to have been an employee and are required to have their income tax and deductions reassessed for the entire period they were incorrectly engaged as a contractor.
What is the test?
The primary test to determine whether a person is working in another’s business or conducting a business of their own is to look at the clear written contract that is in place. This will be decisive of the characterisation of the relationship, where the validity of the contract is not challenged as a sham, has not been varied after its commencement, or there is no conduct or circumstances showing that a term of the contract is legally ineffective.
Failing there being clear written contract, the courts will adopt a test requiring an examination of a wide range of factual matters that tend to indicate whether a person is working in another’s business or conducting a business of their own. Some of the key factors or ‘indicia’ the courts look at include:
- the degree of control which the business exercises over the person’s activities (the greater the control, the more likely the person is an employee);
- whether the business or the person are responsible for the supply of their own tools or equipment (supply by the person rather than the business suggests the person is a contractor, at least if the equipment is substantial);
- whether the business presents the worker to its clients or the market generally as being part of the business. This could include providing a company email address, advertising a staff profile on the company website, providing business cards or other stationary or requiring uniforms to be worn;
- Whether the worker can accrue business goodwill in through the work they perform for the company;
- Whether the worker can sub-contract their work out to others;
- the extent to which the person has other business activities and is free to organise his or her time and work arrangements as he or she wishes; and,
- whether the person provides tax invoices and is responsible for deducting their own tax and taking out business insurance.
The above indicia are still appropriate for the courts to look at if a clear written contract is in place, but it must be applied by reference to the parties’ rights and obligations under the contract, not to the post-contractual conduct of the parties. For example, the way in which the written contract addresses how remuneration occurs, the level of control over work hours and if work must be accepted, the way work is conducted, holiday entitlements, supply of tools and equipment, and the ability to subcontract work may demonstrate that no employment contract exists.
Also relevant, but not determinative is whether or not the parties believed the worker was a contractor.
How do you weigh up these factors?
There have been cases where one court found that a courier was a contractor for the purpose of an income tax dispute, but then different court found a different courier engaged by the same business was an employee in a personal injury claim brought against the business by a member of the public.
Other examples include:
- An authorised representative for a financial services provider that operated an incorporated business and employed his own staff was, nevertheless held to be an employee of the financial services provider;
- A fast food delivery driver was held to be a contractor because the contract did not require the worker to work any specific hours and therefore the worker could determine when and how often they performed work; and
- A hotel cleaner, engaged through a labour hire agency that provided her services to a hotel, was held to be an employee of the hotel she worked at and not an employee of the labour hire agency.
However, it should be noted that the courts now have a more streamlined test to follow where a clear written contract exists by which they can directly refer to the rights and obligations of the parties.
What should businesses do to manage these issues?
While it is very difficult to anticipate what a court will decide when faced with this problem, it is possible to identify risks within your business, and to identify steps business can take to mitigate against an adverse finding by a court. Some common areas of risk we see are:
- Where a person was originally engaged genuinely as a contractor but over time, their role within the business has changed so that now they are more likely than not to be an employee;
- Employees, and in particular, senior employees that request to be engaged as a contractor for tax minimisation purposes;
- Where the contract between the parties imposes conditions on the contractor that are inconsistent with the contractor operating their own business, such as the inclusion of non-compete restraint of trade terms and restrictions around working for, or marketing to third parties;
- Where the contractor is engaged to provide unskilled or semi-skilled labour and is therefore highly unlikely to be operating a genuine business; and
- Where the formal contractual terms do not reflect the reality of the relationship between the worker and the company, or where no clear written contract exists at all.
It is also important to make sure that all contracts and other documents, and the systems and operations of the business, are consistent with the desired status. Whichever side of the line you want to be on, it is critical to have a clear written contact to govern the relationship, and that you act consistently with the contract and status intended.
Liability to pay superannuation, PAYG tax, workers compensation and payroll tax can depend on the employee vs contractor issue, but the rules are complex, and businesses need to be aware of the possible liabilities even if the person is a contractor.
How can Coleman Greig help you?
Coleman Greig’s employment lawyers can assist you by analysing contractor/employee issues and can advise you on the factors which are likely to indicate whether a person is an employee or whether they can be engaged as a contractor and how to structure contractor engagement to reduce the risk of a Court later determining that they are an employee. Coleman Greig can also draft contractor agreements that comply with current legal requirements while also clearly defining the nature of the position and performance expectations.
Disclaimer: The information provided above is a general summary and is not intended to be nor should it be relied upon as a substitute for legal or other professional advice.