Employee or Contractor? The Cost of Getting it Wrong in Australia
Engaging contractors to keep your employee headcount down can seem like a good idea – no tax, super or work cover obligations to worry about and you can finish them up when it suits you. But if it’s found they aren’t genuine contractors, you can be hundreds of thousands of dollars out of pocket. So how do you tell the difference between an employee and a contractor?
As we surge towards re-establishing our businesses in a post-COVID world, one of our main priorities is to ensure we are staffed up to meet the demand. Depending on what industry we’re in, there is a temptation to not “add to the payroll” in favour of bringing contractors on, where you pay a monthly invoice and leave it up to the contractor to sort out their tax and superannuation obligations.
That way, the cost of the contractor becomes an operating cost, rather than a wage cost and you are exempt from the normal employer obligations like payroll tax, superannuation and workers compensation. Makes life much simpler. Or does it?
The reality is that there is a clear distinction between an employee and a contractor and getting it wrong can be very costly.
Disguising an employee as a contractor is called Sham Contracting. And it is illegal.
Penalties for sham contracting can be (and have been) imposed by the courts. The maximum penalty is $13,320 for individuals and $66,600 for corporations per contravention. For some companies, who may have multiple sham contractors in their employment, penalties imposed have been in the hundreds of thousands of dollars.
What is the difference between an employee and a contractor?
Understanding this difference is important for businesses. You need to start with being very clear about what obligations you have to them (and the ATO) and what behaviours you expect from them.
To start with, look at what the relationship actually is. Our friends at lawpath.com.au sum it up simply by saying:
The relationship between you and your employee is a contract of service, but the relationship between you and an independent contractor is a contract for service.
Who is an Employee?
An employee is recruited to do a job on a position description outlining duties and stated lines of authority and/or reporting responsibilities. He/she is generally appointed for a probationary period and is given performance appraisals and salary reviews as decided by the principal/s of the company.
Other indicators that someone is an employee are:
If and when appropriate, or as standard practices within the company, the employee wears a uniform, signs a time sheet, reports to a manager and is expected to work as a team member and help other work mates in addition to his/her duties
An employer is not registered for an ABN and does not forward an invoice for monies earned
The employer is responsible to adhere to laws governing minimum rates of pay, holiday and paid leave, tax, and superannuation rules and regulations
Employees are on an Employer’s Payroll, dependent on and responsible to the employer
In short, an employee works to the instructions and directions of the company and carries no financial risk – the employer manages everything to do with their employment.
Who is a Contractor?
A contractor is a person who agrees to complete a specific task for the company but is not part of the company.
Contractors work for themselves, usually have a specialised skill/and or profession and are employed to perform specific tasks on an infinite freelance basis or contracted period of time and can meet the criteria below:
They don’t have a minimum pay rate dictated by an Award but rather negotiate a fee for the work that is required
Don’t receive leave as prescribed for employees
They have their own Australian Business Number (ABN), and generally have a Registered Business Name, pay their own Tax, GST and Superannuation, and spend their own remuneration on personal business expenses
They engage in basic business transactions such as invoicing, personal insurance coverage and maintenance of financial and business records
They also usually provide their own tools and equipments to do the work, advertise their own brand name and promote business to the general public
They tend to dictate the manner in which work is completed, what hours will be worked, and can delegate their work to subcontractors who are not employees of the employer
They are paid upon completion of agreed tasks, rather than a salary for hours worked
Contractors have independent authority and are responsible for their own work incomes
What is Sham Contracting?
Sham contracting is a term used to describe the situation where a worker is engaged by a company as an independent contractor when in fact, they should be engaged as an employee.
It can be tricky making the distinction between a contractor and an employee. Even though someone has been brought on as a contractor, there is an element of their services that are dictated by, and supervised by the company. There may also be an agreement about the hours that are worked.
How do I know if a person is an employee or an independent contractor?
To avoid falling into the trap of sham contracting, applying the ‘common law’ test is a good idea before any arrangements are entered into. Also referred to as the ‘multi-factor’ test, this involves identifying and weighing up various features of the relationship to see where the balance lies. This table extracts some common features that courts have considered:
|Measure of control exercised by the Principal/Employer||Employer usually has the right to control how, when and where a worker performs their duties. Tasks are usually performed at request of employer.||Contractor works at own initiative to achieve a stated result. Contractor maintains discretion and flexibility as to how work is completed, although contract may specify some terms as to materials used and methods of performance.|
|Exclusivity||Employee usually works exclusively for employer.||Contractor is free to provide services to multiple clients.|
|Right to delegate||Employee is personally engaged to perform the role and has no inherent right to delegate performance of the role to another employee, unless authorised by employer.||Contractor may delegate all, or some, tasks to another person and may employ other persons to perform the services (although this may be subject to the principal’s consent).|
|Risk, rectification of faults||Employee bears little or no responsibility to rectify poor work. Employer is responsible to others for poor work of employee.||Contractor must rectify poor work at own cost and effort and bears commercial risk of loss incurred by principal due to contractor’s poor work.|
|Tools and equipment||Employee generally performs work using tools and equipment provided by employer, at employer’s place of work. Employee is generally reimbursed for expenses personally incurred by them in performing work, as long as they are authorised by the employer.||Contractor generally provides their own tools and equipment. Contractors are not usually reimbursed for expenses they incur in providing the services.|
|Hours of work||Employee has hours of work set by employer.||Contractor can set their own hours of work, as long as they perform the services.|
|Leave entitlements||Employee is entitled to annual leave, long service leave and sick leave, and this is usually provided for in written contract. Written contractor agreement would not usually provide for these things.||Contractor is not entitled to paid leave and the written agreement does not provide for it.|
|Payment||Employee is generally paid for their time, e.g. hourly, weekly, annual salary.||Contractor is generally paid for providing services or completing units of work. Contractor issues tax invoices.|
|Method of engagement||Employees are always personally engaged.||If an individual is engaged through a trust, partnership or company, this usually indicates a contractor relationship.|
|Part of the business||The work of an employee is usually essential to the business carried on by the employer. Employee is working in the business of the employer.||Contractor carries on their own business, independently of the employer and as distinct from the employer’s business.|
What are the penalties for getting it wrong?
The maximum penalty is $13,320 for individuals and $66,600 for corporations per contravention. For some companies, who may have multiple sham contractors in their employment, penalties imposed have been in the hundreds of thousands of dollars.
Additionally, if you have incorrectly classified an individual as a contract, you may be required to back pay:
- Superannuation charges
- Additional payroll tax (including penalties and interest)
- Unpaid penalties under a modern award
- Unpaid annual and long service leave
- Compensation for unfair dismissal or for other prohibited conduct
While there are numerous Fair Work Commission decisions to be found, here are just a couple of case studies that might help you understand the difference between an employee and a contractor. In both cases, the independent contractors were deemed to be employees and their employers are up for back paying superannuation and leave entitlements.
In Jamsek v ZG Operations Australia Pty Ltd  FCAFC 119, a Full Court of the Federal Court found that two drivers who had worked for the company for 35 years were employees and not independent contractors.
The trial judge found that they were independent contractors because they:
- Chose, paid for and maintained their trucks
- Formed business partnerships, issued invoices and paid GST
- Organised their own runs and arranged for replacement drivers when they were on leave
However, the Full Court disagreed, finding that the pair did not have sufficient control or autonomy to be genuinely independent. It took into account the fact that they:
- Worked set hours and days
- Marked their trucks with the company’s logo, and sometimes wore the company’s uniform
- Could not work for other clients
- Were told what to deliver each day
- Had been taken on as employees and then told to become contractors
Compensation has not yet been awarded but is likely to include 35-years’ worth of annual and long service leave. The employer also faces possible penalties.
In Aster Home Nursing Service Pty Ltd v Peel  FWCFB 6760, the Fair Work Commission Full Bench found that a Nurse was an employee and not an independent contractor. The Nurse was engaged as a contractor to provide home-care Nursing Services to patients on behalf of Aster Home Nursing Service.
The Commissioner found that there were a number of indicia which clearly pointed to an employment relationship, including:
- The nurse was not conducting a valid business of her own. The patients to whom she provided services were sourced by Aster through its commercial contractual arrangements and then assigned to her
- The nurse did not have the capacity to increase or decrease the number of patients, thus control her income or her time
- The nurse was expressly restrained from entering into any separate contractual arrangements with any of the patients
- The nurse’s primary source of income was from Aster
- The day to day activities of the nurse were directed by Aster
- The nurse was not permitted to subcontract or delegate any of her duties if she was unable to provide them e.g. due to illness
- The nurse presented herself as an employee of Aster – name badge, business cards, folder and all paperwork were branded with Aster and an Aster-branded uniform was on order at the time of the hearing
Weigh up the Pros and Cons
Before jumping on the contractor bandwagon, be very clear about what you are wanting the person to do/achieve and what your obligations are. Being honest about the hours of work, the reporting lines, the pay cycle, the ability to subcontract, whether the agreement is exclusive or not may save you (and them) tens of thousands of dollars further down the track.
Just because someone has an ABN and can submit invoices doesn’t automatically mean they are a genuine independent contractor.
Think before you leap.
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