Accounting and Tax

Making the distinction between employees and contractors

3 March 2021
3 min read

3 March 2021

It is important for your business to know whether its workers are employees or contractors as significant penalties and charges may apply if you have classified your workers incorrectly.

In broad terms, an employee works in your business and is part of your business whereas a contractor is running their own business and completes work for your business.

Some of the main differences in taxation and superannuation treatment between employees and contractors are:

  • For employees you must withhold PAYG withholding from the employee’s wages and report and pay the withheld amounts to the ATO whereas for contractors you don’t need to withhold from their payments unless they did not quote their ABN to you or you have a voluntary agreement with them to withhold tax from their payments;

  • Eligible employees must be paid superannuation at least quarterly whereas you may only have to pay superannuation for individual contractors if the contract is principally for their labour.

  • You must report and pay fringe benefits tax (FBT) to employees if you provide them with fringe benefits whereas there are no FBT obligations where benefits are provided to contractors.

Although the contract between the parties is a key piece of evidence, various other factors are also considered to determine whether the relationship is one of an employee or contractor. Taken together, the factors below can help indicate whether a worker is an employee or contractor of your business:

  • An employee is not able to subcontract, delegate or pay someone else to do the work whereas a contractor can.

  • An employee is generally paid either for the time worked, a commission or a price per item or activity whereas a contractor is paid for a result achieved based on the quote they have provided (e.g. hourly rate or price per item of work).

  • A contractor provides all or most of the equipment, tools and other assets required to complete the work and does not receive an allowance or reimbursement for providing their own tools. Employees, on the other hand, are provided most of the equipment, tools and other assets required to complete the work by the employer. Should the employee need to provide their own equipment, tools and other assets to complete the work, they can receive an allowance or reimbursement from their employer.

  • An employee takes no commercial risks for sub-standard work and is not liable for the cost of rectifying any defect in their work whereas a contractor takes commercial risks and would be liable for the cost of rectifying any defect in their work.

  • A contractor has more freedom to decide how to do the work subject to the terms of any contract of agreement whereas the employee must do the work as directed by the employer.

  • An employee does not operate independently of the business and is a part of the employer’s business whereas a contractor is operating their own business independently of your business.

The Courts have adopted a multi-factor test to consider a range of factors when determining whether a worker is an employee or independent contractor. The weight attributed to each factor considered varies depending on the particular work arrangement in question.

If you require assistance with the employee/contractor distinction or if you want to talk about any other employment tax issue, please speak to your adviser or get in touch with the Findex Tax Advisory team.