Employee vs contractor: are you 100% certain you know the difference?

On paper, the line between employee and contractor seems very clear.

An employee works for your business as a part of your business. As their employer, you are responsible for paying their taxes and superannuation, as well as providing paid leave and other entitlements.

A contractor, on the other hand, supplies services to your business through their own business.
They are responsible for their own tax and super arrangements and do not receive any employee entitlements.

All good, right? Absolutely. Well, that is, until we’re looking at these things in person. Then it’s a little less clear-cut.

The gig’s up: how contracting sometimes wanders into a ‘grey area’

Businesses are increasingly comfortable using freelancers and contractors – and why not? The work gets done – often more efficiently. The biggest plus, of course, is that you save yourself the costs of recruitment and employee entitlements.

Contractors, who now make up 8% of the Australian workforce, often enjoy the arrangement too. Working for themselves gives them the flexibility to choose what kind of work they do, as well as when (and often where) they do it. They also get to set their own rate of pay.

But this rising ‘gig economy’ has started to blur the lines when it comes to who works with and for your business.

What happens when a small business starts to take up most of a contractor’s time? They can sometimes come to view a contractor as ‘one of the team’ and even seek to restrict the contractor’s ability to work with other clients.

This leaves contractors vulnerable: if they lose that ‘big fish’ client, they are left with no work and no severance entitlements. They’ve been engaged as a contractor but treated as an employee… only with none of the perks.

Don’t let your business get caught in an accidental “sham contract”!

The Federal Government is cracking down on what they call “sham contracts”. If they decide that you have been treating employees like contractors, you could face penalties for not meeting your tax and super obligations – even if you didn’t realise that your arrangements with an employee weren’t compliant.

You need a way to help you decide whether someone is working with your business, or for your business…

Six questions to help you clear up the confusion about contractors:

1. Can this person sub-contract/delegate their work? Contractors can to pay someone else to do their work in their place. For example, if your cleaning contractor is unwell, they may have another suitable cleaner do the job in their place. You would pay them as normal and they would then pay the person they subcontracted the work to. An employee does not have this power.
2. How are they paid? Employees are paid according to the hours, output (items or activities) or on commission. Contractors are paid according to an agreed result outlined in the quote they have provided. Their hours or output may be used to work out the total cost of the work they perform.
3. Who supplies/pays for tools and other assets related to their work? Employees must be supplied with (or reimbursed by their employers for the purchase of) the tools or equipment etc required to carry out their work. Contractors typically supply their own assets, tools and equipment.
4. Who shoulders the risk? Employees take no legal responsibility for their work. A contractor takes on the risk and responsibility related to their work and is liable for the cost of fixing any errors.  
5. Who has control over their work? A contractor has the ability to determine how their work is done as long as it fits with the terms of their contract (which should specify elements such as the timeframe, budget and agreed outcomes). Employees have little or no control over the work they do (ie the business determines what, where when and how the work is done).
6. Are they independent of your business? If someone wears your business’ uniform, takes part in training you provide, works as part of your team or is expected to take on additional work as required, then they are an If, on the other hand, they supply their own equipment, tools or training, shoulder the risk of any negative outcomes of their work, are free to turn down work offered by your business and take on other clients… well then, they likely a contractor.

NB: if you’re still feeling a bit confused about how to determine the status of someone working in your business, the ATO has a handy “employee/contractor decision tool” that might help you clear things up.

Six dos and don’ts of using contractors in your small business

Do:

• Be honest with yourself about what you need in your business. For example, if you’re after someone who will become a part of your team and be invested in the long-term success of your business, then a contractor may not be the way to go.
• Be clear on the scope of the work you want performed and the outcome you expect from that work. As previously stated, contractors are engaged on this basis, as opposed to an employee who is often engaged in terms of the hours they work.
• Take the time to formulate and agree upon clear terms and conditions for working with a contractor before you both sign on the dotted line. It can be a good idea to have a lawyer check over everything for added peace of mind.

 

Don’t:

• Assume that having an employee get an ABN transforms them into a contractor. This alone does not mitigate a person’s ‘employee’ status in your business.
• Rely too heavily on one contractor to supply a function within your business. Having a policy of rotating contractors regularly can avoid accidentally slipping into ‘employee’ territory
• Get lax about your engagement of a contractor and start treating them as ‘part of the business’. Maintain clear boundaries and communication: check yourself before you get annoyed at them for taking on new clients or refusing extra work.

 

Employ right, sleep tight

Contracting offers many benefits to both contractors and businesses alike. However, treating someone who is really an employee as if they are a contractor could land you in some serious hot water. If you aren’t sure how to categorise the work someone does for or in your business, the six questions outlined above should provide some clarity. If you can get the contractor relationship right, you can enjoy those great benefits for your business and rest easy that you’re meeting your obligations to the people you work with.