As an employer it is crucial that you understand the difference between employees and contractors.
The obvious benefit of engaging a contractor is that you don’t have to remit tax and superannuation payments to the Australian Taxation Office (ATO) on their behalf. However, misclassifying your employee as a contractor can have significant consequences.
What is the difference between an employee and a contractor?
The key difference between employees and contractors is that:
- an employee works in your business and is part of your business;
- a contractor is running their own business.
You are able to determine whether a worker is an employee or contractor by taking into consideration the below criteria.
Employees are unable to subcontract/delegate work by paying someone else to do the work, whereas contractors are able to pay someone else to perform the agreed service.
Basis of Payment
Employees are paid for the time they work, whereas contractors are paid as a result of completion of:
- an agreed service;
- at an agreed price quoted.
Equipment, Tools and Assets
Employees will use equipment and tools provided by your employer, whereas contractors:
- provide all of the equipment or tools required to complete the work; and
- do not receive reimbursement for the costs associated with the equipment and tools.
Commercial and Financial Risk
Employees take no commercial risks and are not legally responsible for the work they complete or any costs associated with rectifying problems with their work. This differs from contractors which takes all commercial risk as they are legally responsible for their work and liable for the costs associated with rectifying any problems.
Control over Work
Employees have no control over the work they complete and are directed by the principal, whereas contractors are free to choose the way their work is completed, subject to any agreed terms in a contract.
Employees are generally engaged to provide general services, whereas contractors are generally engaged to achieve a specific result within a specified period.
Acceptance/Refusal of Work
An employee cannot accept or refuse work, whereas a contractor is free to accept or refuse work.
An employee will not be operating independently of your business, whereas a contractor will be operating their own independent business and may maintain any relevant licences or insurance policies that are separate from your business. This is because employees have limited independence when engaged by an employer.
Provision of Services
An employee provides services for the principal business only, whereas a contractor may provide services to the general public and/or other businesses.
How do tax and super obligations differ between employees and contractors?
Your tax, super and other obligations will vary depending on whether your worker is an employee or contractor.
If your worker is an employee you’ll need to:
- withhold tax (PAYG withholding) from their wages and report and pay the withheld amounts to the ATO;
- pay super, at least quarterly, for eligible employees; and
- report and pay fringe benefits tax (FBT) if you provide your employee with fringe benefits.
If your worker is a contractor:
- they generally look after their own tax obligations, so you don’t have to withhold from payments to them unless they don’t quote their ABN to you, or you have a voluntary agreement with them to withhold tax from their payments;
- you may still have to pay super for individual contractors if the contract is principally for their labour;
- you don’t have FBT obligations.
What are the consequences of incorrectly classifying workers?
It’s against the law for a business to incorrectly treat their employees as contractors.
If you’re incorrectly treating an employee as a contractor, you will be liable for a range of penalties and charges including:
- PAYG withholding penalty – for failing to deduct tax from worker payments and send it to the ATO;
- super guarantee charge, made up of super guarantee shortfall amounts (the amount of super contributions that should have been paid into a complying fund), interest charges and an administration fee; and
- additional super guarantee charge of up to 200%.
In addition to the super guarantee charge – which imposes nominal interest and an administrative charge in all cases on top of the super guarantee shortfall – you may also be liable for additional penalties of up to 200% of the super guarantee charge.
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