Talking Cents

Small business accountant in Sydney tells you what is the difference between an employee and a contractor

In our modern mobile economy an increasing number of individuals are seeking the freedom of working for themselves and hiring out their skillset as contractors. This presents a conundrum for the employer or small business owner. We often get asked “What’s the difference between an employee and a contractor and why does it matter?”

Employee or Contractor? What’s the difference?

Note that where a subcontractor has their own private company with an ACN and ABN, they are safely treated as a subcontractor and you need not worry any further as they are treated as a separate business. However, the criteria for deciding whether payments to individuals are in the nature of an employer/employee relationship or a contractor/subcontractor relationship can be broken down into six key criteria that all need to be considered before making a decision.

1. Does the worker have the power to sub-delegate the requested tasks? If not, they are more likely to be an employee than sub-contractor.
2. How do you pay them? If you pay the person on hours worked or item completed basis they are more likely to be an employee. If you pay them on completion of a set result then they are more likely to be a contractor.
3. Does the worker provide their own equipment or do you supply it for them? If you supply your worker with all the necessary equipment then they are more likely to be an employee than a contractor.
4. Who is legally responsible for the work performed? If the worker is legally liable for rectifying any defects then they are more likely to be a contractor.
5. Does the worker have complete freedom to complete the tasks? If not, they are an employee.
6. Does the worker operate an independent business? If so, they are more likely to be a contractor, if not, then they are more likely to be an employee.

Employee or Contractor? Why does it matter?

The consequences in terms of potential fines and penalties can be significant enough to send a small business to the wall. If you treat an individual as a contractor and they are later deemed to be an employee by the ATO or a state-based body then the following consequences can be expected:

1. You will be held liable for SGC superannuation (currently 9.5%) on top of what you paid them as a subcontractor. Plus applicable penalties. As an extra slug, these SGC amounts are not tax deductible once paid.
2. You will also be held liable for PAYG withholding on payments made to subcontractors. Plus applicable penalties.
3. You may also be fined for not submitting an annual PAYG payment summary for deemed employees.
4. In NSW subcontractors deemed to be employees must also be included for payroll tax calculations. If not the OSR can impose penalties and back charges.
5. In NSW subcontractors deemed to be employees must also be included in gross wages for works compensation premium calculations.
6. Fairwork Australia may also have a say and deem that such cases will also involve leave entitlements that you have avoided by treating an employee as a subcontractor incorrectly.

As you can see the consequences of getting this wrong can be quite disastrous, so it pays to err on the cautious side. Even if an individual comes to you with an ABN and wants to be paid as a subcontractor and you agree to it, you as the business director/owner will be the one held liable for engaging their services incorrectly. In such cases, you must either say no or take them on properly as an employee, even if it is just on a temporary or casual basis.

With our modern open economy, this issue is becoming more and more predominant. As a consequence you can appreciate that the ATO are cracking down on such practices with increasing focus on industries where it is prevalent, such as the construction and IT sectors.

Your options are either to employee them correctly, use a labour-hire firm and let them take the responsibility or only use sub-contractors that have their own genuine businesses, preferably operating as private companies. Whenever you engage an individual to perform work either for or on your business always consider the six key criteria and make a decision based purely on those criteria, don’t ever let the wishes of the individual in question sway you into making a decision that could come back to bite your business long after the individual has been paid and moved on.