There are times when a company prefers to hire a contractor rather than a permanent employee as it may be more cost effective and flexible to meet the short-term demand of the business. In most cases, the relationship between an employer and an employee/independent contractor is clear cut. However, sometimes the true character of the relationship can be unclear, and a ‘contractor’ can also be regarded as an employee under the law.
While the line is not always clear, it is important for companies to be able to distinguish whether an individual is an employee or a contractor.
The common law tests
The courts generally adopt the Common Law Test to determine whether an individual should be treated as an employee or an independent contractor. Under the tests, the following key indicators (not an exhaustive list) are taken into consideration to determine whether an individual is an employee or independent contractor.
| Employee | Contractor | |
| Control | Told what, how and when a work is to be completed and operates within a business.
| Engaged to achieve a specific result and operates on his/her own account. |
| "Results" contract | Ongoing relationship with employer and not only employed to achieve a specific result | Where the substance of a contract is to achieve a specific result, there is a strong (but not conclusive) indication that the contract is one for services.
|
| Exclusive service | Contractually required to personally perform the work. | Freedom to subcontract or delegate the work to a third-party labour and paid an agreed sum consideration for the job to be completed.
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| Risk | Bears little or no-risk for mistakes in carrying out the work and employer bears the costs for injury as a result of carrying out work.
| Required to complete the work and rectify any mistakes at own cost. Bear losses if unable to deliver the work. |
| Whether the individual performs work for others. | Only perform work exclusively for the employer.
| Freedom to take on multiple jobs at the same time. |
| Provision of tools and equipment and payment of business expenses | Tools and equipment are generally provided by employer. If the employee is required to purchase a tool for carrying out the work, he/she will be reimbursed by the employer.
| Have their own set of tools and equipment to carry out the work. Generally will not be reimbursed if they are required to purchase a tool to carry out the work. |
|
| Employee (con’t) | Contractor (con’t) |
| Other factors | Entitled to benefits such as annual leave, sick and long service leave.
| Not entitled to leave (per contractual agreement). |
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| Required to adhere to fixed working hours and generally receive salary/wages hourly, weekly or monthly.
The employer has the rights to suspend or dismiss the employee.
| Flexible in performing work in their own set/agreed time, as long as they are able to complete the work.
Generally paid according to service performed where a tax invoice is issued. |
Tax and superannuation reporting obligation
The tax and superannuation reporting obligation are different for employee and contractor. Where an individual is an employee of the company, the company is required to:
- Withhold and pay PAYG Withholding on salary/wages to the Australian Tax Office (ATO)
- Pay superannuation guarantee
- Report and pay fringe benefits tax for benefits provided to the employee
- Pay workcover
- Report and pay payroll tax.
Where an individual is a contractor of the company, the individual would be responsible for his/her own tax and reporting obligations. There is no requirement for the company to withhold tax from payments made to a contractor unless the contractor request for tax to be withheld.
However, it is important to note that according to subsection 12(3) of the Superannuation Guarantee (Administration) Act 1992 (SGAA), Superannuation Guarantee applies to a person who works under a contract that is wholly or principally for the labour of the person, the person is an employee of the other party to the contract.
According to the Superannuation Guarantee (SG) Ruling 2005/1, subsection 12(3) was intended to extend the scope of the SGAA beyond traditional employment relationships to take into account some independent contractors who principally provide their own labour to meet obligations under a contract. The commissioner has further explained that for the purposes of subsection 12(3), where the terms of the contract in light of the subsequent conduct of the parties indicate that:
- The individual is remunerated (either wholly or principally) for their personal labour and skills;
- The individual must perform the contractual work personally (there is no right of delegation); and
- The individual is not paid to achieve a result,
The contract is considered to be wholly and principally for the labour of the individual engaged and he or she will be an employee for SG purposes.
To summarise, if a company engage an individual as a contractor, the company will be required to pay SG contributions to that individual if the nature of the contract between the company and the contractor satisfies the 3 conditions outlined above.
How can we help?
A&A Tax Legal Consulting would be pleased to discuss any aspect of this blog and provide you with further information. Please contact us at +613 9939 4488 if you require any assistance from us.