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Why do so many business owners think it is a good idea to take on a worker as “independent contractor” instead of as employee? There are so many court cases involving businesses that have tried to make their workers independent contractors, and there are hardly any where the courts have ruled in favour of the business owner.

The perceived advantages in engaging workers as independent contractors:

• No responsibility to provide paid annual leave, sick leave, long service leave or redundancy pay.
• No minimum wages or award conditions of employment.
• Avoid the administration hassle of withholding PAYG tax from wages and complying with Single Touch Payroll.
• Avoid the expense of paying superannuation, workers compensation or payroll tax if the worker is a contractor instead of an employee.
• There are tax advantages for the workers if they are in their own businesses. Businesses have more options for claiming expenses as tax deductions than employees, and may be able to redirect income to family members on low tax rates.

The reality

While they can apply to a genuine independent contractor, these advantages do not apply if it is found that the worker is in fact an employee. Even if the worker is a genuine independent contractor, superannuation guarantee, workers compensation, payroll tax also apply to contractors who charge mainly for their labour. The tax advantages will not apply if the arrangement falls foul of the Personal Services Income tax rules.

What determines whether a worker is an employee or a contractor is not what the parties call the arrangement, or even what they genuinely believe the arrangement to be. The question is determined by the actual circumstances of the working relationship regardless of what the contract says. There have been cases where the terms of the contract indicated that the worker was a contractor, yet the actual conditions of work were those of employment. In these cases the contract was held to be a sham.

What determines if a worker is a contractor or an employee?

Because terms of engagement can vary so much there is no single factor that divides between employees and contractors. There are seven factors that courts look at when deciding if a worker is a contractor or an employee:

Nature of work provided

• Contractors are separate businesses that provide ancillary services to your business.
• Employees are part of your business and their work is central to your business. Freight companies and call centre operators were unsuccessful in arguing that their workers were contractors because the drivers and telephone staff were providing the core services of these businesses.

Ability to sub-contract or delegate

• A contractor is providing a service so they can pay someone else to provide the service.
• An employee is engaged for their own skills and labour – they cannot get someone else to do their work for them.

Basis of payment

• You pay a contractor based on a quote they gave to provide a certain result.
• An employee may be paid for time worked, a piecework rate, or a commission.

Equipment, tools and vehicles

• A contractor provides all or most of the assets needed to achieve the contracted result.
• Your business provides the tools and assets needed by an employee, or else pays the employee an allowance or reimburses the employee for providing the tools or vehicle.

Commercial risk

• A contractor takes commercial risks, with the worker being legally liable for their work and the cost of rectifying any defects.
• An employee takes no commercial risks. Your business pays the employee to rectify defective work.

Control over the work

• A contractor may carry out the work as they see fit. Their only restrictions are specific terms in the contract.
• You have the right to direct the way your employee does their work.

Independence

• A contractor is independent of your business, and is free to accept or refuse work from you or any other business.
• An employee does not operate independently from your business. There have been cases where so-called contractors were found to be employees because (among other things) they were required to wear the uniform of the employing business.

What factors do not determine the issue

It is irrelevant whether the worker has an ABN, has a business name, or registers for GST! A person can have all of these and still be an employee! Often the arrangement with the worker contains features of both a contractor and an employee. In these cases the courts have looked at the predominant features.

Whether the worker is engaged for a short period or only for a few hours a week is also no indication of them being a contractor. An employee may be employed on a casual or a part-time basis.

Courts look at the actual working relationship. For example, the contract may state that the contractor is required to rectify defects at their own expense, but in actual fact the business has paid workers for the time taken for rectification.

Even where the worker operates through a partnership or a company, courts have on occasion ruled that the facts showed that the contract was really with the individual instead of being with the separate entity!

Some workers that courts have held to be employees:

• Real estate agents
• Shop assistants
• Cleaners
• Telesales and telemarketing workers
• Call centre workers
• Hair and beauty workers
• panel beater
• security guards
• vegetable peelers
• courier drivers
• market survey workers

Some of these employees, such as estate agents and courier drivers, could have been contractors under different circumstances.  On the other hand whoever heard of a shop assistant service business!

Before you take on a worker as a contractor always use the ATO’s Employee/Contractor Decision Tool.

If you incorrectly engage an worker as a contractor you run a serious risk.

Several government agencies police this issue:

• The Fair Work Ombudsman is there to ensure workers receive their legal entitlements. “Sham contracting” (treating an employee as a contractor) is illegal under the Fair Work Act.
• The Australian Taxation Office (as responsible for the Superannuation Guarantee Charge) ensures that businesses make superannuation contributions for workers, including contractors whose services are mainly providing labour.
• The Australian Taxation Office (as Registrar of the Australian Business Register) restricts the issue of ABNs to genuine businesses. For a contractor who is really an employee to obtain an ABN it is necessary to provide false information about the nature of the working relationship. In this case the ATO can cancel the ABN and impose penalties for providing false information.
• The Australian Taxation Office also enforces the Personal Services Income provisions in the income tax law, which limit the tax deductions and income-splitting opportunities to those that apply to employees.
• The state revenue offices enforce payroll tax, including tax on payments to contractors providing labour.
• WorkCover audits businesses to ensure that they are paying the correct workers compensation insurance premiums for employees and contractors.
• These government organisations also share information between themselves!

The penalties can be significant:

• Just having to pay a number of years’ unpaid employee entitlements can be a major shock to a small business.
• Unpaid worker superannuation is subject to the Superannuation Guarantee Charge. This is calculated on total employee earnings (not just ordinary time earnings), is subject to interest on the late payment and is not tax deductible. Directors of companies can be personally liable for unpaid super, so even limited liability will not help in this case!
• For sham contracting under the Fair Work Act the courts can levy fines of up to $51,000 per contravention. For a company the directors can be fined as well as the company.
• Even if the matter does not go to court, the Fair Work Ombudsman can impose Enforceable Undertakings to ensure that the contravention is not repeated. This includes things like compulsory training and also publicly acknowledging the contravention.

It is so easy to be caught!

Only one disgruntled ex-employee can bring down a storm of trouble on your business!

It is just not worth it!