Employee or a Contractor – Contractual Differences

Sharon Givoni Consulting Intellectual Property

These days there is a blurred line as to whether you are legally considered an employee or a contractor. There are many different requirements and obligations for employers depending on if the worker is an employee or a contractor so it is an important question to answer.

Failing to correctly classify an employee or a contractor can also result in hefty penalties for a business and various missed entitlements for individuals.

At the most basic level, an employee is a person who is employed by a company or business to work for wages or salaries while a contractor provides labour or services pursuant to a contract or agreement.

The distinction between whether a work arrangement is a contract of employment or an agreement to provide services can be difficult to establish and is generally something that will be decided by a court or tribunal, rather than the label decided by the employer.

Are you an Employee or a Contractor?

There are numerous factors which determine whether you are considered an employee or a contractor. It is worth noting that no individual factor will determine whether a person is an employee or a contractor. Courts will look at the full workplace relationship between the parties in order to determine which title best suits the persons‘ employment.

Is there a contract?

It is far from unheard of and to a certain extent quite common for a business to engage a person to perform work and due to the time-sensitive nature of the work, fail to record the terms of engagement in a written form. Thus, if at a later stage a dispute is to arise as to whether the person is a contractor or an employee, or there is a dispute about the terms of the work, there may be a rather large disagreement between parties. This can then lead to litigation.

In order to avoid situations such as these, it is recommended that the terms of engagement are recorded in a written contract before the engagement commences with both parties signing. Even if the work has already been started, it is worth writing a contract and acknowledging that the engagement has already begun.

This being said, writing that an individual is a contractor in a written contract, or owning an Australian Business Number (ABN) or registered business name does not mean that this is determinative of the relationship. A court may still look behind the contract to determine the exact nature of the work relationship. Further, having a written contract does NOT mean that you can get out of your obligations under legislation.

What are the differences between an employee and a contractor?

Measure of Control

A relationship is more likely to be seen as an employment relationship where the employer exercises (or has the legal right to exercise) control over the work of the other party, including what work is performed, as well as when and where the worker performs their duties. This does not mean there must be direct supervision, rather it is a question regarding which party has the utmost authority over the performance of the work by the individual.

In contrast, a contractor works at their own initiative to achieve a certain result. They retain the discretion and flexibility as to how the work is completed. Employers may specify certain terms as to materials to be used or particular methods to be employed, however, a contractor will still maintain a high level of control as to how the work is done. 

Hours of Work

When it comes to the hours of work, an employee will generally have standard or set hours of work which are determined by the employer. This rule applies to casuals as well even though their hours tend to vary week to week.

A contractor, on the other hand, may decide what hours they work in order to complete the task. An agreement may deem a certain amount of hours worth of work be completed, but as for when these hours take place it is entirely at the discretion of the contractor.

Risk

Employees bear hardly any responsibility to rectify poor work. Rather the employer is responsible to others for poor work of an employee. Further employees tend to face no financial risk as this is also the responsibility of their employer. Employers also have obligations regarding the safety of their employees and have responsibilities from any injury that occurs during the course of their employment. 

Contractors, on the other hand, are responsible for their own conduct and any risks of making a profit or loss are their own. They typically bear the responsibility and liability for poor work or injury sustained from the work. Thus, it is common that contractors tend to have their own insurance policies. 

Expectations

Employees usually have an ongoing expectation of work while contractors are typically engaged for a specific task. It is also worth noting that some employees are engaged for a specific task or period of time.

Equipment and Tools

An employee is normally provided with tools and equipment necessary to perform the required work by their employers. Further, employees are generally reimbursed for any expenses personally incurred in performing the work as long as they are authorised by their employer.

In contrast, contractors typically provide their own equipment and tools and are not commonly reimbursed for expenses incurred for the provision of services.

Superannuation

Employees under the Superannuation Guarantee (Administration) Act 1992 (Cth) are entitled to superannuation contributions from their employers which are paid into a nominated superannuation fund. However, contractors typically pay their own superannuation. There are some circumstances where an employer may be entitled to pay an independent contractor superannuation contributions. 

The extended definition of ‘employee’ in the above act means that, if you engage an individual as a contractor, you may need to pay superannuation contributions for their benefit, even if your written contract with them does not provide for this and even if they use an ABN.

Method of Payment

Employees are paid on a regular basis. This typically consists of weekly, fortnightly or monthly payments. They are paid for the time worked, a price per item or activity, and/or a commission.

Contractors are not paid this way. Instead, a contractor will invoice the employer for work completed or is paid once the agreed upon work or task is finished. The amount paid is determined by the result achieved per the quote provided. A quote may be calculated on the basis of an hourly rate or price per item. 

Taxation

Employees have their income tax deducted by their employers. Contractors will pay their own tax and GST to the ATO. In most Australian states and territories there are specific contractor provisions which deem payments to independent contractors as part of ‘taxable wages’ which are subject to payroll tax. Western Australia is the only state that has yet to join the rest of Australia in these provisions. PAYG withholding also does not need to be withheld from any payments to a contractor if they are genuinely a contractor. 

Leave

Employees are entitled to receive paid leave or receive a loading in lieu of leave entitlements (i.e. casual employees). For example, these include annual leave, personal/carer’s leave, sick leave and long service leave.

Contractors do not receive any form of paid leave nor would a written contract or agreement typically provide any kind of leave.

Subcontracting and Delegation

An employee cannot subcontract or delegate the work they are hired for. Employees are personally engaged to perform the work and unable to pay someone else to do their work (unless authorised by the employer).

A contractor, however, is free to delegate some or all of the work to other persons. They may also employ other persons to perform the work (although this can be subject to the agreement with the employer). 

Exclusivity

An employee usually works exclusively for the employer while a contractor is free to provide their services to as many clients as they wish. 

Method of Engagement

Employees are normally engaged personally, typically through an interview process. 

An independent contractor may be engaged through a trust, partnership or company. This is usually a strong indicator of a contractor relationship. 

Business Status

An employee is part of the business and is working in the business for the employer. An employees work is typically essential to the business carried on by their employer. Further, an employee can be identified as part of the business through attire, for example, the work uniform that a worker is required to wear or the use of identifiers such as business cards. 

Alternatively, contractors own and run their own business. They are independent of the employer and their services are distinct from the employer’s business. The work they perform is specified by an agreement or contract and they are free to accept or refuse additional work. 

These are just some of the main considerations a court will look to in order to determine whether someone is an employee or a contractor. It is very important to know the difference as it affects your tax, superannuation and other government obligations and miscatergorisation can carry heavy penalties.

Employment Contract vs Contractor Agreement

Another important question is what is the difference between an employment contract and a contractor agreement?

An employment contract is an agreement between an employer and an employee that sets out the terms and conditions of the employment relationship. This may be written or verbal. It is highly recommended that a written agreement is made in order to clarify any and all obligations of the employer.

In contrast, an independent contractors agreement is a contract between a company/employer (usually known as the ‘principal’) and a party/entity providing a service (the contractor). This agreement sets out the services to be provided, the price for the services, dates or timelines for the provision of the services and any other conditions or obligations between the principal and the contractor.

These agreements or contracts will lay out the legal requirements of/for the employee or the contractor relationship. Some relevant provisions include:

• Insurance
• Taxation
• Payment
• Superannuation
• Reporting
• Subcontracting/Delegation
• Exclusivity
• Restraint of Trade/Non-Competition Clause
• Dispute Resolution Clause
• Terms of services
• General Standards – i.e. Hours, Leave
• Confidentiality Clause
• Special conditions
• Termination provisions

Consequences of Incorrectly Classifying Employment Type

Sham Contracting Arrangements

There are can be harsh penalties for failing to determine if a worker is an employee or a contractor.

A sham agreement, for example, occurs where an employer attempts to disguise an employer/employee relationship as that of an independent contractor relationship. This is typically done in order to avoid responsibility for employee entitlements. An employer, per the sham contracting provisions in the Fair Work Act 2009 cannot:

• misrepresent an employment relationship or a proposed employment arrangement as an independent contracting arrangement
• dismiss or threaten to dismiss an employee for the purpose of engaging them as an independent contractor
• make a knowingly false statement to persuade or influence an employee to become an independent contractor

These sham contracting provisions were recently addressed by the High Court in the Fair Work Ombudsman v Quest South Perth Holdings Pty Ltd [2015] HCA 45 (‘FWO v Quest‘) case. 

Quest had originally employed two employees as cleaners. Quest attempted to convert these employees to independent contractors through a triangular agreement with Contracting Solutions Pty Ltd (‘Contracting Solutions‘). 

It was held in the Full Federal Court that the attempted conversion was never effected, and Quest was found liable for representing to the employees that they were contractors of Contracting Solutions engaged to perform work for Quest, rather than employees employed by Quest itself.

The Full Courts decision in finding that Quest had not breached the sham contracting arrangements provisions on the basis that the representation it made was not about the relationship between Quest and the employees, but actually, the relationship between Contracting Solutions and its employees was consequently overturned by the High Court.

The  High Court’s decision is important as it means an organisation will be liable for a misrepresentation about the relationship between an employee of a company or business, no matter the ‘counterparty’ of which the representation is made. Thus if an employer wishes to enter into a triangular arrangement, or is unsure of whether they have classified the working relationship correctly, they must ensure that the contracting agreement is properly constructed.

If it is not, the Fair Work Act 2009 provides serious penalties for failing to determine if a worker is an employee or a contractor, and for contraventions of the sham contracting provisions.

Penalties of Misclassification

Businesses that fail to correctly determine whether a worker is an employee or a contractor could face penalties including:

• Monetary penalties for failing to meet PAYG withholding requirements;
• A super guarantee charge for failing to make the correct superannuation contributions, consisting of the shortfall (up to date payments), the interest on the shortfall and an administrative fee.

Further, Courts may impose a maximum penalty of $12,600 for individuals and $63,000 for corporations per contravention of the sham contracting arrangement provisions.

Further, an injunction or an interim injunction may be sought if an employer seeks or threatens to dismiss an employee for the purpose of engaging them as an independent contractor. Courts may also make other orders to have an employee reinstated or compensated.

What should you do?

Before taking on an employee, you must confirm whether they are an employee or a contractor. This must be determined before entering into an agreement or contract. You must also keep records to support your decision as to whether the person you wish to take on is an employee or a contractor. These records should include any factors you relied upon in making this decision. 

Sharon Givoni Consulting can help you if you require assistance in drafting an employment or a contractor agreement, or need advice in relation to employment/contractor relationships.

You can also book a free 15 minute consultation to discuss your enquiry below.