What's the Difference Between an Employee and an Independent Contractor?

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Work culture in Australia has been rapidly changing in recent years. Because of this, many companies are choosing to create a workforce based on what works for them, hiring employees for some roles through an Employment Agreement, and hiring contractors for other roles through a Service Agreement. In this respect, independent contractors have been a growing segment of the workforce, with many businesses choosing to create a team based on multiple different working relationships, employees and contractors alike.

If you run a business and are thinking about hiring independent contractors, it's important to know exactly how contractors differ from employees. It is against the law for a business to incorrectly treat a worker as a contractor when they should be treated as an employee. In doing this, the business will be neglecting its various obligations such as payment of superannuation and employee entitlements. There can also be significant penalties associated with this.

Here, we'll discuss the significant differences between employees and independent contractors and will help you figure out exactly which work structure is right for your business.

What defines an employee?

Generally, employees work in your business and are a part of your business. Companies often choose to hire employees because they are looking for a long-term, mutually beneficial relationship whereby the employee can grow with the company, work on key aspects of the company's business, and in return, get a regular wage and benefits. Employees often have at least some degree of job security and long-term growth potential.

What defines an independent contractor?

Contractors run their own business. They control their work: everything from what they do to how they are paid. Instead of an employee, a company might choose to hire an independent contractor because they need a specific task done, or they need work done for a limited period of time, that is not key to the company's business. An independent contractor might choose this type of work in order to have more freedom over their work.

Why does it matter?

The differences between independent contractors and employees matter a lot for your business. Here are the three main reasons to ensure that you have a proper understanding of all of your working relationships:

1. Tax liability

If a worker is an employee, employers are required to withhold tax (PAYG withholding) from the worker's wages, and report the withheld amounts to the Australian Taxation Office. In addition, the employer may need to report and pay fringe benefits tax if the employee receives fringe benefits.

If the worker is not an employee, and instead is a contractor, then the worker generally takes care of their own tax obligations. Incorrectly categorising a worker could result in back taxes and penalties.

2. Superannuation

Employers are required by law to pay superannuation, at least quarterly, for eligible employees. For most (but not all) contractors, there is not a requirement to pay superannuation. Employers who fail to pay superannuation when required may also face penalties.

3. Applicability of employment laws and independent contractor laws

Various laws apply to Australian workers, including the Fair Work Act 2009, the Independent Contractors Act 2006, the Work Health and Safety Act 2011 as well as various industry specific or state based laws.

Different laws will apply depending on whether the worker is an employee or a contractor. For example, unfair dismissal laws may apply to employees, but not to contractors.

Is the worker an employee or an independent contractor?

The difference between an employee and a contractor is based on many factors, and no single factor is determinative. Simply using a contract which describes the worker as a contractor is not enough to convert an employee into a contractor. Instead, the courts will look at the entire arrangement, and decide whether the worker is working within the business, as part of the business (like an employee) or whether the worker is running their own business (like a contractor). Some common considerations include:

  • the amount of control that the worker has - whether the worker can choose their own hours or location of work (more likely to be contractor), and how much control the business has over how the work is performed (more control suggests worker may be employee)
  • whether the worker tends to work set hours (if so, worker is more likely an employee, although hours for casual employees can also vary somewhat), or whether the worker has more freedom in determining when to do the work
  • whether the worker can subcontract/delegate the work (if so, worker is more likely to be contractor)
  • whether the worker provides their own tools and equipment (if so, worker is more likely to be contractor)
  • whether the worker is paid for the time worked (more likely to be employee), or based on a quote for the result achieved (eg a quote for the painting of a room - more likely to be contractor)
  • who is responsible for mistakes in the work - whether the worker has to rectify mistakes at the worker's own cost (more likely to be contractor), or whether the business is responsible for any mistakes in the work (more likely to be employee)
  • whether the worker is considered part of the business (if so, more likely an employee) or is considered to be running a separate business (if so, more likely a contractor)

Sham contracting arrangements

The Fair Work Act 2009 specifically deals with what is often referred to as "sham contracting". This occurs when an employer tries to disguise an employee as a contractor. This is often done in order to avoid having to deal with employee entitlements (such as annual leave, sick leave and superannuation). There are serious penalties for employers who are found to have engaged in sham contracting.

In particular, under the Fair Work Act 2009, employers are prohibited from:

  • misrepresenting an employment arrangement, or a proposed employment arrangement, as an independent contracting arrangement
  • making a statement which the employer knows is false, for the purpose of influencing or persuading an employee to become an independent contractor
  • dismissing or threatening to dismiss an employee, for the purpose of rehiring the employee as an independent contractor

The key differences

The key differences between employees and independent contractors can be summarised as follows:

1. Independent contractors fully control themselves and their business.

As discussed above, independent contractors have the full ability to control how they work, how they get tasks done, what tools they use, and almost all other elements of their business. Employees, on the other hand, generally have to report to work as their employer requires and can be subject to detailed instructions on their work as well as how and when they do it.

2. Independent contractors fully control their payment.

Independent contractors will generally get paid either once in a lump sum or through an invoicing system. They do not get paid on a regular schedule that their company sets. They fully control how they take payment and if any late fees are due for lack of payment or late payment. Employees, on the other hand, tend to get paid on a set schedule determined exactly by their company, including how payments are made.

3. Independent contractors get no benefits.

Independent contractors do not receive any benefits like annual leave, long service leave, sick leave or superannuation. Employees, in contrast, generally receive these benefits.

4. Employees are generally hired for an indefinite term.

In an employment relationship, the length of time that the employee will be working for the employer is usually indefinite because the relationship is meant to grow. For contractors, it's the opposite: contractors are hired for a limited time or a specific task.

5. Taxes are not withheld for independent contractors.

Employers are responsible for withholding taxes from their employees' pay. For contractors, that is not the case, with contractors being entirely responsible for their own tax liabilities.

6. Independent contractors can work for multiple businesses at once.

Independent contractors are often able to take on multiple clients at once. In contrast, many employees are limited by some kind of Non-Compete Agreement or provision meaning they are only permitted to work for the employer.

7. Employees are paid regular wages on a regular schedule.

Employees make regular income at regular intervals. Most often, employees are paid every week to two weeks and they can generally rely on what will be contained within that paycheck. Independent contractors, on the other hand, are usually paid by the job, though they may be paid in another way, as well. Regardless, contractors do not have a regular paycheck and may even face a business loss if they don't allocate funds properly.

8. Independent contractors may be able to sub-contract out the work.

Independent contractors are generally able to hire others, called sub-contractors, to assist with their work or do their work for them. Their clients do not control this feature of the relationship. Employees, on the other hand, are required to do the work they are assigned to do, either by virtue of their employment position or by their supervisor.

9. Independent contractors generally use their own equipment.

Independent contractors can use their own equipment and tools. Usually, these equipment and tools go with them on all of their jobs and in fact it may be their responsibility to provide these tools. Employees, on the other hand, are usually restricted to using the equipment and tools owned by their employer and most are required to work in an office or at a specific location.

In conclusion

As you can see, there are many different ways to really understand the differences between employees and independent contractors. Your business might be best suited for just one of these types, or you may wish to develop a workforce that makes use of both. Either way, making sure you know how to distinguish between the two is a great first step in deciding how to grow your business.

If you are a business or a worker and have any concerns about these matters, seek legal advice.

The Australian Taxation Office provides further information as well as a decision tool which can help in working out the status of a particular worker. In some cases, the Fair Work Ombudsman may be able to provide assistance to workers who believe that their rights have been contravened.

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