Employee or Contractor? What’s the difference?
Employees and contractors serve very different functions, and while this may seem obvious, nuances in the way you engage the people that perform services for you may have unforeseen ramifications.
For example, if you have engaged a contractor, they run their own business and assume many of the liabilities of a business owner, including tax obligations.
On the contrary, if you have an employee, you undertake many responsibilities for them and may even assume vicarious liability.
Why is it important?
The difference between employees and contractors is important as it determines the rights and obligations of both parties.
Employers have different responsibilities and obligations to employees and contractors, and it is essential to understand the differences between the two classifications.
If you have an employee you become responsible for their tax, superannuation, Workcover/Insurance, and many other obligations that are an inherent part of being an employer.
If you have not made the necessary preparations for employee entitlements, working conditions and safety, and tax obligations, you might be out-of-pocket a substantial amount, or in the worst-case scenario held criminally liable.
What is an employee?
An employee is usually hired under a formal employment agreement and is someone who works for an employer. The business can be any scale, but the determining factor as an employee is usually the relationship they hold with their employer as an employee of a business.
Not all employer-employee relationships are the same. The employer-employee relationship can be the rigid corporate business structure that we regularly see portrayed, but this relationship can extend to family members if they are technically an employee of the business by being part of it. If the family member is not adequately and property provided for in accordance with employment legislation such as the Fair Work Act 2009 and tax obligations.
An employee may work full-time, part-time, or casually. A range of legal entitlements and protections, including minimum wages and conditions of employment, leave entitlements, superannuation, and protection from unfair dismissal are enjoyed by employees and are covered by statutory frameworks. Employers are required to pay employee entitlements, such as superannuation contributions and workers’ compensation insurance, and may be liable for other costs such as payroll tax.
What is a contractor?
Opposite to employees are contractors, who essentially manage their own businesses and are hired for specific tasks with a specific scope and duration. Accordingly, they do not receive employee entitlements and are responsible for their insurance and tax obligations.
A contractor may conjure images of freelancers whose payers are conceivable as clients, such as a photographer who is paid for a once-off service and has multiple clients at the same time.
The “gig economy” is an example where confusion arises as to the nature of the relationship however it has been considered by the Fair Work Ombudsman that drivers such as Uber drivers are self-employed independent contractors. The finding was supported by the factor of control where the drivers were not under an obligation to “perform work”, which is a minimum in an employer-employee relationship. Fair Work Ombudsman Sandra Parker stated that “Uber Australia drivers have control over whether, when, and for how long they perform work, on any given day or on any given week.” [1]
In the construction industry, sub-contractors also come to mind, where one person engages a builder for a project, and the builder in turn hires sub-contractors to perform different roles in the building project such as carpentry, scaffolding, electrical work, and plumbing. The overarching contractor being able to hire people in their place is quintessential of “substitution”.
Distinguishing Factors
There are nuances in the difference between contractors and employees, as sometimes both are “hired”, formally retained under agreements and paid by the person seeking their services.
Accordingly, we have outlined factors that may be considered in the event of a dispute, or as preparation for your agreements, but the determination is largely established on a case-by-case basis and the true nature of the relationship:
- Control: Employees are typically subject to the direction and control of the employer, while contractors have more control over how they perform their work.
- Tools and Equipment (Integration): Employees are integrated into the employer’s business and are expected to work within the employer’s systems and processes. Contractors, on the other hand, usually work independently and provide their own tools and equipment.
- Risk: Employees have limited risk, while contractors assume many risks, such as the cost of rectifying defective work if the services contract provides for this. They also will be required to take out any requisite insurance and are responsible for their own tax obligations.
- Substitution: Employees are typically not able to provide a substitute to perform their work, while contractors are often able to engage others to perform the work on their behalf (sub-contractors).
- Duration: Employees are usually engaged for an indefinite period, while contractors are engaged for a specific project or time frame.[2]
Employment Agreements
With a well-drafted agreement, it’s possible to pronounce the distinction between an employee and a contractor, as long as it is a genuine distinction and not a reliance on clever wording. An agreement is one thing, but employment law is an area that focuses on more than black-letter law and sees the forest for the trees. This might be ascertained by physical evidence, verbal agreements, additional incentives, and comparison to the employee vs contractor distinctions. Sometimes this method of scrutiny can be referred to as a “factual” matrix.[3] Looking at the facts of the case as a whole rather than just one aspect.
This in turn adds weight to the importance of a solicitor who understands your business and commercial law, as they can comprehensively analyse your business and provide advice as to whether (even with a cleverly drafted agreement!), it might fall short of what you believe it operates as. Saving you from considerable costs, penalties, or legal issues in the future should it be found that employee entitlements were owed but not bestowed.
In the case of ZG Operations Australia Pty Ltd v Jamsek reference was made to Yellow Cabs of Australia Ltd v Colgan in which the business was successful in transitioning from an employer-employee relationship to that of independent contractors, but as the actual ZG Operations case outlines, this will not always be successful. A business that maintains control over things such as tools (or in the Yellow Cabs matter vehicles), or hours, will likely be considered an employer. A key focus on the distinction between the two was the amount of control their fleet drivers had.
While being an employer carries significant risk, there are certainly benefits to being one. This includes the growth of your business, and with a carefully selected team positive experiences your employees have with members of the public may encourage positive brand recognition.
Hiring a contractor is not without its own risk. For example, as hiring a contractor is usually associated with less control, this may mean that the task you have them engaged for is not carried out in the way you intend.
IMPORTANT: This is not advice. Readers should not act solely on the basis of the material contained in this article. Items herein are general comments only and do not constitute or convey advice per se. Also, changes in legislation may occur quickly. We, therefore, recommend that our formal advice is sought before acting in any of the areas covered in any newsletter.
This webpage is made available by Arrow White for educational purposes only as well as to give you general information and a general understanding of the law, but not to provide specific legal, tax, financial or investment advice. By using this webpage, you understand that there is no lawyer-client relationship between you and Arrow White. The webpage should not be used as a substitute for competent professional advice from a suitably qualified professional. Nothing on this webpage should be construed as an offer to sell, a solicitation of an offer to buy, or a recommendation for any asset by Arrow White or any third party. You alone are solely responsible for determining whether any investment, asset or strategy or any other product or service, is appropriate or suitable for you based on your investment objectives and personal and financial situation. You should consult a suitably qualified professional regarding your specific legal, tax, financial or investment situation.
[1] https://www.fairwork.gov.au/newsroom/media-releases/2019-media-releases/june-2019/20190607-uber-media-release
[2] https://www.fairwork.gov.au/find-help-for/independent-contractors
[3] Construction, Forestry, Maritime, Mining and Energy Union v Personnel Contracting Pty Ltd [2022] HCA 1 (9 February 2022) http://www.austlii.edu.au/cgi-bin/viewdoc/au/cases/cth/HCA/2022/1.html; ZG Operations Australia Pty Ltd v Jamsek [2022] HCA 2 (9 February 2022) http://www6.austlii.edu.au/cgi-bin/viewdoc/au/cases/cth/HCA/2022/2.html
Disclaimer: This publication is intended for general and informative use only and is not to be relied upon as professional financial or legal advice.
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