Contractor vs Employee: Which to Hire for Your Company?

contractor vs employee

Whether you’re a startup, a multinational setting up in Australia, or an SME whose hard work is beginning to pay off, when you’re ready to hire someone for your business, you’ll be asking yourself this question – should I hire a contractor or an employee?

According to the Independent Contractors of Australia, Australia had over 2 million self-employed workers in 2013. A little over about 17% of the workforce. And with Australia’s insatiable appetite for a better work / life balance, this figure is expected to grow significantly over the next decade.

However, as a business, you can’t designate whether you hire an employee or a contractor to do the work. The Australian Taxation Office (ATO) has a strict set of criteria that classify a worker as an employee or contractor.

In this post we’ll take a look at the differences between the two, and help you work out which is better for your business.

What is an employee?

An employee must be a person. An employee works in, and is a part of the business. If you hire an apprentice, trades assistant, trainees, or labourers, they will always be employees.

There are legal obligations that go with hiring an employee, such as PAYG, super contributions, workers compensation and perhaps payroll tax.

What is a contractor?

A contractor provides services through a business entity with its own Australian Business number (ABN).

What difference does it make?

The ATO wants every business to be on a level playing field with its competitors.

It also states each business must pay its fair share of award wages, superannuation, taxes and leave entitlements to its employees.

When a contractor is hired, the business does not need to make any of these payments.

For businesses found to be involved in wrongful hire, the ATO may levy penalties and charges against them.

To encourage businesses to create new employment opportunities for employees, there is the Small Business Grant through the NSW Government.  The grant is $2000 for each new full time employees, pro rata for part time positions. The new position must also be registered before it is filled.  See our EOFY Hacks for more details.

What are the factors determining employee or contractor?

The ATO uses the following 6 factors when defining the employee or contractor relationship.

It is important to note, that it is the totality of the relationship between the parties that determines the status of a person’s employment, not just one factor.

How is payment for the work calculated?

The method of payment to the person hired for the work is the main determinant of whether they are an employee or contractor.

Employees are paid hourly rates, award rates, a weekly or monthly salary, or a price per piece / activity. Contractors are paid a quoted price for an outcome or pre-determined result.

Who is responsible for the risk

Who bears the legal risk for the work and is liable for rectifying any defect in the work, at their expense.

Employees do not have any commercial risks. The business is liable for the work of the employee and has responsibility to pay to rectify any defect. Contractors have the legal risk for the work, must rectify any defects or pay to have them rectified and cannot ask the business to pay for the rectification.

Who provides the equipment, tools and other assets

This factor refers to the supply of equipment, tools or assets such as heavy equipment or motor vehicles.

Employees do not supply any equipment, tools or assets. If the employee does provide equipment, its costs will be reimbursed, or an allowance paid. Contractors provide all the equipment, tools and assets to complete the work.

Are they working independently?

Employees – dependent on the business, and considered part of that business. Contractors – work independently of the business and are free to accept or reject work.

Who controls the work

Employees – told what work to do, where to do the work, how to carry out the work, and when the worker completes the work. Contractors – decide how to complete the work, subject to the contract or agreement.

Who can delegate or subcontract the work

This factor considers whether the agreement or contract (written or oral) gives the worker the right to pay another person to do the work instead of them.

Employees have a contract that states they are to complete the work or they can give the work to another employee of the business. Contractors can delegate or subcontract the work when not contractually required to do the work personally. They can pay another person to complete the work.

Remember, just because someone has an ABN, it does not automatically qualify them as a contractor. The range of factors outlined above will determine the classification.

Employee / Contractor Decision Tool

The ATO has created this mobile friendly decision tool to help employers work out if the hire should be an employee or contractor.  The tool is anonymous, and can be used as a definitive ruling when all questions are answered truthfully.

About Payroll Tax

Payroll tax has a different definition for employees and contractors.

For the purposes of payroll tax, the above definition of employee and contractor may be different. Your business may be liable for payroll tax for contractor payments in certain circumstances.

For example in some states, a contractor who works more than 90 days for a business in one financial year may be classified as an employee.

Need more help?

Visit the Fair Work Ombudsman for more information about the criteria of hiring an employee or a contractor.

Most Australian workplaces will be governed by the Fair Work Act 2009.  The Ombudsman was created to help employees, employers, contractors and the community understand and comply with the new system.

Featuring education, information and advice, they help to resolve workplace complaints and conduct investigations. It also enforces relevant Commonwealth workplace laws available for everyone.

In addition, The Independent Contractors Act 2006, in conjunction with the Fair Work Act 2009, protects the rights and entitlements of independent contractors.