Getting it wrong can have serious consequences.
It is very important to get the relationship right, and as an employer, ensure that your contractor or employee understands the relationship. Most bad consequences for employers occur where there has not been a clear understanding of the relationship and dissatisfied contractors or employees report their grievances to the Australian Taxation Office or Industrial Relations Authority.
Who is an employee?
While there is no definition of employee in tax legislation, the definition is taken from the common meaning of ‘someone working for another person for pay’. In other words an employee contracts for labour while a contractor contracts to provide a service. Numerous court cases have highlighted the significant indicators to be considered when deciding the difference between an employee and contractor.
1. Control
An employee is typically told what to do, when to do it, and how to do it by the employer. They do not to have control over the operation even thoughthe employee can dictate how a job is to be performed by subordinates.
An employee does not conduct a trade or a business – thus if the work is withdrawn they have no business to carry on.
Employees do not have independence in their operations – they cannot choose to employ another to do their work.
2. Results
Subcontractors are contracted to produce a result and are paid at completion of service or by progress payments. If the result is not achieved payments made be withheld. They are generally responsible for any defect in their work and must rectify the defect.
Employees are paidby salary, hourly rates, or at a set rate based on a predetermined outcome.
3. Delegation
Subcontractors have the right to employ other workers to complete the contract.
Employees may have a right to delegate to other workers but cannot employ workers outside the organisation to perform their duties.
4. Provision of Tools & Equipment
Subcontractors will provide the tools and equipment of significant value to perform their service.
Employees will generally be supplied all tools and equipment of significant value required to perform their work.
5. Other factors
The right to suspend operations is indicative of a contract while the provision of work benefits such as long service leave etc will generally indicate that someone is an employee.
The provision of a company uniform and the public perception that one is an employee may also indicate that an employment relationship exists.
Not all of these factors must be present to establish if one is an employee – each case must be considered on its merits. Factors will be weighted differently for individual industries. The Australian Taxation Office provides a decision making tool on their website www.ato.gov.au.Type in the search:Employee/contractor decision tool.
Consequences of getting it wrong.
The Employee
- Deductions may have been over claimedas work deductions are not as generous as business deductions. This can result in additional tax and penalties.
- Entitlements such as holiday pay, sick leave, and parental leave are lost.
- Superannuation entitlements are not paid and contractors who are actually employees are unable to claim superannuation contributions.
The Employer
Tax must be withheld from employee’s wages and failure to do so incurs penalties.
- Superannuation guarantee must be paid on employee income and failure to do so will result in the double penalty of superannuation guarantee charge and thenon deductibility of late superannuation payments and superannuation guarantee charge.
- Employees can claim unpaid entitlements – if the employee was incorrectly classified as a contractor for several years, this can result in substantial costs.
- The payroll tax threshold may have been breached and unreported payroll tax will have to be paid together with late fees.
- There may be other industrial relations laws that have been breached which may result in penalties.