Should I Hire An Employee Or A Contractor?
While it might seem at first glace that a contractor is cheaper and easier because of PAYG Withholding, Superannuation & Annual Leave – it can be a very complicated space where there might not be a right answer.
The Main Differences Between a Contractor & An Employee
1. PAYG Withholding
There is no legal accounting or tax requirement to withhold tax from amounts you pay to a contractor (unless you’re in the rare situation of having a PAYG Voluntary Agreement). Conversely, you must withhold tax each time you pay an employee based on their earnings.
2. Superannuation Guarantee
There is generally no requirement to pay certain contractors Superannuation Guarantee – although we have come across a cases where a business owner pays Superannuation for a contractor. This in itself does not tip the scales in the contractor/employee distinction, but may play a role.
3. Fringe Benefits Tax
Clients can be liable for FBT on non-cash benefits provided to employees, but not to contractors. Additionally, concessional FBT rules regarding living-away-from-home allowances and salary sacrifice do not apply to contractor engagements.
4. Workplace Entitlements
Contractors are not entitled to annual leave or sick leave and are excluded from a range of other employee entitlements such as the redundancy payout provisions of the Fair Work Act.
5. Workers Compensation
Employers generally do not have to cover contractors as part of their insurance arrangements, unless the contractor is a rateable payment. Other occupational health and safety requirements may also not apply.
6. Payroll Tax
While remuneration paid to employees will generally always be subject to Payroll Tax, special exemptions may exclude amounts paid to contractors from attracting payroll tax.
How Do I Tell An Employee From A Contractor?
While in many cases it will be clear cut, edge cases will present themselves as the decision relies on six tests which are derived from common law cases and set out in ATO taxation ruling TR 2005/16 and superannuation guarantee ruling SGR 2005/1.
The first thing the ATO will do in the event of an audit is to use their Employee/contractor decision tool and apply it to workers in the business. Ideally a client would use this tool regularly in high risk industries (IT, Construction, Cleaning, Hairdressing) and keep it on file.
However, the tool can in some cases provide irregular results and, in our view, has a slight bias towards classifying workers as employees.
This is because it fails to assess two of the six tests:
• Factor 1 – degree of control (which is described at paragraph 37 of SGR 2005/1 as: “the most important factor to be considered”), and
• Factor 2 – does the worker operate in the employer’s business, or on their own account in their own business? (paragraph 39 of SGR 2005/1, notes that High Court stated that “the distinction between an employee and independent contractor is rooted fundamentally in the difference between a person who serves his employer in his, the employer’s business, and a person who carries on a trade or business of his own”).
Below are the 6 factors that will determine an employee vs a contractor –
|The 6 Factors||Employee||Contractor|
|Control over work performed||Employer controls the employee & work is performed how they are instructed||Contractor performs the contract, regardless of how the employer thinks it should be done|
|Expectation of Work||An employee will perform tasks in their employment contract as long as they are employed||A contractor performs one task, then a new contract must be negotiated|
|Payment is based on?||Hourly rates, yearly salary or commission||Completion of job|
|Risk Involved||An employee takes on no risk, and as such does not require “employee insurance”||A contractor bears the risk involved with work performed (both to fix, and for public liability), and is required to be insured|
|Can They Delegate?||An employee cannot subcontract a job out||A contractor can subcontract a job, unless their contract specifically forbids it|
|Tools & Equipment Required||Unless agreed otherwise, an employer will provide all tools||A contractor provides everything required as part of their services|
What Happens If I Am Wrong?
The passage into law of the Black Economy Taskforce Measures No.2 Act 2018, has brought new rules which substantially change the outcome of incorrectly classifying an employee as a contractor.
From 1 July 2019, a deduction is no longer allowed in relation to the following payments if withholding applied to the payment, and the payer was required to withhold an amount from the payment and did not withhold an amount OR did not notify the ATO when required:
• salary, wages, commissions, bonuses, or allowances to an employee
• directors’ fees
• for a supply of services – excluding supplies of goods and supplies of real property – where the recipient of the payment has not quoted their Australian Business Number (ABN).
Deductions are only denied where no amount has been withheld at all from the payment that attracts withholding (including innocent mistakes) or no notification is made to the ATO. Withholding an incorrect amount (such as from an allowance etc.) will not result in a deduction being denied.
In summary, provided an amount is withheld (even if it is incorrect) and a notification to the ATO is made, a deduction is allowed. A deduction will also not be denied where:
• an ABN is quoted by a worker, and no amounts have been withheld from the payments because the employer reasonably believes they are a contractor, or
• the payer voluntarily notifies the ATO of its mistake in the approved form (such as by amending an Activity Statement) before the ATO commences an audit or other compliance activity.
Although there is a carve-out for not withholding from contractors, the onus is on the payer to prove that your belief that they were a contractor was ‘reasonable’. This could be difficult, especially where the ATO’s Employee/contractor decision tool determined that the worker was an ‘employee’.
The other area where this new law has relevance when paying contractors is ensuring that ABN’s have been correctly quoted, otherwise a deduction may be denied. The current ATO position per their website is: “generally you do not need to check if the ABN quoted to you by a supplier is correct. If it looks reasonable, you can accept”. However, the new law provides no relief/exemption if an ABN “looks reasonable”. In the near term and unless there is clarification to the contrary, it would be advisable to check the validity of all ABNs through software or on ABN Lookup.
On a wider level, with this new law now in place, clients should review their payroll systems and ensure amounts are being withheld from required payments.
If you are looking for guidance or thinking it’s time you made a change of accountant, please give us a call on (03) 8568 3606. With over ten years of combined experience working with a diverse range of clients, Bookkept is well equipped to assist your business. We offer bookkeeping & tax services, and can help you in both payroll and your contractor worries.