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Demystifying the Employee vs Contractor Confusion
Finding employment solutions for your business is a challenge – sourcing the right person, with appropriate experience, at a fair wage, isn’t always easy. Furthermore, classifying your workers correctly as a contractor or employee may not always be clear when you’re recruiting for a role, and is an area where many businesses have been caught out in the past.
Those businesses that don’t do the right thing as far as employee/contractor classification is concerned can potentially face significant penalties, not to mention in doing so they may be denying their workers employee entitlements. If you employ staff, or are looking to do so in the foreseeable future, read on to find out the difference between employees and contractors, some common misconceptions around the different classifications, and what can happen to businesses that aren’t compliant.
Defining an Employee or Contractor
In order to be able to correctly classify your workers as an employee or contractor, first we’ll need to define the two. An employee is someone who works on a regular basis within your business, is paid for their time worked, per activity/item, or on a commission, and takes no commercial risks (i.e. the business is responsible for any issues with the worker’s output). You are responsible for PAYG withholding and Superannuation Guarantee (SG) payments. A contractor operates their own business independently of yours, and performs a service based upon an agreed quote. They also have the freedom to control the way the work is done (per the arrangement between themselves and the business), and accept or reject additional work outside the scope of an agreement or contract.
Further to this, a business provides an employee all or most of the necessary tools, equipment and other assets required to complete the work (or reimburses the employee if they provide them); whereas a contractor will provide all or most of these items and does not receive compensation for this. Contractors also have the right to delegate or subcontract the work out to another provider and pay accordingly, while an employee is not able to do so.
Note that if your business pays labour hire organisation for work undertaken by someone they have provided, then your business has a contract with the firm rather than the worker themselves. In this situation, the labour hire firm is responsible for PAYG withholding, SG payments and Fringe Benefits Tax (FBT) obligations, as well as any other relevant tax and compliance obligations.
Employee vs. Contractor – Common Misconceptions
There are a few common misconceptions around the differences between employees and contractors, and how they are defined. Here are a few that may resonate with your business or industry, followed by some information on the reality of each.
Length of jobs/busy periods: The length of time for which you engage a worker has no bearing on their classification. Both employees and contractors can be used for casual, temporary, on-call and infrequent work; to cover busy periods (e.g. Christmas casuals in retail stores); and for short jobs and projects.
The 80/20 Rule: You may have heard of the 80/20 rule, which relates to Personal Services income (PSI) and contractors working more than 80% of their time for one business. As this is PSI-related and only impacts the way the contractor reports their own income and claims deductions, it does not factor into a business’ decision regarding their classification as a contractor or employee.
Workers’ Preference: Your business may be looking at engaging someone who would prefer to work as a contractor rather than an employee – but this is not a matter of choice. The classification of an employee or contractor is dependent upon the terms, conditions and arrangements outlined in the agreement between the two parties. Even specific wording in a contract than outlines this preference will not override the business’ obligations in terms of PAYG-withholding or SG payments.
Other Businesses in Your Industry: It may be tempting to look at other businesses in your industry taking on contractors and feel like your business should be doing the same. Not only may those businesses have different working practices that allow those workers to be classified as contractors, it is also possible that they are doing so in error. When it comes to employee classification, your safest bet is to judge the situation within your own business and the arrangements you have in place, and make a decision from there.
Penalties for Non-Compliance
If your business is engaging employees misclassified as contractors, you risk receiving penalties and charges from the ATO. These can include PAYG withholding penalties for failing to deduct income tax from their payments; and SG charges – made up of SG shortfall amounts that should have been paid into complying funds, interest charges, and an administration fee. You may also be hit with an additional SG charge of up to 200% of the shortfall. In certain cases this can amount to thousands of dollars in penalties, reinforcing the need to get the classification right.
First and foremost, avoiding these potentially tricky situations is to classify a worker correctly before they’re hired. If you’re unsure about exactly how to go about hiring or classifying a person, or have questions about your PAYG withholding and/or superannuation obligations, the team at McKinley Plowman are here to help. Feel free to give us a call on 08 9301 2200 (Joondalup) or 08 9361 3300 (Victoria Park), or visit www.mckinleyplowman.com.au for more information.
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