Employee or independent contractor — do you know the difference?
Limit your risk as a franchisor, franchisee or small business owner when it comes to classifying your workers correctly. Read on for tips from Sophie McDonald of HR Central on how to tell the difference between employees and independent contractors.
It is essential to classify your workers appropriately as either an employee or contractor, as incorrect classification can result in legal and financial consequences, including denying a worker their benefits, as well as potential breaches of workplace, taxation, superannuation and workers compensation law.
It is more important now than ever since the recent passing of the government’s new laws under the Fair Work Amendment (Protecting Vulnerable Workers) Bill 2017. This amendment holds franchisors liable for workplace violations by franchisees.
The reason that the classification of work relationships is not as black and white as once thought comes from the way the employment relationship is determined. It is important to note that just because you define a relationship as a contractor through an agreement, that doesn’t necessarily make it so. We have to look at the relationship as a whole to consider both the agreement and the work practices performed in the relationship.
When looking at the practices performed, we would consider a number of indicators to determine whether, in total, the relationship seems to be a contract for services (independent contractor) or a contract of service (employee).
How to classify the relationship
An employee is an individual engaged on a permanent, fixed-term or casual basis who performs a specific role on an ongoing basis. The practicalities of employment are covered by the employer, including payment of superannuation, payroll tax, personal leave and annual leave.
An independent contractor or contractor is generally a self-employed individual/firm who undertakes a contract with a business to provide services or labour at an agreed price and within a predetermined time frame. Most contractors are engaged on a project basis or engaged to complete a specific task. They don’t work for anyone exclusively, but rather work for themselves. Fundamentally different from employees, genuine independent contractors are typically regulated by commercial rather than employment laws.
To determine whether a contract for services (contractor) or a contract of service exists, we would then go through a multifactor test. We ask the following questions to assist in the process:
- Can it really be said that this person is in a business of their own?
- In performing work, is this person working in and for their own business, rather than as part of someone else’s business?
The following indicators must be considered in totality to determine whether the relationship appears overall to be one of employment or contracting. The types of indicators we look at include but are not limited to:
- The level of control over how work is performed: The individual is more likely to be an employee if they have little control over how their work is performed, ie, an employee performs their work under direction and control of their employer on an ongoing basis. Employees need to be compliant with company standards, policies and procedures of how work is performed, whereas businesses have little control over how a contractor performs their work.
- Level of independence: Employees have a low level of independence from the business, whereas a contractor is highly independent from the business.
- Ability to delegate work: Employees have a low level of delegation, whereas a contractor has a high level of delegation in that they can engage a subcontractor to complete the task.
- Whether tools and/or equipment are supplied by the business or by the individual: Contractors will provide their own tools and equipment because they are usually performing more specialised work, whereas the employee does not supply these things and is usually compensated through an allowance (eg, car or phone).
- How they are paid/remunerated: Employees are paid regularly (weekly, fortnightly, monthly) into their preferred account, whereas contractors have an ABN and submit an invoice at the end of the project or job.
- Expectation of work: Employees usually have an ongoing expectation of work, whereas contractors are engaged for a specific task/project.
- Hours of work: Contractors have flexibility in the hours they work to ensure they get the job complete, whereas employees work standard set hours (excluding casuals, who have varied hours).
- Risk: Contractors bear all the risk of making a profit or loss on the task or project. They also bear the risk if they do a poor job or injure themselves in doing the job. It is therefore a requirement that they possess their own insurance. Employees in contract bear no financial risk, as this sits with their employer.
- Superannuation: Contractors are responsible for paying their own superannuation, whereas employees are entitled to super contributions from their employer.
- Tax: Contractors are responsible for paying their own tax and GST to the ATO, whereas employees have their tax deducted from their pay by their employer.
- Leave: Contractors do not receive leave entitlements, whereas employees are entitled to paid leave (eg, annual leave, parental leave, personal/carer’s leave) or receive a loading in lieu of leave entitlements in the case of casual employment.
Classification can be grey as every business is different. However, if it can be determined that the individual is more likely an employee than a contractor (or vice versa) in total, then there are substantial risks associated with getting the classification wrong.
What are the risks of getting it wrong?
Legal and financial
Misclassification can lead to a contravention of the Fair Work Act (2009), including the National Employment Standards, minimum wage orders and terms of a modern award or enterprise agreement, among other employer obligations (eg, providing employee records and pay slips). Because of a contravention, employers may be exposed to back payments and superannuation payments with consequent tax implications.
Denial of entitlements
Employees who are misclassified as contractors can be denied important employee entitlements. This includes access to leave, minimum rates of pay and superannuation, protection from unfair dismissal laws and the benefits of ongoing job security. This can potentially contribute to relationship breakdowns within the business and losing top talent.
Increased risk for certain jobs — unskilled labour
The risk of workers being considered employees increases when those workers perform tasks that involve the application of relatively unskilled labour over a period of time. Contractors engaged in service roles where individuals are performing regular maintenance are at risk of having the relationship blur into one of an employee. For example, a cleaner performing simple work for a single principle contractor, who wears their uniform, operates their equipment and accepts little or no commercial risk, cannot be defined as anything other than an employee.
Sham contracting is when an employer attempts to disguise an employment relationship as an independent contractor agreement. This is usually in an effort to avoid the responsibility of employee benefits or because both parties agree that they want the relationship to be a certain way.
Under the Fair Work Act (2009), an employer cannot misrepresent an employment arrangement as an independent contracting agreement; dismiss or threaten to dismiss an employee for the purpose of engaging them as an independent contractor; or make a knowingly false statement to persuade or influence an employee to become an independent contractor.
It is very important to correctly classify workers as either an employee or contractor. If it is determined that your staff member is a contractor but they are operating for all intents and purposes like an employee, you could be liable under the Fair Work Act (2009).
Penalties and fines
Fair Work inspectors can seek the imposition of penalties for contraventions of sham contracting arrangements and reform opt-in provisions. The courts may impose a maximum penalty of $33,000 per contravention for a body corporate or $6600 for an individual.
This means that in certain circumstances, a franchisor may be held accountable for an individual franchisee who engages in sham contracting arrangements or other workplace breaches.
How to reduce your risk
Franchisees or any business that engage contractors, particularly for lengthy periods of time, should periodically review the nature of the relationship, utilising the indicators previously discussed to assess whether the arrangements have become more like that of an employee.
|Factors to consider||Contractor||Employee|
|Degree of control over how work is performed||Has a high level of control over how the work is done.||Low — performs work under the direction and control of their employer, on an ongoing basis.|
|Ability to delegate||High||Low|
|Tools/equipment||Uses their own tools and equipment (alternative arrangements may be made with a contract for services).||Tools and equipment are provided by the employer, or a tool allowance is provided.|
|Payment/remuneration||Has obtained an ABN and submits an invoice for work completed or is paid at end of contract or project.||Time-based; paid regularly.|
|Expectation of work||Usually engaged for a specific task.||Usually has an ongoing expectation of work (some employees may be engaged for a specific task or specific period).|
|Hours of work||Under agreement, decides what hours to work to complete the specific task.||Generally works standard or set hours. (a casual employee’s hours may vary from week to week).|
|Risk||Bears the risk for making profit or loss on each task. Usually bears responsibility/liability for poor work or injury sustained while performing a task. Contractors generally have their own insurance policy.||Bears no financial risk (this is the responsibility of the employer).|
|Superannuation||Generally pays their own superannuation (in some circumstances, contractors may be entitled to be paid superannuation contributions).||Entitled to have superannuation contributions paid into a nominated superannuation fund by employer.|
|Tax||Pays their own tax and GST to the ATO.||Has income tax deduced by employer.|
|Leave||Does not receive paid leave.||Entitled to receive paid leave (eg, annual leave, personal/carer’s leave/long service leave). Casual employees receive a loading in lieu of leave entitlements.|
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