Contactor or employee: The difference and why it matters for tax
There are significant differences between a contractor or employee under the laws in Australia. Importantly, there are different tax consequences and obligations that arise depending on whether you are considered to be a contractor or employee.
If you incorrectly classify yourself as a contractor when you are actually considered to be an employee under the law, you will fail to correctly meet you tax obligations as an employee under the law. In those circumstances, it is likely that you will be audited by the ATO and heavily penalised.
Similarly, if you incorrectly classify yourself as an employee when you are actually considered to be a contractor under the law, you will fail to correctly meet you tax obligations as a contractor under the law. If that happens, it is likely that you will be audited by the ATO and heavily penalised.
The difference between a contractor or employee is commonly misunderstood by some taxpayers and they end up getting in trouble with the ATO for failing to meet their tax obligations.
Ignorance of the law is not a defence in tax matters. Therefore, it is important that you contact King Lawyers as soon as possible and get legal advice on your tax affairs. This will ensure that you correctly classify yourself as a contractor or employee from the start and you avoid a costly and stressful tax audit by the ATO on this issue.
The difference between a contractor or employee
A contractor is running their own business. An employee works in your business and is part of your business.
The ATO has provided six main factors to determine whether a worker is an employee or contractor for tax and super purposes:
- Ability to subcontract or delegate work: an employee generally cannot subcontract or delegate the work and they cannot pay someone else to do their work, but a contractor can subcontract or delegate their work;
- Basis of payment: an employee is either paid for the time worked, a price per item or activity, or a commission, but a contractor is paid for a result achieved based on the quote they provided;
- Equipment, tools and other assets: for an employee, the business they work for provides all or most of the equipment, tools and other assets required to complete their work or the business reimburses the employee for the equipment, tools and other assets they provide for their work; but for a contractor, the worker provides all or most of the equipment, tools and other assets required to complete the work and does not receive any allowance or reimbursement for the cost of this equipment, tools and other assets from the business;
- Commercial risks: an employee takes no commercial risks and the employer is legally responsible for the work done by the employee and liable for the cost of rectifying any defect in the work, but for a contractor, the worker takes commercial risks, with the worker being legally responsible for their work and liable for the cost of rectifying any defect in their work.
- Control over the work: for an employee, the employer has the right to direct the way in which the worker does their work, but for a contractor, the worker has freedom in the way the work is done, subject to the specific terms in any contract or agreement;
- Independence: an employee is not operating independently of the business and they work within and are considered part of the business, but a contractor is operating their own business independently of the main business that they are providing services to.
Your tax obligations depending on whether you are a contractor or employee
Your tax and superannuation obligations to the ATO will be different depending on whether you are legally considered to be an employee or contractor.
If you are legally considered to be an employee, the employer is required to:
- withhold tax (PAYG withholding) from your wages and report and pay the withheld amounts to the ATO
- pay super, at least quarterly, for eligible employees
- report and pay fringe benefits tax (FBT) if your employer provides you with fringe benefits
If you are legally considered to be a contractor, then:
- you generally look after your own tax obligations and you do not have to withhold tax from payments (unless no ABN is quoted to you or you have a voluntary agreement to withhold tax from payments)
- you may still have to pay superannuation for individual contractors if the contract is principally for their labour
- you do not have FBT obligations
Legal advice from experienced tax lawyers in Australia
This content of this article is offered as general information only and should not be relied on as specific legal advice.
To get legal advice from King Lawyers on your specific circumstances, please contact us to arrange an initial consultation with our expert tax lawyers.