Employee or contractor? (there's a big tax difference!)

If you are being put on for a new job, first of all congratulations. But second, a warning.

The status of your engagement can be an important distinction – whether you are being put on as an employee or as an independent contractor – and has consequences for both yourself and your new boss that could put either of you into unforeseen hot water.

An employee can seem to be set up in the workplace in a similar way to a contractor, but generally is paid on a time-on basis and has leave entitlements such as sick leave and annual leave.

As an employee, you will be supplied with all that you need to do your job, you will not make a profit or loss from work carried out on a particular project (just a wage or salary), and you will be expected to perform certain duties as agreed and in work hours as set out in that agreement. And if you are taken on as an apprentice, you will be an employee, not a contractor.

Typically, a contractor will have the qualities outlined in the table at right.

There are different tax obligations for each worker classification that your employer will need to cover; and apart from having to withhold tax from your salary if you are classified as an employee, there are also obligations for superannuation and perhaps fringe benefits tax compliance requirements (and of course penalties if the boss does the wrong thing).

The Fair Work Act prohibits 'sham contracting arrangements', where an employer treats a worker as an independent contractor in an attempt to avoid meeting employee entitlements.

The unscrupulous boss who simply converts staff to contractors is acting illegally, and will face penalties for avoiding workers compensation laws for example, as well as prosecution for tax evasion and flaunting compulsory superannuation law.

Legitimate contracting
Legitimate contracting will continue to grow, with more outsourcing becoming the norm. To cover a spike of business coming in the door, many employers look to taking on contracted workers – the benefit for businesses is that when the spate of extra work is completed, contractors can be taken off the books. This is a sensible way to cover a temporary shortfall in staff, and done properly can serve the workplace well, as well as offer helpful temporary work to people who need it.

But if you are engaged just for your labour rather than for a specific outcome, for example, you will likely be considered an employee rather than a contractor from a tax point of view. In a sales job for example, even a salesperson working for commission and therefore not receiving a fixed remuneration, will usually be deemed to be an employee.

Many an employer has been caught out when they find that the workers they hired as short-term contractors are in fact deemed to be employees – who expect (and are entitled to) all the usual employment add-ons.

There have been cases where, for example, cleaners have been hired as independent contractors. A subsequent search by the Tax Office for the Australian business number (ABN) of the contracting business found that no such independent 'business' existed, and that the hiring business had, without really intending to, actually taken on more employees (and therefore found that it was liable for all the pertinent employee entitlements).

In fact, just because a person has an ABN does not automatically translate into them being an independent contractor. And as it stands, there is no one concrete factor that is necessarily conclusive in this regard, but rather a slew of deciding factors.

Other differences
Most independent contractors take care of their own tax liabilities (instead of the employer withholding employees' tax under the PAYG withholding system) and therefore may require an Australian business number (ABN) to avoid having tax deducted at maximum rates from payments made by recipients of the contracting service. Contractors may also need to register for goods and services tax.

As a contractor, you have to register for GST if your GST turnover is at, or above the GST turnover threshold of $75,000 (exclusive of GST) and $150,000 (exclusive of GST) or more for non-profit organisations. Your GST turnover is your gross business income excluding:

• GST included in sales to your customers
• Sales that are not for payment and are not taxable supplies (some supplies to associates for instance)
• Sales not connected with a business that you carry on
• Input taxed sales you make (such as financial sales or supplies of residential premises by way of rent or sale)
• Sales not connected with Australia.

Contractors may also have to include personal services income in their individual tax return if their contractor services are being provided to the client via an entity (and the contractor is an 'employee' of that entity which has the contract with the end client).

BONUS: A government handbook for all things an independent contractor will need to know. Download 'Contracts Made Simple' or the earlier brochure 'Independent Contractors: The Essential Handbook' here (they're 89 and 84 pages, so you might like to order your free copy from the independent contractors hotline on 1300 667 850).

Last reviewed 2/08/2012

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