In today's economy, many businesses are opting to hire contractors rather than employees due to various reasons, including perceived cost-effectiveness, flexibility, and reduced liability. However, understanding the difference between employees and contractors is essential for businesses to ensure compliance with labour laws and avoid legal issues. With our over 30 years of combined experience in advising small to medium-sized businesses on business law we share our top insights below.
Whether you as an employer identify a worker as an employee or contractor has relatively little weight on how that worker is treated under law. Instead, the substance of the relationship will be characterised by employment law. The key indicators as to whether a worker is an employee or contractor are set out below.
Why is control and direction important?
One of the significant differences between employees and contractors is the level of control and direction exercised by the employer. Employers have more control over employees' work, including the hours worked, the work performed, and the tools and equipment used. Employers can also dictate the location where the work is performed, how the work is performed, and the pace at which the work is done. This means that employees are usually not liable for any damages or injury caused by their work (because the damage or injury arose whilst under the direction or control of the employer).
In contrast, contractors have more autonomy over their work. Contractors are typically hired for a specific project or task and bear the risk of any damages or injury that may arise from their work. Contractors also have more control over the details of their work, including the tools and equipment they use, the pace of the work, and the location where the work is performed.
Taxation
Employees have tax deducted from their salary and receive compulsory superannuation payments from their employer. Contractors generally have to pay their own tax from their gross earnings, and also need to make their own superannuation contributions.
The burden of making sure a contractor is working under the right conditions rests with the hiring business. If the business wrongly classifies a work as a contractor, the business will have to account for PAYG on wages, pay superannuation, provide annual leave and long service leave. Accordingly, it is critical you correctly classify your workers.
The Fair Work Act prohibits "sham contracting arrangements", where an employer treats a worker as an independent contractor in an attempt to avoid providing employee entitlements. It may constitute and illegal act if a business owner converts employees into contractors for the purpose of avoiding its obligations to those workers. Employers who try to do this can face prosecution for tax evasion and may be severely penalised for breaking superannuation and workers compensation laws.
Benefits and Protections
Employees are entitled to various benefits and protections that are not available to contractors. For example, employees are entitled to minimum wage and overtime pay, workers' compensation benefits, and unemployment insurance benefits. Employers must also comply with various labor laws, including anti-discrimination laws, workplace safety laws, and family and medical leave laws. The obligation to provide these benefits is one reason that employees may be paid a lower hourly rate than a contractor would be for the same work.
In contrast, contractors are not entitled to these benefits and protections, and businesses are not required to comply with labor laws regarding contractors. Contractors must obtain their insurance, including liability insurance and workers' compensation insurance.
The below paragraphs set out the key high level distinction between contractors and employees:
Contractors
Contractors are usually hired on a project-by-project basis, which means they are only paid for the work they complete. They are responsible for their own taxes and superannuation, and do not receive employee benefits such as sick leave or annual leave.
Employees
In contrast, employees are hired for an ongoing role within a company and receive a regular salary or wage. They are entitled to employee benefits, such as annual leave, sick leave, and superannuation. Employers are responsible for deducting taxes and superannuation payments from their employee's wages.
When talking about the difference between contractors and employees it is important to also distinguish between permanent and casual employees. This is especially the case when it comes to casuals vs contractors.
What is a permanent employee?
A permanent employee is usually engaged under an employment contract or Award as either part-time or full-time, and has a guaranteed number of working hours per week. Permanent employees are entitled to paid holiday and personal leave, which accrues from the commencement of employment.
All permanent employees, irrespective of whether they are working part-time or full-time, accrue leave on an annual basis. Permanent employees may also be entitled to other types of leave such as parental leave, defence forces volunteers leave, bereavement leave, or jury service leave if they meet certain conditions.
What is a casual employee?
A casual employee, on the other hand, does not have a minimum number of hours they are required to work per pay period. They have a more flexible working pattern and may refuse or accept extra work when offered by the employer.
According to Fair Work Australia, a casual employee:
Casual employees receive a higher pay rate than equivalent full-time or part-time employees, called ‘casual loading’. The purpose of the loading is to offset the lack of benefits provided to permanent employees, such as paid annual leave. Casual loading allowances may be set by an award.
Pros and Cons of Hiring a Contractor
There are several benefits to hiring a contractor. Firstly, they offer flexibility, as they can be hired for short-term projects or specific tasks. They also bring a unique skill set to the table, which can be valuable for businesses that require specialist expertise.
However, there are also some downsides to hiring contractors. They can be expensive, as they typically charge a higher hourly rate than employees. Additionally, they may not be as invested in the company's success as an employee would be, as their focus is on completing the project they were hired for.
Pros and Cons of Hiring an Employee
Hiring an employee also has its advantages. Firstly, employees are more invested in the company's success, as they have a long-term stake in the business. They also bring a sense of collaboration to the workplace and can contribute to the company culture.
However, there are also some downsides to hiring employees. Firstly, you will need to ensure you calculate the obligation to provide employee benefits into the equation (don’t forget about long term benefits such as long service leave). Secondly, they are less flexible, as they are usually hired for an ongoing role rather than a specific project. This means if you experience a downturn in work flow you may be under additional cash flow pressure as you’ll need to continue to pay employee wages.
Determining Whether to Hire a Contractor or Employee
So, how do you determine whether to hire a contractor or an employee? The answer depends on your business's specific needs and circumstances. If you require specialist expertise for a short-term project, hiring a contractor may be the best option. However, if you are looking for a long-term hire who can contribute to your company's ongoing success, hiring an employee may be the better choice.
It is also important to consider the legal and financial implications of hiring a contractor or employee. Contractors are responsible for their own taxes and superannuation, while employers are responsible for deducting taxes and superannuation payments from their employee's wages. It is also crucial that you are compliant with Australian employment law and that you understand your legal obligations as an employer when working with contractors and employees. Reach out to the Dexterity Law team if you’d like to discuss your options in further detail here .
What is sham contracting?
The Fair Work Act defines sham contracting as an arrangement where an employer treats a worker as an independent contractor in an attempt to avoid providing employee entitlements. This is a serious offence under Australian law. It may also be illegal for a business owner to convert employees into contractors to avoid their obligations. Employers who try to do this can face prosecution for tax evasion (e.g. if the conversion was done to escape PAYG liabilities) and may be severely penalised for breaking superannuation and workers compensation laws.
Do contractors have legal rights?
Independent contractors have legal rights under the contract for services in contract law. Generally, the scope of these rights are negotiated between the business and the contractor under the terms of the contract of engagement they will enter into. They may also be protected from coercion, adverse action and abuses of freedom of association under the Fair Work Act 2009 depending on the nature of the relationship.
Do I need a contract if I hire a contractor or employee?
When it comes to contracts, clearly defining and understanding the scope of services to be provided through a contract is crucial. This not only helps prevent any potential misunderstandings or conflicts, but it also allows both parties to maintain a positive and secure business relationship. Accordingly, you should ensure you have a contract in place with all contractors and employees.
At Dexterity law we have significant experience in employment and business law, if you are in need of tailored legal advice feel free to reach out to us here .
