As a small business owner, at some stage, you will probably be hiring a contractor.
You may need extra labour for a short period of time, or hiring a specific skill for a specific project or task. It sounds simple, but it's not as simple as it sounds!
There are a number of legal, tax and performance issues that you really need to be aware of, and you need to do your due diligence before you are the subject of a tax dispute, or you are in a legal dispute with the contractor because their work was not up to what you expected.
Let's break down what you need to know.
These are the areas that you need to be clear on:-
- Difference between a contractor and an employee
- Taxation and other compliance treatment
- Terms of Engagement
The Difference Between a Contractor and an Employee
We all know what an employee works for you, and a contractor works for themselves, but it's not so simple.
Generally, a contractor usually has their own tools and methods for working on the job. You tell them what the end result you want is, and they will do their job their way, in their own schedule, using their own tools and possibly extra hands that they employ.
On the other hand, an employee does what you tell them to do, in the way you tell them to do, and using the tools you give them. They have an employment start and end time and they are expected to work within that time.
There are some examples that are very clear about the difference.
If you hire an accountant to be at your office from 8 to 5 every day, give them a set of duties, a desk and a computer, and they have to work in the way that you tell them to (or at least that you agree to), and you pay them a set wage - that person is an employee.
You hire a firm of accountants (even if it is only one person) who is registered as a separate business to do your books, as long as they meet agreed timeframes they can work whenever they want and use as many other people from their company as they want, don't even have to show up at your office, use their own computers and software, for some agreed price - that person or company is a contractor.
However, some examples are not as clear.
You hire an accountant and agree that they come to your office every Wednesday and Friday between 8 am to 12 pm. They may have their own ABN and even a website. When they are at your office they use your computer and leave all the files with you. You tell them what you want to have done at the start of each day and they only work on what you tell them you need to have done. In fact, because you are finance-trained, you even show them your process of recording payroll.
Is this person a contractor or an employee?
Our common sense screams at us that they are a contractor, but in some cases, they may be deemed to be an employee.
Taxation and Other Compliance Treatment
Here in Australia, a number of laws take effect depending on if the relationship with someone you hire is that of a contractor or an employee.
The Fair Work Ombudsman describes the differences depending on the following characteristics:
- The intention of the parties - whether there is an intention to create an employment relationship, for example getting the worker to provide a TFN and sign employment declarations as opposed to asking the worker for an ABN
- The ability to delegate or subcontract the work - employees do not have this ability whereas contractors do
- The amount of control they have over their own work - contractors have a high level of control over their work including hours and location whereas an employee works under the direction of the employer on an ongoing basis including time, location and even how work is done
- Financial responsibility and risk - an employee gets a regular payment no matter if the work is profitable or not while a contractor bears their own responsibility for profit or loss on the job. A contractor will have to fix mistakes at their own cost while an employee gets paid regardless (but may get a really bad review!)
- Tools and equipment - a contractor generally uses their own tools and equipment whereas an employee has them provided
- Work hours - generally an employee has set times to turn up for work (unless they are casual in which case their hours may vary from week to week but still within agreed start/stop times) as opposed to a contractor who can do the work at any time as long as they finish to an agreed schedule
- The expectation of work continuing - an employee expects their work to continue, even if it is only for a relatively short period or for a specific task) whereas a contractor is engaged task by task and may not be renewed after each task
The Australian Taxation Office also defines the differences in a similar (but not exactly the same) way. The key difference is they are not as swayed by the "intention" and look at "independence". Tax Rulings make it clear that the question of independence is reliant on whether it is a "contract of service" (e.g. be the Sales Manager) or a "contract for service" (e.g. prepare a Business Plan).
The other legislation, which we will not go into here, are the State Payroll Tax legislation and Workcover legislation. These complicate matters even more because their definitions are different from State to State, and again, slightly different from the Australian Taxation Office and from Fair Work Australia.
If you get it wrong, that is, think that you have engaged a contractor when in fact the "facts of the case" show that you have employed an employee, there could be several different ramifications:
- The Australian Taxation Office could fine you for not deducting Pay As You Go Withholding Tax;
- You could be penalised for not paying Superannuation Guarantee;
- You may have to accrue and pay holiday and other statutory leave;
- You may have to pay Workcover insurance;
- You may exceed your Payroll Tax threshold.
The takeaway is clear - get proper advice from your accountant or legal advisor if there is any doubt! Maybe even have a discussion if you think there is no doubt!
Terms of Engagement
Let's say you navigate your way around the issue of whether someone is a contractor or an employee and you are satisfied that they are a contractor.
In order to help that definition in less obvious examples, and because this is a contractual arrangement, you should agree on and prepare written terms of engagement or agreement or contract. For more obvious examples like calling a plumber to fix a leaking tap, this isn't necessary, but you should probably check their terms of payment and so on at least to know what your obligations are.
For all other cases, you should agree on the terms of engagement. Accountants and lawyers will send you periodic "Letters of Engagement" to set out what their responsibilities are - this is required by the professional associations. Financial Planners send you details of what they do and don't do - required by legislation.
So, if you hire someone to prepare a marketing program, or to implement a project, or to prepare a special project - why shouldn't you put your agreement in writing?
Here are the basic matters that should be agreed upon in your contract:
- A work description and schedule - describe what work is required and what the output is, and agree on a schedule of milestones and delivery. Make sure the standard of the output is clear - for example, "a written report" or "a completed user manual". If a schedule is not agreed, then at least provide an estimate of hours required to produce the outcome.
- The payment terms - how much it will cost (or a rate) and when it will be paid - on delivery and completion or in agreed stages?
- Expenses - how are expenses on the job to be incurred and claimed? What is to be included and what is not included?
- Termination - when and how the contract can be terminated for example, sub-par work or missing deadlines.
- Restraints - terms in regard to confidentiality, use of intellectual property, ability to work for a competitor while working for you, and so on.
- Dispute resolution - what is the process if there is a dispute?
This can be as simple as a letter that you both sign, or it may involve a contract drawn up by your lawyers, or it may be a standard contract used by yourself or by the contractor that is amended to suit.
Having Terms of Engagement will resolve a lot of disputes and ill feelings because both parties know what is to be expected from the start.
Sooner or later, you will probably be hiring a contractor because you need extra labour for a short period of time, or you need to hire someone with a specific skill to do a specific task.
The legal, tax and performance implications could trip you up if you don't do your due diligence in order to avoid tax or legal disputes.
If you would like some advice on if you are about to enter into a contractual relationship or indeed if it is actually an employment relationship, or if you need to understand the difference, you can email us at or call 08 9242 2085.