Employee or Contractor – The Definitive Guide

Distinguishing between an employee or subcontractor relationship in your business is a little harder than most think, hence the exponential increase in businesses of all sizes being caught. Not to mention the advent of the gig economy where businesses can be vulnerable to legal action by virtue of the fact that certain categories of workers operate invariably as contractors from third-party platforms. For example, Australian creatives who may avail their services on gig orientated platforms.

What’s important to be stated at the outset that it’s likely that many businesses don’t intentionally set out to underpay a person who was once considered by them as a contractor, only to find that the relationship was later deemed as employment. Consequently, they’re required to make amends with tax, superannuation and other entitlements that have been missed because of the oversight.

The term often used to envelope all types of these wrong-doings, innocently applied or otherwise is “sham contracting.”

Put simply, a “sham contract” is an arrangement when an employer misrepresents the working relationship, that being that the worker is in fact, an employee and not a contractor. Many sham contracts are not intentional, but the consequences of falling foul to the Fair Work Act 2009, sham contracting provisions can be serious.

The Act says that an employer is not allowed to:

  • Claim an employee as an independent contractor
  • Force an existing employee to become an independent contractor
  • Dismiss or threaten to dismiss an employee if they refuse to become an independent contractor.
  • Dismiss or threaten to dismiss an employee in order to engage them as an independent contractor to do the same work.
  • Mislead an employee in order to persuade them to perform the same (or mostly the same) work as an independent contractor

Topically, the security industry in Australia at present is under close examination for this type of activity.

Employee or Contractor – Take Home Message

Critically, in the light of recent cases, the determination of whether a worker is an employee or contractor turns on the nature of the work and how it’s performed by the person.

Unfortunately, there are no hard and fast rules when it comes to the determination as there is no statutory definition of the term “employment.”

Seeking legal advice in this respect is recommended, particularly prior to the engagement of the worker to ensure that the contractual relationship is in fact whats intended by both the employer and the relevant employee or contractor.

Employee or Contractor – The Complexity

Integral to identifying whether a worker is an employee or contractor is an assessment of the extent of control that the business has over the relevant person. It tends to be the case that the greater degree of control exerted by the business over the worker the more likely it is that the person will be deemed as an employee. In coming to this view, the court will examine the ‘totality of the relationship’ as opposed to one or two things in isolation.

Where many businesses can get caught is when the relationship shifts. This typically occurs when a business starts to grow and the demand on the worker who the business originally deemed as a contractor becomes more onerous and controlling.

For example, let’s say you own an IT company and upon starting the business you engaged a software engineer to take care of specific projects. When a job came in that required the skill set of the engineer you directed the task to her with an ETA. You exerted no control as to when the engineer would start the job, but rather only a completion date so you’re able to communicate that to your customer. In this case, it’s likely that the relationship would be defined that of a contractor.

But the IT business starts to grow and you now require your software engineer to increase their availability. Consequently, you now require them to be available at 8.30 am through to 4.00 pm each day for work to be delegated to them. In addition to this, at times, as you focus on business development, you occasionally need your engineer to discuss project specifications on behalf of your business. Coinciding with this, you no longer require the engineer to invoice you for each project, but rather pay an agreed amount. In this case, it’s likely that the relationship has now transgressed into employment.

In this circumstance, as the business owner, you haven’t intentionally set out to undercut the worker, but simply took your eye off the ball as your business has grown and you adapted accordingly. Over and above this of course, both you and your worker were happy until the relationship went south and before you knew it, you’re having to respond to allegations from their legal representative.

Increasingly, it’s these types of cases of employee or contractor that end up in dispute.

Notwithstanding this, there are other cases where there is a blatant intention on behalf of a business owner to deceive the worker and misrepresent the working relationship for economic gain. But, by and large, of the matters that end up before Fair Work Australia, these are the minority.

Employee or Contract – Some Myths

Fiction: I only hire this worker for a few hours each day. Surely they’re a contractor?
Fact: Employees and contractors can work, casual, temporary, infrequent or on-call work.

Fiction: My worker has an ABN. So, they’re a Contractor?
Fact: Having an ABN and supplying it to you does not make a worker a contractor.

Fiction: Every week my contractor supplies an invoice. They’re a contractor?
Fact: No, not necessarily. There are numerous other factors that need to be considered.

Fiction: In my industry, every worker is a contractor, so I’m safe.
Fact: This is not always the case. The nature of the industry does not dictate who is an employee or contractor.

Fiction: My contractor signed an agreement that they are a contractor and not an employee. All good?
Fact: Disregard the fact that your worker signed a contractor agreement. A contract does not do away with your obligations under relevant legislation and does not give you the right not to pay an employer’s tax and super if all other factors point to your worker as being an employee.

Employee or Contractor – A Very Slippery Slope

Many employers of sizeable businesses who face an allegation of sham contracting can soon find out that the matter can escalate very quickly, engulfing all other workers. In other words, one worker may mount an action, soon to be followed by numerous others. Hence the importance of employers not only reviewing both their existing contracts with workers but a closer analysis of the nature of the work.

Employee or Contractor – The Test

As mentioned previously there are no definitive means of determining if your worker is an employee or contractor. Instead, it falls on an understanding of the “totality of the relationship.”

More specifically, a court or tribunal looks at such things as:

  • Degree of control over both when and how work is done
  • The expectation of ongoing work
  • Who provided the relevant tools and equipment
  • Method of payment for the work
  • Frequency of payment
  • Ability to work for other companies
  • Right to delegate or subcontract
  • How the worker was represented to customers

This is by no means an exhaustive list, but it will be useful in considering the nature of the relevant work relationship.

Importantly the personal preference by the contractor is also irrelevant. Legally, it’s not a matter of choice, as employment status is determined by the nature of the work arrangement.

Therefore the signing of work contract or agreement stating an individual is a contractor does not absolve the true employment relationship and relevant legislation, despite the worker may be wanting that to be the case.

This circumstance can easily occur during the infancy of the working relationship when potentially the worker was, in fact, a contractor and wanted to be treated that way, but the volume of work that soon followed or a change in the nature of such work results in the worker looking more like an employee than a contractor.

Roy Morgan Research v Commissioner of Taxation (2010) – in this case, a team of market research interviewers had a contractor relationship with the business, the nature of which they could accept or reject assignments as they desired, but in accepting an assignment had to adhere to detailed rules.
Here are some cases that illuminate the difficulty at times in making such a determination.

Hollis v Vabu (2001) – bicycle courier was engaged as a contractor, paid according to the number of successful deliveries he did. However, as a part of his work he had to wear the company uniform, was told when he had to work and how much he had to charge.

This table may assist you in demarcating the actual relationship.

wdt_ID Feature Employee Independent Contractor
1 Measure of control exercised by the principal/employer Employer usually has the right to control how, when and where a worker performs their duties. Tasks are usually performed at
request of employer.
Contractor works at own initiative to achieve a stated result. Contractor maintains discretion and flexibility as to how work is completed, although contract may specify some terms as
to materials used and methods of performance.
2 Exclusivity Employee usually works exclusively for employer. Contractor is free to provide services to multiple clients.
3 Right to Delegate Employee is personally engaged to perform the role and has no inherent right to delegate performance of the role to
another employee, unless authorised by employer.
Contractor may delegate all, or some, tasks to another person and may employ other persons to perform the services (although this may be subject to the principal’s consent).
4 Risks, rectifications or faults Employee bears little or no responsibility to rectify poor work.
Employer is responsible to others for poor work of employee.
Contractor must rectify poor work at own cost and effort, and bears commercial risk of loss incurred by principal due to contractor’s poor work
5 Tools and Equipment Employee generally performs work using tools and equipment provided by employer, at employer’s place of work. Employee is generally reimbursed for expenses personally incurred by them in performing work, as long as they are authorised by the employer. Contractor generally provides their own tools and equipment.
Contractors are not usually reimbursed for expenses they incur in providing the services.
6 Hours of Work Employee has hours of work set by employer Contractor can set their own hours of work, as long as they perform the services.
7 Leave Entitlements Employee is entitled to annual leave, long service leave and sick leave, and this is usually provided for in written contract. Contractor is not entitled to leave, and a written contractor agreement would not usually provide for these things.
8 Payment Employee is generally paid for their time, e.g. hourly, weekly,
annual salary.
Contractor is generally paid for providing services or completing units of work. Contractor usually issues tax
invoices.
9 Methods of Engagement Employees are always personally engaged. If an individual is engaged through a trust, partnership or company, this usually indicates a contractor relationship
10 Part of the Business The work of an employee is usually essential to the business
carried on by the employer. Employee is working in the
business of the employer.
Contractor carries on their own business, independently of the
employer and as distinct from the employer’s business.
Feature Employee Independent Contractor

Employee or Contractor – Where Are You At?

Depending on whether you have now formed the view that the working relationship with your contractor is skating close to the line or you are in receipt of correspondence from your worker’s lawyers to make amends, will determine your next steps.

I’m Skating Close to the Line

If you now believe that the working relationship has shifted, then seeking legal help is smart. Why? Because if you have a good employment lawyer, they’ll be able to not only advise on how you should respond to the worker moving forward and retrospectively if need be, but also be able to assist in ensuring you put into action a water-tight contractual relationship to protect you and your business. It may be the case that you do not wish to have such an employee relationship with your worker/s and good legal advice in this respect will be able to help you instigate practices that are better aligned with contract work and put into place procedures that minimise the risk going forward.

In this circumstance, the worst thing you can do is do nothing! The longer you leave this issue, the more substantial will be the costs in back-paying full entitlements, and of course, a much more significant fine if the matter reaches Fair Work Australia.

I’ve Received a Letter from My Worker’s Lawyer

In the event that you have received correspondence from your worker’s lawyer asserting that you have partaken in a sham contract arrangement, then obviously you’re going to require legal help.

Given that lawyers are expensive, in the vicinity of $350 – $500 an hour, if upon initial advice your lawyer believes that the evidence against you is strong, it may be wise to push the matter to mediation promptly.

The longer you’re involved in a protracted legal dispute, the more expensive it becomes and more than likely, with the same, or worse outcome. By mediating the matter, you at least have a little more control or influence over the outcome.

If you’re in receipt of correspondence from a worker’s lawyer, disregard the figure that they’re likely asserting that you owe. There is often significant room for negotiation.

Employee or Contractor – What Are the Consequences of Getting it Wrong?

The consequences of getting it wrong, obviously depend upon to what extent. If you have a number of contractors who possibly are employees, then the impact upon your business can be substantial. If you have one or two workers, then less so.

If it is proven to be the case that you have made an incorrect classification of your worker/s as a contractor and not an employee, you may be liable for:

• superannuation deriving from the fact that you failed to make superannuation contributions for the relevant worker/s
• payroll tax (including penalties and interest)
• back pay under the relevant award
• unpaid annual and long service leave

In addition to this, if the matter ends up before Fair Work Australia, it will be likely that you will be fined. The extent of the fine, of course, depends upon your circumstance.

In this podcast, Dan Toombs discusses the implications of getting it wrong with David Koschitzke of Harris Lieberman. 

 

Read the Transcript of the Podcast Below

Employee or Contractor – I Can’t Afford it

Business owners by nature are often both resilient and creative. In the event that you have come undone because of a sham contracting arrangement and you’re not in a position to pay the debts and the fine, the inclination may be to fold the business into insolvency. If this is the case, be very careful that any future incarnation of a new business is in fact not a reincarnation of the previous. The latter activity is known as a “phoenix” and there is case law to suggest that at times sham contracting can be synonymous with the practice.

Simply put, phoenix activity is the deliberate and systematic liquidation of a corporate trading entity which occurs with the fraudulent or illegal intention to avoid tax and other liabilities, such as employee entitlements and continue the operation and profit-taking of the business through another trading entity.

Employee or Contractor – Your Next Steps

If you’re a business owner and you are having difficulty determine the nature of a working relationship or alternatively, you’re now facing claims from a disgruntled worker, seeking legal advice is your best option.

At Australia Lawyers, regardless of your location, we have employment lawyers that can help you.

Employee or Contractor – Podcast Transcription

Dan Toombs:

We often hear that the world of work is changing dramatically with technology allowing an increasing number of workers to work remotely. But at the heart of it, irrespective of the nature of how people work, has much changed at all in relation to the legal position of workers being considered as either employees or contractors. I’m David Koschitzke of Harris Lieberman. David has much changed at all in this respect.

David Koschitzke

It’s probably changed in terms of whether we favor people working on a contract basis or on an employment basis. Certainly the contract basis has become more flavor of the month, but it still comes back to the old proposition. You can’t just determine someone’s contract by calling on that and say I’ll sing it if it walks like a duck, if it walks like a duck, if it quacks, it’s a duck. So you just can’t label someone a contractor and make them less.

And so that’s always been the challenge. And the law is what is a contractor or what is an employer.

So for a business owner, whether they’re starting or contemplating whether or not they should put on a prospective worker as either an employee or a contractor.

So the pluses and minuses of actually considering them to be an employee or engage in the employer contract are as follows. If you are taking on someone as a full time employee, there’s always that psychological proposition that they’re going to take pride in being part of your business, that they’re part of your team. You’ll pay them an hourly wage, which ultimately, because of the security they obtain, may mean that they’re cheaper in the long run. You don’t need to scramble to find someone when your workload increases.

They’re there. They’re ready to go. You don’t have to wear all the business at yourself. You can delegate tasks. You don’t need to continually train them because they’re there and ready to fulfill the roles that you’ve got for them. And if you want to break, you can have one because they’re there to back you up when you’re gone. The downsides are that you do have to pay in accordance with national employment standards for employees and accords with awards.

Whereas for the contractor you can set an agreed rate. You have to deduct tax, you have to pay super and employees accumulate various types of leave. You’ve also got a situation where you’re obliged to pay. Even if you haven’t got the workers with a contract, you can put them on and off as you need them.

Dan Toombs:

Sounds like very little responsibility or obligation with contract workers.

David Koschitzke

It does in terms of obligations. That’s right, because pretty much a contract is in business for themselves. So they take the business risk and they had that. They shared their own obligations for making sure that they’ve got themselves properly covered for leave and they’ve got to pay their own super. Often they’ll be supplying their own tools and equipment and they are responsible for the work that they do. So they’ll be doing it. They’ll be results oriented where your employees are basically turn up and do the work on it on an hourly basis.

Dan Toombs:

Are there risks, David, in perhaps the contractor starting to perform work duties? You know, after a period of time look like an employee or vice versa?

David Koschitzke:

That is a clear risk because, of course, the concern is particular if they’re working pretty much for you and you alone. And that’s selling one of the concerns. If you’ve got someone who’s basically only working for you, it’s going to be very hard to say that they are truly a contractor and it’s easy to slip into that position. We’ve engaged them for a period that just keeps on going and going because you’re finding that they’re more and more essential to your business.

And of course, the concern there is that when they do cross that line to become an employee, they may be accumulating employment obligates entitlements, which you’re not fully appreciating, mature incurring. You may be find filing that you’re liable to pay them various leave entitlements and you should be limiting their super and the like.

Dan Toombs:

In this context, is it far better for a business owner or manager to be getting advice in this respect?

That’s right. I’ll always encourage you to do that. There’s an independent contract decision tool where you can go on there and plug in the characteristics of the relationship you’ve got with this particular person and determine whether they are a contractor or an employee. And it’s a good starting point.