Employment
Employee or contractor
Whether a worker is an employee or a contractor is decided by the real nature of the working relationship, and it determines PAYG withholding, super and GST obligations.
Deciding whether a worker is an employee or a contractor is one of the most important classification questions for a small business. The answer sets whether the business must withhold PAYG tax, pay super guarantee, report through Single Touch Payroll and provide employee entitlements, or whether the worker is responsible for their own tax and invoices the business with an ABN.
The ATO and the courts look at the whole relationship, not just the contract label or whether the worker has an ABN. Common factors include who controls how, when and where the work is done, whether the worker can delegate or subcontract, whether the worker supplies their own tools and equipment, whether payment is for hours worked or for a result, who carries the commercial risk, and whether the worker is free to offer services to others. No single factor decides the outcome, and the overall picture matters.
The ATO provides an online employee or contractor decision tool and also private rulings, so businesses can get a binding answer on their specific facts. It is also wise to check workplace law, because the Fair Work system looks at the question separately for minimum pay and entitlements, and state workers compensation schemes may have their own definitions. The tests are similar but not identical.
The consequences of getting it wrong can be significant. If a worker treated as a contractor is later found to be an employee, the business can be liable for unpaid PAYG withholding, super guarantee charge, interest and penalties, and may owe leave and award entitlements. On the other hand, treating a true contractor as an employee wastes effort and may cause incorrect reporting.
GST adds another layer. A contractor who is registered for GST adds GST to invoices, and the business claims credits if it holds a valid tax invoice. An employee does not charge GST on wages. Where a worker is a contractor but the contract is mainly for their personal labour, super guarantee can still apply, because the law extends the definition of employee for super purposes. This surprises many businesses.
A common misunderstanding is that a worker can choose to be a contractor simply by getting an ABN. Another is that a written agreement stating contractor status will protect the business if the substance is employment. The ATO looks through labels to the facts.
This is general information only, so confirm the position for your workers with the ATO or a registered tax professional.
Worked example
A cleaning business engages Jo to clean offices at fixed hours, using the business's equipment and uniform, paid $35 per hour. Jo has an ABN but takes direction and cannot send a substitute. These facts point to employment. For 20 hours, gross pay is $700; the business should withhold PAYG, pay super on top, and report through STP, even though Jo has been invoicing it.
Practical tips
- Run the ATO employee or contractor tool and keep a copy of the result with your records for each worker.
- Remember the extended super definition: a contract that is mainly for labour can create super obligations even for a contractor.
- Review arrangements when the work changes. A role that began as a short project can drift into ongoing employment.