Taking staff on is a huge and impactful decision for small to medium businesses. When you bring additional people into your business, you’ll need to determine whether to hire employees or engage contractors. While both are valuable options with their own pros and cons, you must understand the differences from the outset to avoid falling into any legal traps.
At Davidsons, we often see businesses make innocent mistakes when classifying their staff. And those mistakes can end up being very costly down the track. Let’s take a look at what you need to know.
What’s the difference between an employee and a contractor?
What does ‘employee’ mean?
An employee works directly for your business. You control when, where and how they do their job. Employees receive a wage or salary, along with entitlements like paid leave, superannuation contributions and protections under the Fair Work Act.
What does ‘contractor’ mean?
A contractor runs their own business and provides services to your business. They have more autonomy over how the work gets done, they can negotiate their own rates and they can work for multiple clients simultaneously. Contractors may also delegate some or all of your tasks to others within their business.
Should I hire an employee or a contractor?
Here are some of the key factors to consider:
1. How much control do you want over your team and when/how they complete their work?
Control is a big one. With employees, your business directs their day-to-day activities, but contractors work more autonomously and independently – they can often determine their own methods and work structure.
2. Do you have enough work and cash flow to sustain regular payments?
Employees are paid regularly (weekly, fortnightly or monthly), including superannuation and leave entitlements, so consistent cash flow is needed to sustain these ongoing costs.
Contractors, on the other hand, can charge higher hourly rates, but you only pay them as they complete the work or achieve milestones. This on-demand engagement can be more cost-effective for businesses with fluctuating workloads.
3. Are you on top of employee benefits and entitlements?
Under employment legislation, employees are entitled to minimum wages, leave, super, and other benefits. Contractors manage their own taxes, super and insurance needs. Employment legislation can be complex, so you may need external advice to ensure compliance.
4. What level of risk are you comfortable assuming?
Contractors generally bear more risk, as they’re responsible for managing their own business operations and related costs, while employees are protected under workplace health and safety regulations.
The pitfalls to watch out for
Misclassification risks:
One of the biggest risks is misclassifying someone as a contractor when they’re really an employee. The ATO and Fair Work Ombudsman keep a very close eye on this. If they determine that your contractor is actually an employee, you could attract significant penalties for unpaid super, leave entitlements and tax obligations.
Superannuation guarantee:
Some business owners mistakenly believe that contractors are not entitled to super. It’s important to know that, even if you’ve hired someone as a contractor, they may still be entitled to super payments from you under the Superannuation Guarantee rules, especially if you’re primarily paying for their labour. If you fail to meet this obligation, you may face fines.
Tax consequences:
From a tax perspective, you need to withhold pay-as-you-go (PAYG) tax from employee wages, but contractors are responsible for their own tax obligations. Getting this wrong can lead to debts and penalties.
Fair Work Act compliance:
Remember that employees have key protections around unfair dismissal, minimum wages and workplace conditions under the Fair Work Act -things contractors generally miss out on. To avoid disputes, it’s important to ensure the terms of engagement are clear and legally sound.
Best practices for employers
Here’s how you can get things right from the start:
1. Have clear contracts in place:
Ensure you have clear, written agreements outlining the nature of the relationship, scope of work and payment terms. A well-drafted contract can help protect your business from legal issues.
2. Get professional advice:
Employment law is complex, so it’s always a good idea to consult professionals. Our business advisory team can discuss your needs with you, and we can also refer you to employment lawyers who can help ensure your employment contracts and agreements are robust and watertight.
3. Regularly review your arrangements:
Circumstances, relationships and legislation can change over time, and someone initially hired as a contractor may begin to take on more of the characteristics of an employee. Make sure you’re periodically reviewing the status and classification of your team to make sure you’re staying compliant with employment laws.
The penalties for incorrect employee classification can be huge, so it really pays to get on the front foot. Speak with our team if you need any assistance determining whether your staff should be classified as employees or contractors. A bit of expert guidance upfront can save you a massive headache later on.
Need help understanding your obligations as an employer?
Chat with our experienced accounting team
If you have any questions about employee classification, our expert business advisors are here to help.
You can reach out to us by:
- calling us on 03 5221 6399
- emailing via info@davidsons.com.au.
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This article was written by Tax and Business Services Manager Michael Rebula.
Disclaimer: The information provided in this article is factual in nature and objectively ascertainable and, therefore, does not constitute financial product advice. Importantly, the factual information that has been supplied does not take into account your personal circumstances, objectives or goals.