Are they an Employee or a Contractor – 5 Questions to Ask Yourself

Small business and fast growing entrepreneurial organisations who are looking to service more clients and bigger projects faster and more efficiently have always been creative in how to manage this growth in their organisations.

One of the key strategies many small business use to facilitate growth in a low risk, cost effective way, is engaging contractors rather than employees to help meet their growing client demands. And there are lots of great arguments for why businesses should utilise this option.

However, recent legal changes have made it imperative for businesses to revisit this issue and ensure they are correctly categorising their workforce. In this article we will explore the key factors that determine the classification, the potential risks of misclassification, and provide guidance on how businesses can navigate this complex question to avoid legal and financial consequences.

What’s Changing

Increasingly in recent years, the line between what constitutes and employee and a contractor has become blurred in the eyes of many business owners. And those who don’t understand this are finding themselves caught in costly and potentially business destroying legal battles, purely because the right structure has not been put in place at the outset.

Whilst the traditional distinction between employees and contractors was primarily based on tax law, recent changes have expanded the definition to include factors from the Fair Work Act and other legislation. This broader perspective aims to provide a more comprehensive assessment of the employment relationship.

A new definition is being added to the Fair Work Act to help determine the definition of an ‘employee’ and there are amendments to ‘sham contracting’ rules.

Effectively not only will it be harder to simply call someone a contractor, if the engagement is that of an employee, and there will now be minimum standards for some contractors, and a pathway to escalate complaints through the Fair Work Commission.

Do Contractors Still Have a Place?

Contractors remain a fantastic way for business to boost their skills, service more clients or offer unique service provision options, but before engaging a contactor you must understand what constitutes a contractor in the eyes of both employment and taxation law – just calling them a contractor and, paying them an hourly rate does not automatically mean they are a contractor.

5 Questions to Ask

Here are some of the key ways to differentiate between whether your new resource is in fact a contractor or should be an employee. Here are 5 questions to ask yourself to help you determine if they are in fact an employee or a genuine contractor:

• Who controls the work? The level of control a business has over how, when, and where the work is performed is a crucial factor. If the business exercises significant control, the worker is likely to be classified as an employee. Conversely, if the worker has autonomy in these aspects, they are more likely to be considered a contractor.
• Can they outsource some or all of the work to others? If you are expecting the work to be completed by that individual, and they do not have the ability to outsource to a third party, then this indicates the relationship is one of employer and employee rather than business and contractor. If you are handing them a project, with a set of end objectives in place, and a set timeframe, but how they get there (including outsourcing to other providers if they choose), is entirely up to them, then it’s likely to be a contractor arrangement.
• Financial Liability - who accepts the risk? Who bears the financial risk associated with the work is another important consideration. If the worker is responsible for rectifying mistakes at their own expense, they are more likely to be classified as a contractor. On the other hand, if the business assumes the financial risk, the worker is more likely to be deemed an employee. Contractors should be accepting the risk and liability for the work they complete and have insurances in place to protect them for this.
• Who is supplying the tools and equipment? The provision of tools and equipment is a factor that can influence the classification. If the worker supplies their own tools and equipment, they are more likely to be considered a contractor. However, if the business provides these resources, the worker is more likely to be classified as an employee, although there are in some cases exceptions to this.
• Are they required to work set hours and is there an expectation of work continuing? The presence of set work hours and a requirement to work a specific number of hours per week or month leans towards an employee classification. Conversely, if the worker enjoys flexibility in their work hours and is not bound by a fixed schedule, they are more likely to be considered a contractor. The expectation of ongoing work and integration into the business are factors that suggest an employee relationship. Conversely, if the work is project-based or for a specific period, the worker is more likely to be classified as a contractor.

Other Factors and Considerations

Of course no situation is ever cut and dry when considering these issues.

Other factors including engagement by other businesses can play a role in determining whether the worker should be classified as a contractor or an employee.

There is no one factor that can determine this relationship, and the new legislation requires employers to consider the totality of the relationship. Specifically it will require employers to consider “the real substance, practical reality and true nature of the working relationship.”

Compliance and Potential Risks

Businesses must carefully evaluate their contractor arrangements and make any necessary changes to ensure compliance with the updated definition. It is crucial to consider all the factors together and not rely on a single factor to determine the classification. By taking proactive steps, businesses can avoid potential misclassification issues.

The reason it’s important to gain clarty at the outset though is that potentially, if you are considering someone a contractor, but they are found to be deemed an employee, you and your business could be liable to back pay employee related benefits such as superannuation, provide workers compensation insurance and appropriate coverage, and be liable to pay a back payment of PAYG withholding.

In addition, with the new laws coming into effect August 2024, misclassifying workers can have even more serious consequences for businesses. The Fair Work Ombudsman now has expanded powers to preside over complaints and make decisions regarding misclassification. This means that businesses found to have misclassified their workers may face back payment claims and other penalties. To avoid these risks, businesses must act now and ensure compliance by the deadline of August 26, 2024.

So before assuming engaging a contractor is the simplest way forward, consider the work you are looking to have performed, and how you as the business owner plan on managing this process, and ensure the structure you put in place is correct from the outset. This will protect you, your business, and ultimately the individual you are engaging as well.

An invitation:

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