March 9, 2018
4 times you should engage a contractor (and 4 times you shouldn’t!)
There are times you really should engage a contractor to get the job done. Then there are times you really shouldn’t. We look at both.
The contractor v employee conundrum has been hitting the headlines for some time – employers using contractors simply as a method to get around the law, and employees thinking this is a way to avoid PAYG tax.
What businesses need to know is that contractors have their place – so long as they really are contractors and they’re used for legitimate purposes. So we’ve put together this guide which explains when to engage a contractor, when the worker should be hired as an employee instead, and how to work out the difference between the two.
4 times you should engage a contractor
There are times it simply makes sense to engage a worker as a contractor instead of hiring them as an employee. These include:
- When you need someone short-term. When you have a project that’s likely to only last a set period of time or you need extra hands over a busy period which you know won’t last.
- When you need a specialist service. That means something that requires specific skills or is outside of your ‘business as usual’ activities.
- When you need flexibility. This can cut both ways. Often a specialist contractor whose skills are in demand won’t want to work solely for you and won’t want to be tied down to regular hours.
- When you’re legitimately transferring risk. Contractors are required to take out their own insurance and many may be covered for different events.
4 times you should never engage a worker on contractor terms
There are times you should think twice before engaging someone as a contractor, such as:
- When it would be better in the long term to keep that knowledge and experience in-house. It might seem more cost effective to get someone in on a short term basis, but it’s a big investment in time to get them up to speed and then you’ll lose that investment and their organisational knowledge when they move on.
- When it’s to avoid your obligations. There’s no point trying to get around having to pay entitlements under the Fair Work Act or an Award. Not only is it unethical (the minimums are there for a reason), chances are you’ll get caught, and the fines are hefty. PAYG, Payroll Tax and Workers Compensation liabilities can also sting you.
- Simply because the person you’re engaging wants to be a contractor. Simply because someone is happy to sign a contractor agreement does not alleviate the risk on you as a business owner should you get audited, or should they “change their mind”. Avoid this scenario completely!
- When your relationship would fail the ATO’s multi-factor test. This is the big one. If the law doesn’t consider that you’re in a principal/contractor relationship then no contractor agreement will stand up to the scrutiny of the law.
How to make sure you’re really in a principal/contractor relationship
It’s vital that you stay on the right side of the ATO’s multi-factor test, so it’s also vital that you know what this test is.
- Subcontracting or delegating
An employee can’t subcontract/delegate or pay someone else to do their work.
A contractor can subcontract/delegate work or pay someone else to do it.
- Basis of payment
As an employee the basis of payment needs to be one or more of:
● Time worked
● Per item or activity completed
● By commission.
A contractor is always paid on achieving a result based on a quote or agreed fee. This can be calculated via an hourly rate or price per item.
- Equipment, tools and other assets
As an employee either:
● your business provides all or most of the equipment, tools and other assets they need, or
● the worker provides these but your business provides an allowance or reimburses them.
As a contractor, the worker provides all or most of the equipment, tools and other assets they need and receives no allowance or reimbursement.
- Commercial risks
An employee takes no commercial risks. Your business is legally responsible for the work and liable for the cost of rectifying any defect.
A contractor takes commercial risks and is legally responsible for their work and liable for the cost of rectifying any defect.
As an employee, your business can direct the way in which the worker does their work.
As a contractor, the worker has freedom to perform the work any way they choose, subject to the terms of your agreement.
An employee doesn’t operate independently. They work within and are considered part of your business.
A contractor operates their own business independently of yours and performs only the services specified in their agreement. They’re also free to accept or refuse additional work both from you or other business.
Contractors, grey area and regular reviews
As you can probably see already, the ATO’s contractor test isn’t straightforward. It’s likely that many workers fall across both sides of the line and there is no rule of thumb to determine whether someone is or isn’t a contractor.
To make things even more difficult there are other employee/contractor tests too, including:
- fair work act;
- the deeming provisions of the superannuation laws;
- the common law taxation (ato) test (which is different from the one above)
- payroll tax laws;
- independent contractors act, which discusses unfair contracts;
- work health and safety act, which includes contractors as ‘workers’ when it comes to health and safety; and
- workers compensation laws
If you have doubts about someone’s status and you’re wanting flexibility it may be worth considering options such as fixed-term employment or casual employment, in lieu of a contractor’s agreement. Just beware of continuing to engage someone on rolling fixed-term employment agreements, as it’s likely this will lead to an employee being treated as permanent.
It’s important to review your contractor agreements regularly. After all, someone can start out as a genuine contractor and eventually morph into an employee, just through the nature of how your business changes and the work they’re performing.
Get in touch if you’d like professional help to know exactly where you stand.