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Employee vs Contractor: ATO Tax Implications

5 min read

Understanding whether you’re an independent contractor or an employee is crucial in certain trades. It can have huge implications and far reaching consequences for both the business and the individual – so you really want to make sure you have it right.

Am I a contractor?

Contractors (sometimes called consultants) are self-employed people engaged for a specific task at an agreed price and with a specific goal in mind, often over a set period of time. 

They set their own hours of work and are paid a fee for completing each set assignment. They don’t receive a salary or wage. Once an assignment is finished, a contractor can move on to a new assignment with a different business. Contractors can also perform work for more than one business at a time.

Independent contractors are effectively treated like a small business, and this set up comes with a range of tax implications including potentially having to manage your own GST registration and payments, as well as paying your own income tax (rather than having it deducted by your employer).

Why do businesses like contractors?

Using contractors can give a business a lot of financial freedom, as it gives them the flexibility to hire and fire whenever needed, to cover fluctuations in the order book. It also generally saves on both expenses and red tape. 

What is the benefit of being a contractor?

The biggest reason many people choose to work as a contractor is that it allows them a relative amount of freedom to choose their clients, hours and rates. For disciplined workers it can be a great option, but the down side is that is that it offers little job security, a lack of access to traditional employee rights and considerably more paper work.

Employee or contractor?

The basic rule is: if you are engaged just for your labour, you are considered an employee rather than a contractor, from a tax point of view.

This may sound simple, but in reality it quickly becomes quite complicated. Although some believe that possessing an ABN is enough to qualify you as a contractor, the table below demonstrates that there’s much more to it than that. 

Here is a summary of the differences between being an employee or a contractor:

 

Employee

Contractor

Definition

An employee works in the  business and is part of the business.

A contractor runs their own business and provides services to a business.

Ability to sub-contract or delegate

An employee cannot sub-contract or delegate the work. They cannot pay someone else to do the work.

A contractor is free to sub-contract or delegate work.

Basis of payment

An employee is paid:

  • For the time worked

  • A price per item or activity

  • A commission

A contractor is paid for a result achieved based on the quote they provided.

Equipment, tools and other assets

The business provides all or most of the equipment, tools and other assets required to complete the work. Or the worker provides all or most of the equipment, tools and other assets required to complete the work, but the business supplies them with an allowance or reimburses them for the cost of the equipment, tools and other assets.

The worker provides all or most of the equipment, tools and other assets required to complete the work. The worker does not receive an allowance or any reimbursement for the cost of equipment, tools or other assets.

Commercial risks

An employee takes no commercial risks. The business is legally responsible for the work performed by the worker and liable for the cost of rectifying any defects in the work.

A contractor takes commercial risks, and is legally responsible for their work. They are liable for the cost of rectifying any defect in their work.

Control over work

The business has the right to direct the way in which the worker performs their work.

A contractor has freedom in the way the work is done, subject to the specific terms in any contract or agreement.

Independence

An employee does not operate independently from the business. They work within and are considered part of the business.

A contractor operates their own business independently from the hiring business. Services are performed as specified in the contract or agreement and they are free to accept or refuse additional work.

What is the difference between employee and contractor when it comes to tax?

The tax obligations facing the two types of worker are very different: Employees have tax deducted from their salary and receive compulsory superannuation payments from their employer. Contractors have to pay their own tax from their gross earnings, and also need to make their own superannuation contributions.

The burden of making sure you are working under the right conditions rests with the hiring business. If they incorrectly – based on the facts – deem you to be a contractor when you should be treated as an employee, the business should account for PAYG on your wages, pay you superannuation and give you annual leave and long service leave. 

The Fair Work Act prohibits "sham contracting arrangements", where an employer treats a worker as an independent contractor in an attempt to avoid providing employee entitlements. It is illegal for a business owner to convert staff into contractors. Employers who try to do this can face prosecution for tax evasion and may be penalised for disobeying superannuation laws and avoiding workers compensation laws. 

Still not sure if you’re an employee or contractor? Talk to H&R Block. Our experienced tax consultants will be able to help. Call 13 23 25 for details or find your nearest office and book an appointment online.

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