Legally, Is Your Team Member A Contractor Or Employee? | You need to get this right.

 


Engaging independent contractors can be an excellent way for small businesses to grow and meet client needs efficiently. However, it’s crucial for business owners to understand the legal difference between a contractor and an employee. Mistaking one for the other can lead to unintended consequences, such as financial penalties or back payments (or both).

Let’s explore the legal criteria used to determine these roles and highlight some common pitfalls business owners should avoid.

Key Differences Between Independent Contractors and Employees

While both independent contractors and employees perform essential tasks for businesses, their relationships with the business differ significantly.

Here’s a breakdown of some of the key distinctions:

1. Delegation of Work
Independent contractors typically have the option to delegate their work to others. A clause permitting delegation in an independent contractor agreement supports the status of an independent contractor. Strictly prohibiting delegation tends to be a hallmark of an employer/employee relationship.

2. Ownership of Tools and Equipment
Contractors are expected to provide and use their own tools, equipment, and materials when providing services to a business, and they are required to keep these in good working order. On the other hand, an employer generally provides an employee with the tools, equipment and materials an employee needs to carry out their duties and responsibilities.

3. Non-Exclusivity
Contractors operate their own independent businesses, and this means that they are entitled to have their own client base as they see fit. This means the relationship with the business is non-exclusive, meaning the contractor can work with multiple clients, including competitors of the business. On the other hand, employers have the right to restrict employees from working for other businesses, including competitors).

4. Payment Arrangements
The manner in which contractors are paid also affects their classification. Contractors should issue invoices to the business, unlike employees, who are typically on payroll. Invoices signal an independent contractor relationship, while payroll indicates employment.

The Importance of a Robust Independent Contractor Agreement

Like all things in business, it is crucial to record the arrangement in writing, in this case, a robust Independent Contractor Agreement that is tailored to the business and the relationship at hand. The agreement should clearly outline the working arrangement, ensuring the contract aligns with the realities of the relationship.

It should cover the following (this is not an exhaustive list):

  • Scope of work/Services to be provided;

  • Payment terms;

  • Whether delegation is allowed;

  • Equipment and material responsibilities to be provided by the contractor;

  • Warranties and undertakings provided to the business by the contractor;

  • Any applicable restrictions on the contractor from soliciting clients or customers of the business (if applicable).

The Independent Contractor Agreement is essential to protect both parties and to ensure the relationship is successful. The agreement should be customised for each working arrangement (as with all legal documents, avoid using a generic template).

The Legal Implications of Misclassification

Misclassification of employees as independent contractors, known as ‘sham contracting,’ is illegal. This issue arises when businesses label employees as contractors to save costs by avoiding paying employee benefits such as annual leave, personal leave, or superannuation contributions. Misclassification can lead to a claim being made against a business for back payments, and if proven, penalties can apply.

Understanding Superannuation for Contractors

It is important to note that even if an independent contractor is correctly classified, there are still certain circumstances where superannuation will need to be paid for the contractor - this is when a contractor is deemed to be an employee for superannuation purposes under the Superannuation Guarantee (Administration) Act 1992 (Cth). This legislation requires superannuation contributions to be made in respect of some contractors under certain circumstances, and in general terms, this is when the contractor is paid for their labour or time, rather than for a specific outcome/results basis.


For example:

  • Time-based payment: If a contractor, such as a virtual assistant, invoices a business based on hours worked. Superannuation obligations will apply here.

  • Outcome/results-based payment: If a contractor is engaged to provide a set of deliverables (such as a social media manager who is engaged to provide a set number of blog posts or social media content per week or month), and a fixed fee is payable for this output (regardless of how many hours the deliverables take), this is an outcome/results-based payment arrangement and superannuation obligations generally do not apply.

Due to the complexity of superannuation requirements and the application of the Superannuation Guarantee (Administration) Act 1992 (Cth) businesses should seek expert advice from a business lawyer or accountant to determine if superannuation is payable in respect of their particular contractors.

Why It Matters

The stakes are high, so getting this right matters. It is a business owner’s responsibility to ensure they understand the legal difference between contractors and employees – ignorance of the issue won’t help if it all goes wrong down the track. Misclassification can lead to legal proceedings being commenced against a business, an order for back pay, and financial penalties can apply. The flow-on effect for small businesses who are caught out, regardless of how well intended they were in the relationship, can be significant.

In understanding the legal difference between contractors and employees, business owners need to take the time to:

  • Seek independent, expert advice when hiring contractors.

  • Engage a business lawyer to develop a tailored independent contractor agreement that reflects the arrangement accurately.

  • Regularly review and update their arrangements with contractors to ensure compliance with evolving laws.

Ensuring the correct classification of your team members can bring peace of mind and legal security, helping your business thrive without the risk of exposure to costly legal issues.

If you’re wondering whether you have applied the correct distinction between employees and contractors in your business – reach out here to discuss this with us so you can ensure your business is not at risk.

You might also like to take a listen to Episode #188 of the Rise Up in Business podcast Is your contractor really an employee? where I speak more about this topic.  

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Employees & ContractorsTracey Mylecharane