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Hiring an employee can be a time-consuming and expensive process. Many Australian businesses like yours are increasingly considering an alternative: engaging an independent contractor to perform similar work. But before deciding, make sure you understand the difference between employee and contractor to avoid legal trouble, compliance issues, or hefty penalties.
The ATO provides a detailed contractor vs employee checklist that evaluates factors like working arrangements, control, financial risk, and tax obligations for contractors and employees.
For employees, your business has several legal obligations. You must withhold PAYG (Pay As You Go) tax from their wages and pay superannuation into a complying fund—currently 11% of their ordinary time earnings. Employees are also entitled to benefits such as annual leave, personal leave, long service leave (where applicable), and public holiday pay, depending on their employment type. Additionally, you’re required to insure them through your state’s WorkCover or workers’ compensation scheme, keep accurate payroll records, and issue payslips for each pay period.
Contractors are generally responsible for paying their own income tax, so you don’t withhold PAYG unless there’s a voluntary agreement or specific withholding rule in place. They also handle their own superannuation, register for and charge GST if their annual turnover exceeds $75,000, invoice your business directly for the work they perform, and manage their own business-related expenses.
The Common Law Test is used by the ATO and Fair Work to determine whether a worker is an employee or independent contractor based on the real nature of the relationship—not just the contract terms.
Misclassifying a worker can have serious legal and financial consequences for your business. If someone is engaged as a contractor but legally qualifies as an employee, you may be liable for unpaid wages, superannuation, leave entitlements, and penalties for non-compliance.
Beyond financial penalties, misclassifying workers can damage your business’s reputation, affect insurance coverage, and expose you to legal risks.
Certain job types are classified by default as employees under Fair Work and ATO rulings such as apprentices, trainees, labourers and trades assistants
Job roles that are always classified as contractors include companies, partnerships, and trusts that contract out their services, as well as workers who operate through business structures rather than as sole traders.
Labour hire involves engaging a third party that supplies workers to perform work for your business. Hiring individuals means you deal directly with the person or their business. Even with an ABN, they may still legally be your employee depending on work conditions.
Australian courts use a common law approach to determine whether a worker is an employee or independent contractor. The focus is on the substance of the working relationship, not just the contract’s wording or the label used.
The High Court decisions in CFMMEU v Personnel Contracting [2022] HCA 1 and ZG Operations v Jamsek [2022] HCA 2 confirm that the legal rights and obligations outlined in the contract are central. However, courts also consider real-world conditions including how the work is actually carried out day to day.
In assessing the nature of the relationship, courts look at factors such as who controls how the work is performed, the level of independence the worker has, whether they can delegate tasks, who supplies the tools and equipment, the extent to which the worker bears the risk of financial loss, and how they’re paid.
Contracts may be written, oral, or implied from conduct, and can change over time. The ATO and Fair Work Australia both support this principle, offering detailed checklists and resources to help businesses understand their obligations. Employers are encouraged to use the ATO contractor or employee decision tool and review Fair Work's guidance when engaging workers.
If your worker is legally an employee, you have a legal obligation to provide entitlements such as superannuation, leave, and minimum wage in accordance with the Fair Work Act. You must also provide a safe working environment and appropriate workplace protections. Ensuring compliance from the beginning not only protects your employees but also safeguards your business from costly disputes.
As a contractor: Engaged to deliver a branding project over 3 months. Sets their own hours, works for multiple clients, and provides their own software.
As an employee: Works full-time in-house, reports to a manager, and is paid a regular wage with superannuation.
As a contractor: Operates a small business, brings own tools, and invoices multiple builders.
As an employee: Works on one site under direction, uses company tools, and is paid hourly with leave entitlements.
One of the most common myths is that having an ABN automatically makes someone a contractor, which is not true. Another is the assumption that contractors don’t get superannuation but if a contractor is primarily paid for their labour, super contributions may still be required. Some businesses also think that paying a worker via invoice ensures they are a contractor, but the ATO focuses on the actual nature of the relationship, not the payment method. These misconceptions can put your business at risk if you don’t review arrangements using the proper legal and compliance frameworks.
If you’re unsure whether a worker should be classified as a contractor or employee, the best approach is to assess the relationship using the ATO contractor or employee decision tool.
You should also consider speaking with a qualified bookkeeper or tax advisor, especially if your business uses both employees and contractors.
Reviewing and updating contracts to ensure they match the actual working arrangement is critical. It’s much easier to prevent a misclassification than to fix one after the fact, particularly if it results in back payments, legal claims, or tax penalties.
Getting the classification right from the start is one of the most important decisions you’ll make when hiring. It ensures that your workers receive their proper entitlements and that your business remains compliant with ATO and Fair Work requirements.
A contractor runs their own business, controls how work is done, and handles their own tax and super. An employee works under direction, with PAYG, leave, and super handled by the employer.
Sham contracting is when an employer misclassifies an employee as a contractor to avoid paying entitlements. It is illegal under the Fair Work Act.
The ATO’s independent contractor definition is someone who provides services to others while running their own business, bears commercial risk, and controls how their work is done.
In some cases, yes. State-based rules apply, especially if the contractor provides labour services and works primarily for your business.
Being on wages means you're an employee with entitlements like superannuation, leave, and workers compensation. Working under an ABN means you're a contractor and responsible for your own tax, super, and insurance. Whether it’s better to be on an ABN or wages depends on your work situation.
Our team can walk you through compliance, payroll setup, and whether an independent contractor or employee suits your business best. Call us on 1300 728 875 or Contact Darcy Bookkeeping & Business Services.
