Are my staff employees or contractors for tax purposes?

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Taxation
By
Stewart Lane
Stewart Lane
Head of Tax
June 29, 2020
10
minute read

The difference between employees and contractors, and what this means for your business

As a business owner, when it comes to employee taxes, you might think that it’s a fairly straightforward process. They’re your employee, and you complete their taxes as such. But the situation is a lot more complicated.

How you define your staff — and how they define themselves — for tax purposes can make a big difference in the amount of tax and super you pay. Paying the wrong amount for either can result in hefty fines.

While it’s possible to renegotiate staff contracts at a later date, it’s always best to start off on the right foot. Contact Liston Newton Advisory today for advice on managing your tax and superannuation obligations.

The difference between employees and contractors

On the surface, your employees and contractors are much the same: you pay them to perform their role.

But when it comes to tax obligations, the similarities end there.

Employees

Your employees are hired to work in your business. You control their role, where and how they work, and the hours they work. You pay them a set recurring salary, and pay for and provide them with the necessary training and tools to fulfil their employment terms.

Under an employee agreement, your staff aren’t able to subcontract the work they’re assigned — it’s their job, and they perform their work.

When it comes to liability, a person who works as your employee shoulders no commercial risk. Your business takes full responsibility for the work your employees complete, and is 100% liable for any errors or defects in their work.

Contractors

A contractor is an outside worker who you engage to work for your business. It’s a completely flexible hiring arrangement, which is why a lot of businesses like employing contractors.

They own and run their own business, and you’re paying them for the services they’re offering to your business. They’re engaged with a specific goal in mind, usually for a set period of time.

You pay a contractor a set fee or rate for the work they’re engaged to complete. They won’t usually receive a salary. As they’re considered their own business, contractors will usually already have their own tools and processes that they follow.

Despite contractor rates being higher than employee rates, you’re not expected to pay for training or tools to help them complete the work they’re engaged to do. This makes hiring contractors for short-term projects much more cost effective than bringing on a new employee.

One of the other big differences when it comes to contractors is that they’re legally allowed to subcontract their work. They can delegate their work to others within their team, or a new subcontractor entirely.

But contractors are also completely liable for the work that they complete. They’re legally obligated to fix or rectify any errors that they make.

The difference in tax obligations

As employees and contractors are engaged for different purposes, the tax obligations for each is different too.

Tax obligations for your employees

Having staff engaged as employees is the situation that most business owners would find themselves familiar with. You’re required to:

  • Withhold tax from their salary or wages (under Pay As You Go withholding) and pay this amount to the ATO on their behalf
  • Make regular super payments for each eligible employee
  • Report and pay any relevant fringe benefits tax, if fringe benefits are something that you offer your employees

Tax obligations for contractors

If you engage some of your staff as contractors, this is where things may become confusing.

Contractors are essentially treated like their own small business, so there are some elements of their financial dealings that you, as an employer, aren’t required to manage.

  • As the person hiring the contractor, you’re generally not required to pay tax obligations on their behalf. As a contractor typically operates under their own ABN, they’re the ones that pay their own taxes. You may be required to pay tax, though, if they don’t supply their ABN, or if agreed upon in a prior arrangement.
  • There are no fringe benefit tax obligations for contractors.
  • If the contractor is engaged primarily by you for their labour, you’re required to pay them super. Conversely, this means that if the contractor works for a range of clients or businesses, then they’re not engaged primarily by your business. In this case, you’re not required to pay super on their behalf.
  • If the contractor is hired by you, but they work through an entity such as a trust or a company, then you’re not required to pay super on their behalf. Under super legislation, this relationship determines that they’re not classified as your employee.

How it works: Calculating the impact of taking on an employee

A common decision for a business is whether to engage someone as a contractor, or add them to the books as a full-time employee.

By spending some time on the calculations, it’s possible to reach a fair agreement between yourself and your contractor. You’ll create an arrangement that’s cost-effective to bring them on as an employee, and they’ll enjoy the benefits of stable employment without feeling like they’re getting a pay cut.

Here’s an example of the considerations for a carpentry business, which includes super, leave loading, and the co-invest scheme.

Example

David is currently subcontracting as a carpenter for Chippy Constructions. He charges $36.53 per hour and works 38 hours per week.

Chippy Constructions is booming. They’ve had so much work on that David hasn't worked for anyone other clients in over 10 months. Therefore, he is also being paid super on top of the $36.53. This makes his total package $40 per hour.

Here’s a breakdown of how much David is costing the business as a contractor:

Package as a contractor:

  • Working weeks per year: 52
  • Total working days: 260
  • Less annual leave days not paid for: 20
  • Less average sick days not paid for: 10
  • Less public holidays not paid for: 12
  • Adjusted working days: 218
  • Adjusted working hours: 1,744
  • Total base pay: $63,708
  • Plus super: $6,052
  • Total contractor pay: $69,760

Package as an employee:

With all the great work he’s done for the business, it’s proposed that David would come on as an employee. The benefit to David is that, as an employee, he would be guaranteed to have a set wage each week, plus sick leave and holiday pay. The new proposed hourly rate is $30.75 + super.

  • Hourly rate: $38.75
  • Weeks per year: 52
  • Hours per week: 38
  • Total pay: $60,762
  • Plus Super: $5,722
  • Plus co-invest contribution: $1,640
  • Plus leave loading: $811
  • Total employee package: $68,985

So as you can see, in some circumstances, it can be more cost-effective for businesses to bring contractors on board as employees instead. There are increased tax obligations but, with the right negotiations on a suitable pay rate, the total cost may possibly be reduced. How you engage your new staff can make a big difference when it comes to your tax obligations.

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