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Contractor or Employee? What’s the difference?

This week, I think I have spoken to more business owners confused about the distinction between an employee and a contractor than I have in my whole working career. Frustration has led me to attempt to clarify the misconceptions. Here are the most common I’ve come across.

Common misconception #1: A contractor can be paid the same rate as an employee

I’ve been to networking sessions where people ask me my hourly rate and when I do, they tell me that I’m too expensive. When I ask why, they tell me that they pay their bookkeeper a cheaper rate (usually an amount equivalent to what an employee would be paid before entitlements like super).
An independent contractor is effectively running their own business where their product is their service. This means that as with any other businesses, they must pay the bills involved in running it and comply with legislation. For service based businesses like bookkeeping, some examples of the costs involved are insurances (public liability, workers comp if you have employees and business), membership fees for professional associations, software and continuing professional education. There are also the usual overheads such as stationery, postage, phone bills, etc. In addition to this, they also must make a profit so that they can pay themselves, as well as pay their own super and tax. I would wonder how a business that charges an hourly rate that’s the same as what you would pay an employee can continue to be profitable.
So if you engage a service provider because they’re “cheap”, take a step back and ask yourself why. Are they registered with the appropriate regulatory body for their industry? Do they have the requisite insurances? If they make a mistake that results in YOUR business losing money, can you recoup these losses from them? Do they have dispute resolution processes in place if they have not performed the work as agreed?

Common misconception #2: Contract for service, not contract of service

An independent contractor is usually engaged and paid to provide a given result, with the methods used to obtain this result largely left to the contractor. An employee on the other hand, is usually paid for satisfactory performance of individual tasks within their given role.

Common misconception #3: A contractor must work to my specifications

An individual contractor usually maintains a high level control and flexibility as to how the work is to be performed. The contract may contain precise terms as to the material to be used and the methods of performance, but discretion still lies with the contractor as to where and when these terms are carried out. This is one of the key factors that the Fair Work Act and the ATO uses to distinguish if an individual is a contractor or not. An employee meanwhile, must perform the task they’re employed to carry out according to the employers instructions within the time frame that they are given.

Common misconception #4: My contractor has an ABN. Therefore, they are not an employee.

Under the Fair Work Act 2009, an employer cannot disguise an employment relationship as an independent contracting relationship. This is what is considered a “Sham Contract” and an employer found to be guilty of this act can be fined up to $33,000. Simply having an ABN is not an indication of an independent contracting relationship. The agreement must be reviewed holistically and the intent behind the agreement being a key factor.

The Australian Government business website have put up some really useful information here as well as a decision tool to help you understand if an individual is a contractor or an employee.

As a business owner or a contractor, have you come across these misconceptions? Can you add any to the ones I’ve mentioned above?

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