Employee v Contractor

It’s one of the most common – and costly – mistakes small businesses make: not understanding contractor obligations.

Whether you’re running a tradie crew, a café, or a growing consultancy, getting this really matters. Misclassifying your workers can mean paying backdated super, PAYG tax, leave entitlements, and even fines from the ATO and Fair Work.

Let’s break down what you need to know to stay compliant and protect your business.

Understanding the Difference Between an Employee and a Contractor

The employee v contractor question isn’t just about what you call someone. It’s about the real nature of your working relationship.

According to the ATO (2024), the distinction depends on how much control, independence, and risk the worker has in the job.

Here’s a simple breakdown:

Employee	Contractor
Works in your business, under your direction	Runs their own business and decides how to do the work
Uses your tools and equipment	Uses their own tools and resources
Paid regularly (e.g. hourly or weekly)	Paid per job or project
You’re responsible for tax, super, and leave	They handle their own tax and super
Usually ongoing work	Usually short-term or project-based

Example:
Let’s say you hire a plumber to help out on a few renovation jobs. If you tell them when to show up, provide all the tools, and pay them weekly — they’re probably an employee, even if they provide you with an invoice and have an ABN. But if they invoice you for each job not based on time, set their own hours, and use their own equipment — they’re likely a contractor.

Employee v Contractor: The Legal Tests That Matter

The Fair Work Act and ATO both use a “whole-of-relationship” test. This means no single factor decides the outcome — you must look at the total picture.

Key factors include:

• Control: Who decides how, when, and where the work is done?
• Financial risk: Who bears the cost if something goes wrong?
• Tools and equipment: Who provides them?
• Ability to subcontract: Can the worker hire someone else to do the work?
• Expectation of work: Is there ongoing work, or just individual jobs?

In 2024, the Fair Work Amendment (Closing Loopholes) Act tightened these definitions. The focus is now on the true substance of the relationship, not just what’s written in the contract (source: Fair Work Ombudsman, 2024).

ATO Requirements for Contractors

If someone is genuinely a contractor, they:

• Need an ABN (Australian Business Number)
• Must invoice for their work
• Be paid to produce a result not paid for time
• Handle their own GST, tax, and super (unless covered by special rules like deemed employees for super)

You, as the hirer, usually don’t withhold tax or pay super — but there are exceptions. For example, if the contract is mainly for labour, the ATO may still require you to pay super.

👉 For full details, visit the ATO’s guide: Employee or Contractor – ATO.

Common Mistakes Small Businesses Make

1. “They have an ABN, so they must be a contractor.”
   Not necessarily. Even with an ABN, they can still legally be an employee if they work under your control.
2. Using the same contract for everyone.
   Each working arrangement is unique — what’s appropriate for a short-term project may not suit a long-term team member.
3. Assuming less paperwork means less risk.
   Incorrect classification can lead to big penalties, especially if the ATO finds unpaid super or tax obligations.
4. Not reviewing arrangements regularly.
   A role can change over time — someone who started as a contractor might evolve into an employee.

What Happens If You Get It Wrong

If you incorrectly classify a worker, the ATO can:

• Demand back payment of PAYG tax, superannuation, and leave entitlements
• Impose penalties and interest
• Require you to correct past BAS and payroll records

The Fair Work Ombudsman may also investigate underpayment or sham contracting claims, which can carry serious fines.

One small business owner I met thought they were saving money by hiring contractors for regular admin tasks. When the ATO audited them, they had to pay over $20,000 in back super and penalties. It was an expensive lesson.

How to Protect Your Business

1. Use the ATO’s Employee/Contractor Decision Tool
   It’s free and gives you a reliable indication based on your specific situation.
   👉 Try it here: ATO Decision Tool.
2. Have a clear, written agreement
   Outline terms, payment, scope of work, and independence. This helps prove the nature of the relationship.
3. Review your arrangements yearly
   As your business grows, so can the risk of misclassification. Set a reminder to review contracts each financial year.
4. Get professional advice
   Accountants and business advisors (like us at Accountants 2 Business) can review your workforce setup and help ensure compliance.

If a worker looks, acts, and operates like part of your team, they’re probably an employee — not a contractor.

Ready to Get It Right?

Getting expert help now can save you thousands later.

💬 Book a free consultation with our senior advisor, Janelle Bartlett, to review your worker arrangements.

📥 And download our free business compliance guides here: accountantbusiness.com.au/our-guides

Let’s make sure your team structure is right — and your business stays compliant and confident.