It can be a bold decision to leave the safety of the traditional workforce behind and do it alone, casting off the certainty of a 40 hour week and stepping into the exciting world of independent contracting.
Such a move comes with unparalleled freedom and autonomy. However, it can also be confusing. So, for first-time entrants into the flexible economy, what’s the difference between a contractor and the more-traditional employee, and how do you know which one you are?
Even if you call yourself a contractor, you could be considered an employee for tax purposes.
Employee vs. contractor – what’s the difference?
While the characteristics of employees and contractors may have some similarities – and are often used interchangeably – they are distinct in several key ways:
Contractor: Organisations turn to contractors when they require specialist skills but don’t wish to (or cannot) bring these in-house. Generally, a contractor provides:
- A set service – usually involving technical or physical labour.
- For an agreed upon price.
- For an agreed upon time frame.
- To specified standards and conditions.
- They may perform their work on-site, but often have flexibility.
- Are free to subcontract the work to another party, or delegate to their own employees.
- Provide most or all of the tools and equipment needed to undertake the work.
- Take on the commercial risk for the work, being legally liable for the cost of rectifying errors or defects in their work.
Employee: An employee is usually considered a core part of their employer’s business. Generally, an employee is:
- Employed on an ongoing basis.
- Usually paid either for the time worked or on a commission basis.
- They cannot subcontract their work to others.
- Required to adopt company-centric standards and values.
- Not required to bear commercial risk.
- Usually works with supplied equipment (or is reimbursed for expenses in relation to equipment they pay for).
- Is entitled to superannuation and leave.
How does this impact your tax obligations and entitlements?
GST and PAYG obligations: As key members of an organisation, employees don’t have to pay GST and have their Pay As You Go (PAYG) income tax withheld on their behalf by their employer. Contractors, by contrast, must generally pay their own income tax, and have to register for and pay GST (if they earn over $75,000 annually from their business).
Superannuation entitlements: Employees are entitled to a minimum 9.5% superannuation guarantee contribution from their employer. This isn’t automatically the case for most contractors.
But wait! Some contractors are entitled to superannuation too: Despite not being rank-and-file employees, some contractors may still be eligible for superannuation payments if they’re paid wholly or principally for their labour. Where the contractual terms indicate that the individual is remunerated wholly or principally (for example, more than half of the total dollar value) for their personal labour or skills, the work must be performed personally by the contractor, and the individual is not paid to achieve a result (for example, paid on a time-basis rather than for a set outcome), the contractor may be eligible for superannuation.
Contractors can deduct a range of costs: Finally, contractors may be entitled to a range of deductions relating to the costs of running their business, including office equipment, depreciating assets, and travel costs. For employees, it’s generally assumed that the employer covers these costs, or reimburses the employee for them.
How to determine whether you’re an employee or contractor
A simple way to determine whether you’re operating as an employee or a contractor is to visit the ATO’s employee/contractor decision tool.
Follow the steps to check your position. If you have additional questions or complicated circumstances, it’s a good idea to consult the advice of a tax professional.
Know your terms before taking the plunge
The decision to leave the rat race for greener pastures is a monumental career step for many. Before doing so, however, it’s wise to know what kind of work you’ll be providing, how this work is likely to be classified by the ATO, and what obligations and benefits each category provides. Doing so will ensure you are compliant from a tax perspective, helping new venture take flight without the worry of non-compliance or penalties for making mistakes in relation to your tax.
Thinking of taking the plunge and becoming a contractor or freelancer? PwC has developed a tool, Airtax, that makes GST filing and income taxes a breeze.