EMPLOYEE vs CONTRACTOR

Should I be an employee or use an ABN?

This was a question posed to us by more than one client this week, so it must be a widespread question being considered.

It seems that some businesses tell applicants there is a specified role but there is a choice whether they will be a regular employee or whether they would be paid using their ABN. That is, whether they would be engaged as an employee or as a contractor.

In my view, it would be rare the same role could be undertaken by an employee or by a contractor as they are completely different and not alternatives to be picked by the worker. Broadly, employees do what they are directed to do are paid for the time they work. A contractor is engaged to produce a result and is paid according to results achieved.

These are some major considerations if there is a decision to make:  

Amount of payment

An employee has twenty annual leave days, ten sick days and around ten public holidays. Contractors get paid only when they work. If the payment is an hourly or daily rate, does it provide enough income for days which are not worked?

Superannuation

The employee enjoys 11.5% superannuation on their gross wages. There is a common misunderstanding that people who are contractors are not entitled to have superannuation paid for them and this is sometimes considered a reason why the payer prefers ‘contractors’.

Under the Superannuation Guarantee legislation, however, payments to a person which are principally for labour leave the payer liable for superannuation, subject to some exceptions. If an exception does apply, is the amount earned sufficient to cover for the lost superannuation?

Insurance

An employee is covered by their employer’s Workers Compensation insurance but a sole trader contractor needs to have their own insurances. Does the contract rate cover the amount of insurance that the contractor will need to take out?

Tax payments

An employee has income tax instalments deducted but a contractor receives the gross amount of their earnings and needs put money aside to meet an annual tax bill and then future tax instalments.

Tax deductions

An employee has limited areas where tax deductions against employment income can be claimed, being where the outlay was incurred as part of you earning the wage or salary.

There is a common misconception that a contractor has a greater range of areas for tax deductions. Examples of the supposed additional areas are car costs, wages to family members, non-essential travelling and others.  

The tax laws define “personal services income” (PSI) and treat people who are deriving PSI virtually as if they were employees for taxation purposes. Broadly, PSI is when more than 50% of the income is for personal efforts or skills, rather than being generated by the use of assets, the sale of goods, or from a business structure. Earning an hourly or daily rate from one payer is clearly PSI.

As always, a professional adviser can help avoid expensive errors.