Employee or Contractor - Avoid Penalties With These 5 Crucial Indicators
Last week I posted a blog post about the basics of the Employee V Contractor question. It is a common question I get asked and treating the arrangement as a contract arrangement when it is in fact an employee arrangement can create complex and costly outcomes for business owners, particularly if the arrangement has been in existence for a long period of time. So how can business owners avoid these outcomes and what indicators help drive defining the work arrangement to get it right, right from the start?
I think one of the fundamental indicators of whether someone is, in fact, a contractor or employee is understanding this element of control of the work and responsibility or ownership of the work. Who has ultimate responsibility for the work that's completed and who has control over how, when, and where the work gets completed? If that's you, as the business owner ... if you're controlling who's doing work, how they're doing it, when they're doing it, where they're doing it, you're most likely looking at an employee. Where if you're not controlling how, when, and where the work is done, it’s most likely, in most cases, a contractor arrangement. I think that could be one of the simplest ways for people to really start considering contractors versus employees.
A good example would be in the construction industry. The control over the actual doing of the job is a big one. What equipment is being used and whether it is major equipment and who supplies this equipment, is responsible for the maintenance of this equipment will often be a guide to the nature of the relationship. Often, just bringing some miscellaneous hand tools, like a shovel, wouldn't necessarily make it and contractor arrangement, but if you're bringing a dingo type digging equipment or whatever it is for the task, the bigger and more comprehensive that equipment, the more likely you are to be a contractor, where the provision of labour is an add-on to the service, rather than the core service, itself.
Another important indicator would be where the liability would sit if something went wrong. Who would be responsible to correct errors or mistakes? Say an IT business sends out a worker to a business to build a computer network which might include advice and establishing hardware and some of that advice is incorrect and causes the business financial loss. The business looks to legal avenues to recoup that financial loss. Who they direct that legal action towards is a good indicator for the nature of the work arrangement? If the ultimate responsibility for the IT advice sits with the IT business then the advice was given by the worker in their capacity as an employee of the IT business. Alternatively, the worker is financially liable for the advice they give than most likely they are a contractor. This can be complex and, in most circumstances, where there is legal action, the courts need to decide what the nature of the relationship is in the first instance before determining where the liability sits. Even if the insurance carried by both parties indicates the nature of the relationship, it isn’t necessarily the case.
Who owns, supplies, maintains, and insures the equipment is an indicator as to the nature of the work relationship. In some cases, this may just be a laptop but in some cases, we are talking about major and expensive equipment. A good example would be in the construction industry. What equipment is being used and whether it is major equipment and who supplies this equipment, is responsible for the maintenance of this equipment will often be a guide to the nature of the relationship. Often, just bringing some miscellaneous hand tools, like a shovel, wouldn't necessarily make it and contractor arrangement, but if you're bringing a dingo type digging equipment or whatever it is for the task, the bigger and more comprehensive that equipment, the more likely you are to be a contractor, where the provision of labour is an add-on to the service, rather than the core service, itself. Especially in construction, this is where the confusion lies. Are you just engaging them for labour, but the labour is a by-product of all the expertise and equipment they bring with them? That's one of the determining factors.
Delegation is something that people are often surprised about when we talk about indicators of the Employee or contractor relationship. The ability to delegate work is one of the key indicators of a contractor. A lot of people I speak to are not only surprised but have some real challenges with getting their head around this. They're engaging someone to be a contractor and they expect the work to be done by that person. When we talk about delegation in this context we mean – Can the person delegate the work required to another person and not complete the work themselves. If it's like, "Hey, Warwick, I want you to dig that hole. You've got to be the one to do it", well I'm not a contractor, I'm more an employee of that person. Where if it's like, "Hey, Warwick", and I go and get my crew to go and do that job. Well, I've delegated that job and therefore, I'm leaning towards being a contractor, rather than an employee.
Risk in this context is different from liability if something goes wrong. That is still risk but risk as an indicator in this instance is about who wears the cost of poor decisions. Who's wearing the risk if you've just grossly underquoted on the job, whether it's underestimated ... if you're an employee, you have no risk, right? You just get paid your wage. Whereas, if you're a legitimate contractor, the job might go perfectly to plan in terms of you get it done in the required hours and time, but you've just grossly underestimated the amount of materials or the cost of the equipment that you needed to bring in. If you're wearing that cost yourself, because you thought to hire the equipment would be $2,000 and instead, it was $32,000, that's on you. Employees typically don't lose money going to work. Contractors sometimes do. Hence, the risk has upward risk where jobs go well and they can make more money and downward risk, where they can lose money. I don't blame anyone for this. Some people want to have their cake and eat it, too. They want the upside and say, I want the high rate because I'm a contractor. Then, they don't want the downside risk of committing to a price on a job. You cannot want all the benefits of being a contractor, but none of the challenges and risks of being a contractor. You've got to be all the way in on that. This is perhaps the greatest source of confusion when it comes to locking down the actual nature of the work relationship.
These indicators don’t exist in isolation and when reviewing an arrangement some indicators may be prominent and simple and others may be subtle and complex. It is however important that you as a business owner get it right due to the potential penalties that exist if you get it wrong. Don’t just assume that because the worker and you have agreed that it is a certain way, that is how the ATO may see it. Get advice from your Accountant or HR professional and work through these indicators.