Contracting has recently emerged as an alternative working relationship along with other types of non-traditional employment such as labour hire. Many businesses use contracting-out arrangements to improve efficiency and allow the business to focus on core activities. Services can often be provided by an outsourcer cheaper than if the firm uses its own employees to do the work.

Small business employers need to recognise who are employees and who are contractors, as their obligations depend on the nature of the relationship.

Employees are engaged under a contract of service, which is characterised by the employer's right to command and control the work of the employee – it is in effect a master/servant role. The employee is essentially an agent of the employer and is remunerated for the provision of labour.

Independent contractors are engaged under a contract for service. A contractor agrees to provide a certain end result; however, how they achieve that result is under their control. Payment is usually based on the completion of the task.

The main factor that will help determine whether a person is an employee or a contractor is the extent of the control over the work that the employer has. If the employer has the right to control when, how and by whom the work is done the relationship is usually that of an employee. Whether the employer exercises this control or not is irrelevant. To decide what level of control is being exercised, you could look at:

• Whether the work can be delegated or subcontracted;
• The type of instructions the employer can give about how the work is performed; and
• How much freedom the worker has about how the task will be performed.

Another test to determine employment status is whether the worker is running a business. Signs of a business include:

• A considerable investment in tools and equipment
• The possibility of making a profit or loss
• Payment on completion of the job rather than for a time period worked.

Regardless of the form of arrangement agreed to by the parties, if a dispute arose the court could still look behind the contract, whether written or oral, and define the true relationship between the parties. An employer cannot contract out of its obligations.

Employers that have incorrectly classified an employee as a contractor may face claims for back pay, annual or long service leave, and compulsory superannuation entitlements. They may also face actions for unfair dismissal or breach of an award.

The Australian Tax Office may also take action if it believes that employees are incorrectly classified as contractors.

Checklist – employee or contractor? (Yes/No)

• Is the worker paid a wage or salary?
• Is the work performed at the employer's place of business?
• Does the worker work regular hours set by the employer?
• Does the employer have the right to direct how the work is carried out and by whom?
• Is the worker restricted in his/her ability to sub-contract part or all of the work?
• Is the majority of the plant and equipment supplied by the employer?
• Is the person engaged for a time-period rather than to produce a particular result?
• Does the employer deduct PAYE tax, superannuation contributions or pay workers compensation insurance?

If the answer is yes to the all the above, then it is likely that the person is an employee.

• Can the person sub-contract any or part of the work without consultation with the employer?
• Does the person employ others to complete the work?
• Can the person decide how the work will be undertaken and by whom?
• Does the person own and maintain equipment required to complete the task?
• Does the person have an opportunity to make a profit or a loss on the job?
• Is the person paid on completion of the job and provision of an invoice?
• Is the person required to rectify any faults with the performance of the job?
• Does the person carry out the work under a business name, partnership or company structure?

If the answer to all the above is yes, then the person may be a contractor. However, no single criterion is likely to be a conclusive indicator of either an employee or contractor relationship.