Getting the answer to that question right can save you a lot of money. Getting it wrong, however, can end up costing you a packet, especially where multiple income years are involved.

Where it turns out that a person you thought you had engaged as an independent contractor is really your employee, you could be up for:

• PAYG withholding deductions you should have made
• A superannuation charge, which includes the shortfall amount, interest at 11% per annum, plus an administration fee
• Penalties and non-deductible interest
• Payroll tax
• Workers compensation

There could also be ramifications under employment laws, for example in relation to leave entitlements and unfair dismissal claims.

It can be quite tricky in some cases to determine with confidence on which side of the line the person falls. While you and the person you’ve engaged may be in furious agreement that they are an independent contractor, the ATO may take a different view, with all the downsides that come with that.

The best starting point is to have a written contract covering all aspects of the engagement. Having a written contract removes any ambiguities about what the rights and obligations of the respective parties are.

A written contract might be expected to cover such areas as:

Control

In an employment relationship, the business has the legal right to specify how, when and where the work is performed, whereas an independent contractor would make those decisions, subject to the reasonable directions of the business.

Integration

An employee is an integral part of the business. They perform work as a representative of the business. An independent contractor provides services to the business as part of their own business.

Remuneration

Employees are paid for the time worked whereas independent contractors are paid for a result, usually based on a quoted price.

Subcontracting or delegation

An employee must perform the work themselves and cannot pay someone else to do it for them. Their contract will have no powers to subcontract or delegate. An independent contractor would have the right to delegate or subcontract their work to others. Such a clause must not be a sham and should be legally capable of being exercised. Having such a clause has been helpful for the taxpayer in disputes with the ATO, even where the right to delegate is never exercised.

Tools and equipment

The business provides any tools and equipment an employee needs to carry out the work (or reimburses the employee where they provide the tools themselves). An independent contractor supplies any tools and equipment needed to complete the work.

Risk

An employee bears little or no commercial risk from any defects in their work. An independent contractor bears the commercial risk of any defects in their work. They are required to rectify mistakes at their own expense.

Exclusivity

While not determinative in itself, someone is more likely to be an independent contractor if they also perform work for others.

Leave entitlements

Independent contractors are not entitled to leave payments in the same way that employees are.

Taking someone on as an independent contractor can save huge oncosts which is obviously attractive for the business. But if you bring someone in who works on your premises according to your instructions, gets paid on the basis of timesheets, uses your tools and equipment, is not at risk for losses or damages that arise from their mistakes, has no ability to delegate and works for you exclusively, the chances are you are on the wrong side of the line.

If you have engaged someone through a company, trust or a partnership, your contract is with the entity and employees have to be natural persons. The person doing the work for the entity may have to work through the complex Personal Services Income rules, but that will be a matter for them.

If the shoe is on the other foot, and you have been taken on by somebody as an independent contractor in circumstances where the relevant factors point more strongly to an employment relationship, you could point out the risk the business is running and ask to be put on an employment basis, although that could raise issues around where the power lies in the relationship.

Please feel free to come in for a discussion about the employee/contractor divide.