Contractor vs Employee: Understanding the Key Differences in Australia

Are you hiring staff? One decision you’ll need to make is whether to engage them as a contractor versus an employee. Australian laws draw clear lines between the two, and that choice impacts tax, superannuation, entitlements and your legal responsibilities.

With changes to the law in 2024, it’s important to get this right. Misclassifying someone can result in significant fines and back payments for unpaid entitlements. Learn what makes someone a contractor versus employee, Australia’s legal framework around this and how to check if you’ve classified your workers correctly.

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What’s the difference between a contractor and an employee?

It’s helpful to understand the basic definition of contractor versus employee and how their roles differ in practice.

Contractors are self-employed and are their own bosses. They’re hired to complete a particular task or project and usually have control over how and when they work. Contractors typically send invoices for their services, often work for multiple clients, and handle their own tax, insurance and super. For example, an IT consultant who takes on short-term projects, invoices multiple clients and manages their own schedule is considered a contractor.

Employees, on the other hand, work in someone else’s business. They follow direction from their employer, generally work regular hours, and are usually entitled to things like paid leave, super and minimum wage. For instance, a waitstaff member who works regular shifts and is paid an hourly rate by the restaurant owner would typically be considered an employee.

Side-by-side comparison of a contractor vs employee

Here’s how an each generally stacks up across key areas:

What the law says: The legal tests you must apply

The ‘start of relationship’ test (pre-26 August 2024)

For work done before 26 August 2024, most businesses used what’s known as the start of relationship test. This looked at what both parties agreed to at the time of engagement, usually set out in a contract. If someone was engaged as a contractor and the terms matched that classification, it was generally accepted.

The ‘whole of relationship’ test (from 26 August 2024)

From 26 August 2024, most businesses must use the whole of relationship test to determine whether a worker is a contractor or an employee. The new test considers the practical reality of the working relationship, not just what’s in the contract.

That means even if your contract says someone is a contractor, they could legally be an employee if, in practice, they work regular hours under close direction and can’t subcontract their work.

Visit the Fair Work website for more info on the whole of relationship test and how to use it.

Common features of employees vs contractors

Below are key features that help identify whether someone is likely working as a contractor or an employee.

Employees typically:

• Work under the direction of the employer, including hours, location and how it’s done
• Can’t subcontract or delegate their work
• Don’t bear financial risk
• Use tools and equipment supplied by the employer
• Are entitled to paid leave and super

Contractors typically:

• Have a high level of control over when, where and how they work
• Can subcontract or delegate tasks to another person or business
• Bear legal responsibility for the work they do and any risks involved (e.g. injury or damage) that occur while performing it
• Bear the risk of making a profit or loss
• Use their own tools and equipment
• Invoice for their time and aren’t entitled to paid leave

Contracts: Why the wording matters

Just calling someone a ‘contractor’ in their agreement doesn’t make it legally true. What matters is the nature of the working relationship.

A well-drafted contract should reflect the reality of the arrangement. If someone is managed like an employee, works fixed hours and can’t subcontract the work, the courts may still find that they’re an employee regardless of the title.

New changes to the Fair Work Act you need to know

New definition of employment

The Fair Work Act now defines employment based on the real substance of the relationship. That means when deciding whether someone is an independent contractor vs employee, the law looks at the full picture: how the work is carried out in practice, the level of control, financial risk and other day-to-day realities. This change aims to prevent misclassification and ensure people are given the correct entitlements under the law.

The ‘opt-out’ regime for high-income contractors

Workers earning above the contractor high-income threshold (currently $183,100 from 1 July 2025) can choose not to use the whole of relationship test. This means the start of relationship test will be used instead to work out if they are a contractor or an employee.

To do so, the worker gives a written opt-out notice to the business that engages them, which includes a statement that they believe their earnings exceed the threshold. They can only do this once per working relationship, and they’re free to withdraw it later if they change their mind. If the opt-out is withdrawn, the whole of relationship test applies again from the date of notice withdrawal.

If you’re engaging high-income contractors, you can let them know in writing that they’re eligible to opt out – especially if they could be considered an employee under the new rules. It’s a good idea to seek legal advice before proceeding to ensure the opt-out is valid and properly documented.

Superannuation obligations for contractors

With contractor versus employee superannuation, it’s important to know that even if someone works as an independent contractor, you may still need to pay them super. Super is generally required if the contractor:

• Works under a contract that’s wholly or mainly for their labour
• Performs domestic work for more than 30 hours a week
• Is an entertainer, artist or sportsperson paid to perform or appear in a show, event, promotional activity or a similar activity
• Provides services related to a performance, presentation or participation in the above activities
• Works in connection with the making of a film, TV or radio content

In these cases, the ATO considers the worker an employee for super purposes – meaning you’re responsible for paying their super. If you’re unsure if you need to make super contributions for any workers you employ, you can use the ATO’s super eligibility decision tool.

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Tax and financial responsibilities

PAYG withholding for employees

When you hire employees, you’ll need to register for PAYG withholding with the ATO. This means you withhold tax from their wages and report these amounts through Single Touch Payroll. Besides tax, you’re responsible for paying super contributions and meeting other employee entitlements such as paid leave.

Tax and GST for contractors

Contractors handle their own tax affairs. If their annual turnover exceeds $75,000, they must register for GST and include it on their invoices. Contractors lodge their own business activity statements (BAS) and tax returns, which means they’re responsible for tracking income and expenses and paying tax on profits.

This independence is a key difference from employees, who have taxes withheld for them. There are also tax benefits of being a contractor versus an employee – Australia’s tax system allows contractors to claim a broader range of deductions and manage their tax payments more flexibly.

PAYG instalments for contractors

Rather than paying all their tax at once at the end of the financial year, contractors can pay quarterly tax instalments through the PAYG instalments system. This spreads the tax burden over the year, making it easier to manage cash flow and avoid large lump sum payments at tax time.

Entitlements and benefits of contractors vs employees

The table below shows how the entitlements and benefits of being a contractor versus employee typically differ:

The benefits of contractor and employee models each have trade-offs: employees get more entitlements and security, while contractors enjoy more flexibility and autonomy.

Special worker types and how they are classified

Always treated as employees

Some roles are always considered employees, no matter what the contract says:

• Apprentices
• Trainees
• Labourers

These workers are usually covered by an award or agreement and often have limited control over how they work. Because of this, the law treats them as employees and gives them the same entitlements and protections.

Companies, trusts and partnerships

If you’re engaging a registered company, trust or partnership (i.e. not a sole trader), they’re always considered contractors. Even if the work is done by one person, you’re contracting the entity, not employing the individual.

Labour hire and on-hire arrangements

If you engage workers through labour hire or on-hire arrangements, the agency is their legal employer, not you. It’s responsible for PAYG withholding and super, even if the worker is performing their duties on your premises.

Sham contracting: What it is and how to avoid it

Sham contracting is when a business mislabels a worker as an independent contractor even though, by law, they’re really an employee. This might be done to avoid paying entitlements like minimum wage, super and paid leave. It’s illegal unless the business can prove it reasonably believed the worker was a contractor.

It doesn’t matter if the worker agrees to the setup. If they’re working under your control, can’t delegate tasks, are paid for their time and effort, and use your tools or equipment, there’s a good chance they’re an employee in the eyes of the law.

Courts can hand down hefty penalties for sham contracting – up to $495,000 for larger businesses. To avoid breaching the rules, check that your contractors meet the legal definition, document how you assessed the relationship, and get advice early.

Unfair contract terms for independent contractors (effective 26 August 2024)

From 26 August 2024, independent contractors have new protections under the Fair Work Act if they believe their contract includes unfair terms. The Fair Work Commission can now review contracts and rule certain terms invalid if they’re found to be:

• Significantly imbalanced between the parties’ rights and obligations
• Not reasonably necessary to protect the contractor’s legitimate interests
• Harsh, unjust or unreasonable requirements on the contractor
• Resulting in pay that’s less than what an employee would receive for similar work

These protections apply to independent contractors who are individuals, not companies or trusts, and they must be working under a services contract.

If a contractor believes a term is unfair, they can apply to the Fair Work Commission, which has the power to:

• Make a stop order preventing a business from relying on an unfair contract term
• Declare a term of a services contract unfair, which renders it unenforceable
• Vary the contract, if appropriate

Previously, only employees had access to unfair contract term protections under the Fair Work Act. Now, sole traders working as contractors also have access to similar protections under the Act. This is a significant expansion of workplace protections aimed at addressing power imbalances in contractor arrangements, particularly for individuals who have historically lacked easy access to dispute resolution regarding unfair terms.

Myths about employees and contractors

• ‘They have an ABN, so they’re a contractor’ – Not necessarily. An ABN alone doesn’t decide employment status.
• ‘They do short-term work, so they must be a contractor’ – Employees can also be hired for short or casual roles.
• ‘They send us an invoice, so they’re a contractor’ – Invoicing doesn’t automatically mean contractor status.
• ‘Most people in my industry are contractors, so they must be one too’ – Common industry practice doesn’t determine individual status.
• ‘They signed a contractor agreement, so they must be a contractor’ – A contract can’t override the true nature of the working relationship or legal responsibilities.

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How to check your worker’s classification

You can follow this step-by-step guide to assess if someone should be an employee versus contractor:

1. Review the contract carefully. Examine whether your agreement gives your worker control over how and when they work, lets them subcontract, and determines whether they bear financial risk or receive a fixed wage.
2. Compare contract terms to the actual working arrangements. Does the contract match the day-to-day working relationship? For example, if someone has a contractor agreement but works fixed hours under your direction, the contract alone won’t hold up.
3. Use employee vs contractor tools on government websites. Both the ATO and Fair Work offer contractor vs employee calculators and information to guide your assessment.
4. Get legal advice. Seek expert advice from a workplace relations lawyer or tax professional, especially for complex cases or high-income contractors.
5. Keep detailed records. Document your assessment process, including notes on decisions, reasons and correspondence. This can protect your business if your classification is challenged later.

Key takeaways for businesses and contractors

• Understand the legal contractor vs employee tests, particularly those applicable from 26 August 2024.
• Review your contracts and work arrangements regularly. Use clear, consistent agreements that match real-life practice.
• Don’t rely on titles like ‘contractor’ alone.
• Utilise employee vs contractor decision tools on government websites.
• Stay up to date with Fair Work and ATO obligations.
• Avoid sham contracting and misclassification risks.
• Seek legal advice for high-income or complex arrangements.
• Keep accurate records of income and expenses for tax reporting. Using digital invoicing tools can help you automate and streamline this process.