Employee vs Contractor: A Practical Guide for Small Businesses

Determining whether a worker is an employee or an independent contractor can be tricky for small business owners. Making the right call is crucial – it affects pay, superannuation, leave, taxes, and legal obligations.  Simply calling someone a contractor or having them sign an agreement with an ABN is not enough. You need to look at the real substance, practical reality, and true nature of the relationship. This guide will explain the differences, walk through a recent case (Murray v 239 Brunswick Pty Ltd & Raffoul [2025]), and give you clear tips and warning signs to ensure you get it right.

Why It Matters to Get Classification Right

Misclassifying an employee as an independent contractor (or vice versa) can lead to serious issues. If you treat someone like a contractor when they are legally an employee, your business could face penalties, unpaid entitlement claims, or even unfair dismissal claims. On the other side, true contractors have different rights and obligations than employees. Understanding the distinction helps you meet your obligations under Fair Work  contractor rules and avoid “sham contracting” (misrepresenting an employment relationship as contracting). In short, getting it right means fair treatment for the worker and peace of mind for you as the employer.

Employee vs Independent Contractor: Key Differences

In general, an employee works in your business and is part of your organisation, whereas an independent contractor runs their own business and provides services to yours. Employees are typically subject to your control – you direct their work, hours, and how tasks should be done. Contractors, however, have more freedom in how they deliver services and often provide their own tools or methods.

Many people assume having an Australian Business Number (ABN) or doing short-term work automatically makes someone a contractor. But that is not always the case.

It does not matter if the worker has an ABN – you must consider the entire working arrangement. For example, a worker might have specialist skills and work on a project basis, yet still legally be an employee if the working relationship has employee-like characteristics.

Here are some classic indicators that distinguish an employee from a contractor:

• Control: An employee works under your direction on an ongoing basis (you say what, how, and when work is done). A contractor usually has a high level of control over how they complete the task.
• Hours: Employees generally work hours set by you or agreed in an employment arrangement. Contractors often set their own hours to accomplish the job or project.
• Expectation of Continuity: Employees usually have an expectation of ongoing work (e.g. permanent or regular casual work). Contractors are typically engaged for a specific project or a set period – once the task is done, the engagement ends.
• Financial Risk: Employees bear little to no financial risk – the business covers expenses and losses. Contractors bear the risk for their work; they might incur expenses, need insurance, and generally must fix mistakes at their own cost.
• Tools and Equipment: Employees are often provided tools, equipment, and resources by the employer (or reimbursed for them). Contractors usually supply their own tools, equipment, and materials needed for the job.
• Payment and Tax: Employees are paid a wage or salary (hourly/weekly/monthly) and have income tax deducted by the employer. Contractors invoice for their work (often after completing milestones or the project) and manage their own tax (including GST if applicable).
• Superannuation: Employees are entitled to superannuation guarantee contributions from the employer. If you hire a contractor primarily for their labour, you may still be required to pay super for them under superannuation laws. This often surprises businesses – even some contractors must get super by law.
• Leave Entitlements: Employees (other than casuals) accrue paid leave (annual leave, personal leave, etc.) and are protected by minimum standards. Contractors generally have no paid leave entitlements – their income should factor in time off.

It is a multi-factor test – no single factor decides the outcome. Courts and regulators look at the whole relationship between the parties when determining the status. For instance, you might have a written contract calling someone an “independent contractor,” but if in practice you treat them like an employee (fixed hours, ongoing role, close supervision), the law can still deem them an employee. In fact, the ATO explicitly notes that any label in a contract (like calling someone a contractor) will not determine the true nature of the relationship. Substance wins over form.

 For a deeper breakdown of how to assess employee vs contractor status, read our guide on assessing employee vs independent contractor status.

Case Study: Murray v 239 Brunswick Pty Ltd & Raffoul (2025)

To illustrate how these principles play out, let us look at a real example. Murray v 239 Brunswick Pty Ltd & Raffoul  involved a dispute over whether a worker was an employee or contractor. Ms. Sarah Murray worked as a performer at a Brisbane nightclub (the company 239 Brunswick Pty Ltd, operating “K Klub”). She filed a claim alleging she was an employee who had been dismissed unfairly. The business, however, argued that she was engaged as an independent contractor, not an employee.

The Fair Work Commission had to decide if Ms. Murray was actually an employee (which would allow her claim to proceed) or a contractor. They examined the practical working arrangement, including factors like control over her work, how she was paid, and the contractual terms. In the end, the Commission concluded that Ms. Murray was not an employee of the nightclub, meaning she could not pursue an unfair dismissal under the Fair Work Act. The case was dismissed on jurisdictional grounds because only employees (not genuine contractors) can make unfair dismissal or general protections claims about dismissal.

Key takeaways from the Murray case: Labels and industry practice did not override the reality of the relationship. The Commission looked at what Ms. Murray actually did and how the club treated her. They emphasised examining the real substance of the arrangement – echoing the principle that it is the true nature of the relationship that matters, not just what the contract says. For business owners, this case is a reminder: if you engage workers (even in less traditional roles like performers, gig workers, etc.), you must consider those core factors (control, independence, ongoing engagement, etc.) to determine status. Simply calling someone a contractor (or having them invoice you) is not a shield if in practice they function like your employee.

Determining the True Relationship: Substance Over Form

How can you properly determine a worker’s status? The answer is to take a holistic look. The Fair Work Ombudsman suggests considering a range of factors and the “whole of relationship” – not just the initial agreement. Ask yourself questions like:

• Who has control over how the work is performed? (If you direct the tasks in detail, which leans toward employment. If the worker decides how to do the job, that leans toward contractor.)
• Does the worker operate their own business (with ability to take on other clients, advertise services, bear profit/loss), or do they work in your business exclusively?
• Who provides the tools, equipment, and resources needed? (Provided by you suggests employee; provided by the worker suggests contractor.)
• Can the person delegate or subcontract the work to someone else? (Contractors often can hire an assistant or substitute to help get the job done. Employees generally cannot subcontract their job – they personally are required to do the work as directed.)
• How is the person paid? (Regular wage for time worked points to employee. Payment for a result or per project, often against an invoice, points to contractor.)
• Are there ongoing expectations of work, or is it a one-off engagement? (Ongoing, indefinite work is typical for employees; a fixed project or task is more contractor-like.)
• Who takes on the financial risk? (An employee typically has no risk – if the project runs over time or needs redone, the employer bears that cost. A contractor usually carries risk – if they under-quote or must redo work, it is generally on them.)
• What about benefits and obligations? (Employees get benefits like super, leave, and are covered by things like workers’ compensation; contractors generally manage their own insurance, do not get paid leave, and must budget for their time off.)

No single answer to these questions is definitive. It is the totality of the relationship that counts. You need to weigh all factors together. If in doubt, consult the Fair Work Ombudsman’s resources or seek legal advice – getting it wrong can be costly. The Fair Work Ombudsman’s website has a useful checklist and explains that it cannot decide for you, but it provides guidance to help you assess correctly. Ultimately, if a dispute arises, a court or the Fair Work Commission will examine the real work arrangement in practice and decide if a worker “looks like” an employee or contractor in substance.

Remember, calling someone a contractor does not automatically make them one. As one industry guide bluntly puts it, “Just because your contract says that someone is an independent contractor, doesn’t mean that they are.” If your working relationship has a lot of employee characteristics, there is a chance the law will deem the person an employee regardless of the label. Always focus on what is actually happening day-to-day in the working relationship.

For more insights on independent contractor arrangements and obligations, see our article on Non-Employees (Independent Contractors) – What You Need to Know.

Top Tips for Engaging Contractors Properly

To protect your business and do the right thing, keep these top tips in mind when engaging independent contractors:

• Use a Written Contract, But Do not Rely on Labels Alone – Having a detailed contract with a contractor is smart. It should specify the project, payment terms, and clarify that the person is an independent contractor responsible for their own tax and insurance. However, be aware that the actual working relationship must match the contract. A contract that says “contractor” will not override a reality where you treat them like an employee.
• Consider the Whole Arrangement Upfront – Before you decide to hire someone as a contractor, review the factors above. Think about how much control you need to exert, whether the person will work exclusively for you, and how you will structure payment. If many factors point to an employment-style relationship, err on the side of hiring them as an employee. It is better to put someone on payroll than to risk a misclassification dispute later.
• Educate Yourself on Obligations – Know your obligations for each type. For example, if you do engage a contractor, understand that you generally do not manage their tax or leave, but you might still owe superannuation if the arrangement is mainly for their labour
• . Contractors also need to manage their own insurance (like public liability or professional indemnity). Being clear on these points will help you set up the relationship correctly from the start.
• Review Long-Term or Regular Contractors Periodically – If you have contractors who have been with you a long time or on repeat contracts, revisit the arrangement occasionally. Over time, a contractor relationship can evolve – they might start to look more like part of your staff (for example, working regular hours, appearing in your company directory, or wearing your uniform). Periodically apply the “whole of relationship” test to confirm nothing has shifted toward an employment relationship. If it has, consider adjusting the arrangement or converting the person to casual/part-time employment.
• Document the Working Practices – Ensure that day-to-day practices align with the contractor status. For instance, contractors should ideally invoice you for their work (rather than you putting them on the weekly payroll run), and they should use their own equipment where feasible. Keep records of their invoices and ABN, and any communications that show their independence (e.g. they set their schedule, or they declined work because they had another client). Documentation can help if you ever need to demonstrate the nature of the relationship.
• Stay Current with the Law – Workplace laws evolve. The rules for contractor vs employee have seen updates (like the 2024 changes we discuss below). Stay informed by following updates from Fair Work Australia or subscribing to trusted HR news. When laws change, take the time to understand how they affect any contractors you engage. Small businesses can also reach out to resources like the Fair Work Ombudsman or industry associations for guidance.

Warning Signs of Misclassification (Sham Contracting)

Be on the lookout for red flags that you might be treating a worker as a de facto employee despite calling them a contractor. Here are some warning signs that could indicate misclassification:

• The Worker Is “Part of the Furniture” – If your “contractor” has been working for you for a long time, works only (or mainly) for you, and is integrated into your team (e.g. they have a company email or business cards, attend staff meetings, etc.), this is a strong sign they might actually be an employee. Independent contractors typically operate independent businesses and often have multiple clients.
• You Dictate How They Do the Work in Detail – Providing a general brief or desired outcome is fine for contractors. But if you find yourself instructing a contractor on the minutiae of their work, their schedule, or requiring them to work at certain times/locations like you would with an employee, be careful. Heavy control over a worker’s daily tasks and hours is a hallmark of an employment relationship.
• Paid Like an Employee – Are you paying the person a fixed hourly or weekly rate indefinitely, rather than a per-project fee or quote? Do they submit time sheets like your other staff? Consistent wages for ongoing work, especially without invoicing, suggest an employment arrangement. Contractors usually negotiate a rate for a job or charge by the hour for a defined period or task, and they handle invoicing and GST if applicable.
• No Business Presence of Their Own – A genuine contractor often has a business name, maybe a website or ads, their own tools, and perhaps their own insurance. If the individual does not market their services to others, has no business infrastructure, and essentially works solely within your business framework, that leans towards them being considered your employee in practice.
• The Work is Indistinguishable from Employees’ Work – If a contractor is doing the same work alongside your employees, under the same direction and conditions, and the average person could not tell the difference, that is a warning sign. For example, if you have a “contractor” salesperson who must follow the same roster and sales scripts as your employee sales staff, the law may deem that person an employee too, regardless of the title.
• Pressure to Get an ABN – If a worker originally expected to be hired as an employee but you asked them to get an ABN and invoice you instead (perhaps to avoid paying super or leave), that is a big red flag. This situation is often regarded as sham contracting, which is illegal. You must reasonably believe the worker is a genuine contractor. If not, you could face penalties for attempting to dodge employee entitlements.

If any of these signs sound familiar, it is wise to reassess the arrangement. It may be safer to put the person on as a casual or part-time employee to ensure compliance. Remember that the Fair Work Ombudsman and courts can penalise businesses for sham contracting if they find you represented an employee as a contractor without a reasonable basis.

Recent Changes: The Closing the Loopholes Reforms (2024-2025)

Australia’s laws on independent contractors vs employees have been updated recently to close loopholes and provide clearer guidance. In late 2024, the Fair Work Legislation Amendment (Closing Loopholes No. 2) Act 2023 was passed, introducing a new statutory definition of employment. What this means for small businesses:

• “Whole of Relationship” Test: From 26 August 2024, for many businesses, determining if someone is an employee now requires looking at how the work is performed in practice, not just what is written in the contract. This change was a response to recent court decisions that had focused only on contract terms. Now the Fair Work Act explicitly says to consider the real substance and practical reality of the relationship, having regard to the totality of the relationship. In simple terms, if a worker looks, acts, and is treated like an employee in real life, they likely are an employee – even if the contract calls them a contractor.
• Start of Relationship vs Whole Relationship: For workers engaged before this change, initially the old approach (looking at the contract at the start) applied. But from 26 Aug 2024 onward, the whole relationship test applies to existing arrangements. If you have long-term contractors, you should reassess their status under the new test, especially if the working arrangements have evolved over time.
• High Income “Opt-out”: The new laws allow certain high-earning contractors (above a specified income threshold, e.g. $175,000 as of July 2024) to opt out of the whole of relationship test and be judged by the start of relationship test. This is meant to give more certainty to genuinely independent high-level consultants or professionals. For most typical small business hires, this will not be relevant unless you are engaging very high-paid contractors.
• Sham Contracting Test Tightened: The defence for businesses in sham contracting claims changed from a “recklessness” test to a “reasonableness” test in early 2024. Now, you must show you reasonably believed the worker was a contractor (not just avoid being reckless). This reinforces the need to do your homework and document why you classified a worker as a contractor.
• “Employee-like” Workers: The reforms also introduced the concept of “regulated workers” – certain contractors in fields like the gig economy (digital platforms) and road transport who get additional protections. If your business operates in those areas, be aware there are now minimum standards and protections for those contractor engagements.

Keeping up with these changes is important. The bottom line is the law is moving towards a clearer stance: if a worker is effectively working in your business, they will be treated as your employee, with all the associated obligations. It is wise for small business owners to err on the side of caution and seek advice if unsure. The cost of getting it wrong (back-paying wages, leave, super, penalties, etc.) can far exceed the cost of a quick consultation or adjusting the engagement terms upfront.

(For more details on the 2024 reforms and how they affect contractors, read our explainer on Understanding the Closing the Loopholes No. 2 Act for Independent Contractors.)

Conclusion: Getting It Right

For Australian small businesses, determining “independent contractor vs employee” is a vital compliance step. Always look beyond the labels to the reality of the working relationship. Use the factors and tips outlined above as a checklist. When in doubt, seek professional advice – talk to an HR consultant or employment lawyer, or reach out to the Fair Work Ombudsman for guidance. Properly classifying your workers not only keeps you on the right side of Fair Work Australia’s contractor rules but also builds trust and fairness with those who work with you.

By taking the time to assess the true nature of each working arrangement, you will avoid the common pitfalls and ensure your business engagements are both fair and legally sound. Remember, a little diligence now can prevent major headaches (and expenses) later. Happy hiring – and here is to building your business with the right team in the right way!