How to establish a contractor relationship

A. Why do you want a contractor relationship?

It is increasingly common for businesses to seek to engage contractors to perform services rather than employees. This may be because certain contractors have particular skills but are not needed on a long term basis. However, it may also be because business owners (called “principals”) mistakenly perceive that it will save money to engage contractors or will avoid obligations to pay tax and workers compensation insurance for instance.

The most important thing for a principal when making a decision to engage a contractor is to do everything possible to establish that there is a genuine independent contract relationship and that the arrangement is not really an employment relationship by another name. There can be expensive consequences if a contractor relationship is not properly established.

There are some important differences between an independent contractor relationship and an employment relationship. An independent contractor does not have the guaranteed minimum terms and conditions of an employee. An independent contractor is really no different from any business owner. An independent contractor may take the form of a sole trader, partnership, company or trust and may well have employees or subcontractors of its own. It is arguable that an independent contractor agreement has an implied duty between the parties of mutual trust and confidence. However, the terms of an independent contract are largely contained in the contract document itself.

If you are a contractor or looking at establishing a business along contractor lines, it is necessary to decide whether the independent contractor model is suitable for your mode of operation. If you are operating a one man (or woman) business, you will need to consider how to cover such issues as annual holidays and sickness as well as commercial issues such as the need to provide invoices and deal with GST requirements. It is important that you realise that contractors don’t have the same rights and remedies available to them as employees. For instance, if an underpayment occurs, the workplace ombudsman cannot pursue the principal for you. Your main avenue of recovery is by taking common law proceedings in the courts.

From a principal’s point of view, contracting relationships have their advantages and disadvantages. Operationally, the contractor generally sits outside the business structure and the principal has limited control over the contractor, so you will need to consider whether this sort of model fits with your style of business. You will also need to consider whether the perceived savings (paperwork and financial) of a contractor relationship are real rather than illusory.

The lines between what is truly an employment relationship and what is a contractor relationship have become increasingly blurred in recent years (as has the line between casual and permanent employment). However, it is more than an academic distinction. For instance, it is relevant to questions of tax, workers compensation and other insurance and rates of payment.

B. Legal tests

Historically, a contract of employment is called a “contract of service” whereas an independent contractor relationship is called a “contract for services”. It is necessary to be careful when entering into a relationship with a contractor to ensure that they are a contractor at law rather than an employee. Just because someone calls themselves a contractor will not necessarily save an employer from being responsible for workers compensation premiums for that person for instance. The ideal example of a contractor is of a landowner engaging a builder to construct their home. The homeowner can give the builder plans for their home but it is up to the builder how they construct the home, their hours of work and they have to provide building supplies and tools.



Abraham Abdalla v Viewdaze Pty Ltd t/as Malta TravelAustralian Industrial Relations Commission, Vice President Lawler, Deputy President Hamilton and Commissioner Bacon, Sydney, 14 May 2003

In dismissing an application for relief in respect of unfair dismissal, a Full Bench of the AIRC helpfully summarised the principles to be applied in determining whether a worker is an employee or independent contractor in light of the High Court’s 2001 decision in Hollis v Vabu Pty Ltd (the Bicycle Couriers case). The fact situation here concerned a travel agent who worked under a document called an “Employment agreement” but with several features of a principal-contractor relationship. The AIRC Full Bench said the following approach should be taken in determining whether a worker is an employee or independent contractor:

  1. The over arching question is whether the contract between the parties is a contract of service or a contract for the provision of services, i.e. is the worker the servant of another in that person’s business or does the worker carry on a trade or business on their own behalf?;
  2. The nature of the work and the manner in which it is performed needs to be considered;
  3. The terms and terminology of any written agreement must be considered. However, parties cannot alter the nature of the relationship just by putting labels on the agreement or particular terms which do not truly reflect the relationship. It is only if there is still ambiguity after considering the totality of the relationship that the written agreement might be decisive;
  4. Consideration should be given to various indicia developed over the years by the courts such as:
    • To what extent the “employer” exercises or has the right to exercise control over the manner in which the work is performed, place of work, hours of work etc;
    • Whether the worker performs work for persons other than the “employer”;
    • Whether the worker has a place of work separate to the “employer” and/or advertises their services to the world at large;
    • Whether the worker provides and maintains significant tools or equipment;
    • Whether the work can be delegated or subcontracted;
    • Whether the “employer” has the right to suspend or dismiss the person engaged;
    • Whether the “employer” presents the worker to the world at large as an “emanation” of the business, i.e. as an integral part of the business (although the weight to be given to this factor will vary from case to case);
    • Whether income tax is deducted from remuneration paid to the worker;
    • Whether the worker is remunerated by periodic wage or salary or by reference to the completion of tasks;
    • Whether the worker is provided with paid holidays or sick leave;
    • Whether the work involves a profession, trade or distinct calling by the person engaged;
    • Whether the worker creates goodwill or saleable assets in the course of their work;
    • Whether the worker spends a significant portion of his remuneration on business expenses;
  5. If consideration of the indicia does not give a clear result, then it is a practical matter of whether the worker was running their own independent business rather than as a representative of another business with little or no independence in their conduct;
  6. If the result is still uncertain, then the determination should be guided by “matters which are expressive of the fundamental concerns underlying the doctrine of vicarious liability” which include but are not confined to the above. In our view, this practically means a consideration of what is fair and just in the circumstances.

This summary highlights the difficulties in distinguishing between the two relationships. With the increasing deregulation of the labour market and consequent flexibility which is occurring in workplaces, the distinction can often be blurred and is not an easy one to make. However, it should be highlighted that the position cannot be changed by artificial labelling.

C. Comparative features

Employment relationships commonly display the following features:

  • The employer has the right to direct how work is performed;
  • The employer is responsible for any loss occasioned by the negligence of employees;
  • Work is usually performed at the employer’s premises and with the employer’s equipment;
  • Employees work standardised hours;
  • Employees receive annual leave, personal leave, long service leave, parental leave etc and superannuation;
  • Income tax is deducted from an employee’s gross pay;
  • Employees are paid regularly;
  • An employee is generally paid an hourly rate;
  • An employee is generally reimbursed for expenses;
  • An employee has no inherent ability to delegate tasks to others;
  • Employers must have workers compensation coverage for their employees;
  • Employees are exclusively engaged by an employer;
  • Dismissed employees can bring unfair dismissal and sometimes unlawful dismissal claims.

In contrast to the employment relationship, an ideal independent contract relationship will display the following features:

  • The contract should be for a given result, a specific task or a series of tasks;
  • The contractor should retain a high level of discretion/flexibility in how the work is performed;
  • The contractor will bear responsibility for poor workmanship or injury;
  • Contractors are required to carry their own income protection, professional indemnity and public liability insurance;
  • The contractor usually maintains a separate workplace;
  • Contractors provide their own tools and equipment;
  • A contractor is normally contracted for a set period of time or to complete a set task or sets their own hours of work;
  • Contractors do not receive leave or other statutory entitlements of an employee;
  • A contractor should be able to delegate their work;
  • Contractors pay their own superannuation/GST/tax (although note the 80/20 rule);
  • Contractors generally submit their invoice for completed work and are paid at the end of a project;
  • A contractor can carry out work for other persons as well as the principal and can advertise their services to the world at large;
  • Generally, contractor agreements contain a mechanism for giving notice to remedy breach to the contractor;
  • Contractors can bring proceedings under unfair contract legislation or the common law.

D. Issues to consider

When considering whether to engage an independent contractor, a business owner should consider a number of practical and strategic issues:

  1. How closely does the business owner need to control the work carried out by the contractor?
  2. How long is the contractor likely to be a part of the business?
  3. Are there any substantive financial benefits to engaging a person as a contractor rather than as an employee?
  4. Is the reduction in paperwork more imaginary than real?
  5. Is the contractor really carrying on their own business?

If a decision is made to engage an independent contractor, there are some guidelines which should be followed:

  • Ensure the contractor delivers the services through a corporate entity;
  • Where possible, ensure the contractor provides their own tools;
  • Where possible, allow the contractor to subcontract and to set their own hours;
  • Where possible, ensure payment is by result rather than by salary or hourly rate;
  • Where appropriate, allow the contractor to contract to other businesses;
  • Pay the contractor only on receipt of an invoice and don’t deduct PAYG tax;
  • Don’t include any form of paid leave arrangement in a contractor agreement;
  • All contractor agreements should be in writing;
  • Ensure the contractor has adequate income protection and public liability insurance and workers compensation insurance for any workers engaged by the contractor;
  • It should be clear from the contract that the parties intend a contractor and not an employment relationship;
  • The contract tasks should be clearly spelled out;
  • The contract should contain commencement and end dates.

E. What terms should be included?

In many ways it is even more important to have an appropriate written contract in place for a contractor than it is for an employee, given that there are no minimum legislative terms and conditions or award coverage for contractors. A contractor agreement should at least address the following issues:

  1. Agreement to provide services rather than contract of service;
  2. Duration;
  3. Obligations of the parties;
  4. Services fees;
  5. Performance review;
  6. Ability of contractor to assign benefit of contract;
  7. Equipment and expenses;
  8. Insurance;
  9. Legislative requirements and indemnities;
  10. Engagement of persons or entities by the contractor;
  11. Warranties;
  12. Training;
  13. Confidential information;
  14. Intellectual property;
  15. GST obligations;
  16. Dispute resolution mechanisms;
  17. Restrictive covenants after termination of contract;
  18. Statement of nature of relationship.