Whether a worker is an employee or an independent contractor is decided by the terms of the contract between you, not by the label you use or whether the worker has an ABN. If the worker is working in your business rather than running their own, they're an employee and you must withhold tax, report through Single Touch Payroll and pay super. Even a genuine contractor is owed super if they're paid wholly or principally for their labour.
This guide explains how the ATO and the courts draw the line, how the Fair Work rules differ since 26 August 2024, and what each answer means for tax, super, payroll tax and workers compensation.
What You'll Learn
- How the ATO decides: employee or contractor
- The Fair Work whole of relationship test
- Super for contractors
- Tax and payroll differences
- What happens if you get it wrong
- How to check a worker's status
How the ATO decides: employee or contractor
There's no single definition in tax law; the question is answered under the common law. Since the High Court's 2022 decisions in CFMMEU v Personnel Contracting and ZG Operations v Jamsek, the starting point is the written contract. Where the parties have a written contract that isn't a sham and hasn't been varied, the ATO looks at the legal rights and obligations it creates, not at labels or at how the work happens day to day. The ATO sets out its view in Taxation Ruling TR 2023/4, which covers both PAYG withholding and super.
The central question is whether the worker is working in your business or in their own business. The indicators the ATO weighs include:
- Control: whether you have the right to direct how, when and where the work is done
- Integration: whether the worker is part of your business or serving you as a client of their own business
- Delegation: a genuine right to subcontract or delegate the work points to a contractor; having to do it personally points to an employee
- Basis of payment: employees are usually paid for time worked, per item or by commission; contractors are usually paid to achieve a result, often for a quoted price
- Tools and equipment: contractors generally supply their own (with no allowance or reimbursement), although the scale and cost of the equipment matters
- Commercial risk: a contractor bears the risk of loss and the cost of fixing defective work; an employee bears little or none
These aren't a checklist where you count ticks. They're weighed together, and no single factor decides the answer. In particular, asking a worker to get an ABN and send invoices doesn't make them a contractor.
The two High Court cases
- Personnel Contracting (2022): a young backpacker was engaged by a labour-hire business under a written "contractor" agreement and placed on a builder's sites, where he did labouring work as directed. Looking at the contract's terms, the High Court held he was an employee of the labour-hire business, despite the label and his ABN.
- Jamsek (2022): two truck drivers had been required decades earlier to become contractors; they bought their own trucks and operated through partnerships with their wives. The High Court held they were independent contractors, because the contracts were between the company and their partnerships, which owned the trucks and carried the business risk.
Fair Work Act: the whole of relationship test from 26 August 2024
Workplace law now takes a different approach from tax law. Under the "closing loopholes" reforms, from 26 August 2024 most businesses must use the Fair Work Act's whole of relationship test, which looks at the real substance, practical reality and true nature of the relationship, including how the work is actually performed, not just the contract terms. That test applies for Fair Work purposes such as minimum wages, leave, unfair dismissal and sham contracting. The tax and super laws weren't changed, so for PAYG withholding and super the ATO still applies the contract-based approach in TR 2023/4.
A contractor earning above the contractor high income threshold ($190,100 from 1 July 2026; $183,100 in 2025–26) can give the business a written notice opting out of the whole of relationship test, so that their status is decided by looking at the contract at the start of the relationship. The new test has some coverage limits (for example, businesses run by sole traders or partnerships outside the ACT and NT are generally not covered), so check the Fair Work Ombudsman's guidance for how it applies to you.
Sham contracting
It's unlawful to misrepresent an employment relationship as an independent contracting arrangement, to dismiss an employee in order to re-engage them as a contractor doing the same work, or to make false statements to persuade someone to become a contractor. Since 27 February 2024, a business can only avoid liability for misrepresentation if it reasonably believed the arrangement was a contract for services (the old defence of not knowing and not being reckless no longer applies). Civil penalties apply per contravention, on top of back pay of the wages and entitlements the worker missed out on.
Super for contractors
Super law has a wider definition of employee. Under the Superannuation Guarantee (Administration) Act, a contractor paid under a contract that is wholly or principally for their labour is treated as your employee for super, even if they have an ABN and invoice you. The ATO treats a contract as principally for labour where:
- more than half the dollar value of the contract is for the person's labour (skills, mental or physical effort), not materials or equipment
- the person has to do the work personally and can't delegate it, and
- they're paid for the hours or work they do, not for achieving a specified result
If the test is met, you must pay the super guarantee (12%) for them, and since 1 July 2026 under Payday Super it has to reach their fund within 7 business days of each payment. The test doesn't apply where the worker contracts through their own company, trust or partnership. For a contractor's side of this, including what to do if a client doesn't pay, see contractor for superannuation purposes.
Tax and payroll differences
Once you know the answer, the obligations follow:
If the worker is an employee, you:
- withhold tax from each pay under PAYG withholding and pay it to the ATO
- report wages, tax withheld and super through Single Touch Payroll (STP) on or before each payday
- pay the 12% super guarantee into their fund
- provide minimum award or agreement pay and National Employment Standards entitlements such as paid annual and personal leave
- cover them under your state workers compensation policy, and include their wages for payroll tax once your wages pass your state's threshold
If the worker is a genuine independent contractor:
- they invoice you, quote their ABN and charge GST if they're registered (registration is required once turnover reaches $75,000)
- you don't withhold tax, unless they don't quote an ABN (then you must withhold 47%) or you both sign a voluntary agreement for PAYG withholding
- they pay their own tax through their return and PAYG instalments, and arrange their own super and insurance
- you still pay super if their contract is principally for their labour (see above)
- you may need to report payments to them in a taxable payments annual report (TPAR), due 28 August, if you're in building and construction, cleaning, courier and road freight, IT, or security services
- if most of their income is a reward for their personal skills or effort, the personal services income rules may limit their deductions
Payroll tax and workers compensation are state rules
Payroll tax and workers compensation are run by each state and territory, and each has its own definition of who counts. In NSW, for example, the payroll tax contractor provisions (relevant contracts) can treat payments to contractors as taxable wages unless an exemption applies, such as services the contractor ordinarily provides to the public generally, or work done for 90 days or fewer in a financial year. State workers compensation schemes can also deem some contractors to be workers. Check with your state revenue office and your workers compensation insurer (icare in NSW) rather than relying on the ATO answer; see our guide to payroll tax.
What happens if you get it wrong
If a worker you've treated as a contractor turns out to be an employee:
- Super: you'll be liable for the super guarantee charge, which includes the unpaid super, interest and an administration component. Paying the missed super late doesn't avoid the interest and administration amounts, and further penalties can apply.
- PAYG withholding: you can be liable for a penalty equal to the tax you should have withheld, and you can lose the tax deduction for those payments unless you correct the mistake by voluntary disclosure before the ATO starts reviewing you.
- Fair Work: you may owe back pay for minimum wages, overtime, penalty rates and leave, plus civil penalties if the arrangement was a sham contract.
- State obligations: unpaid payroll tax and workers compensation premiums, with interest and penalties.
The ATO's practical compliance guideline PCG 2023/2 sets out how it approaches worker classification and says that the substance of the contract, not its labels, decides the classification. Fixing a mistake voluntarily before the ATO contacts you usually leads to lower penalties.
How to check a worker's status
- Read the contract. Work out what rights and obligations it actually gives each party, and make sure it reflects the real arrangement.
- Use the ATO's guidance and tools. Start with the ATO's difference between employees and independent contractors. Its Superannuation guarantee eligibility decision tool helps businesses work out whether super is payable, and workers can use the Am I entitled to super? tool. The answers are only as good as the information you enter.
- Consider the Fair Work test separately. A worker can be a contractor for tax purposes but still be an employee under the whole of relationship test, or vice versa.
- Check your state's payroll tax and workers compensation rules.
- Keep records of how you made the decision, and review it when the arrangement changes.
- Get advice when it's close. Our business accountants can review your contractor arrangements, super and payroll obligations.
If you're a worker and think you've been misclassified
If you're paid as a contractor but think you're really an employee, or you're a labour-only contractor not receiving super, you can check your position with the ATO's tools, report unpaid super to the ATO, and contact the Fair Work Ombudsman about wages and entitlements. Working out your status also matters for your own return: employees claim work-related expenses, while contractors claim business expenses and may be caught by the PSI rules. For more on the contractor side, see what is a contractor according to the ATO.
Sources: ATO, TR 2023/4 Who is an employee?, ATO, Difference between employees and independent contractors, ATO, Super for independent contractors, Fair Work Ombudsman, Independent contractor changes, Fair Work Commission, Contractor high income threshold, Revenue NSW, Payroll tax contractors.
Need help classifying your workers?
If you're not sure whether your contractors are really employees, or you've found a problem with past super or PAYG withholding and want to fix it before the ATO does, contact us or call 0488 854 200.
How do I get help with this from the ATO?
The ATO provides guidance through ato.gov.au, the Small Business Support Line (13 28 66), and Online Services for individuals and businesses. For complex situations, a registered tax agent provides advice tailored to your specific circumstances and professional indemnity protection. You can verify agent registration at the TPB register at tpb.gov.au.
What records do I need to keep for tax purposes in Australia?
Most tax records must be kept for five years from the date of lodgement or the date the transaction occurred, whichever is later. Records must be in English or convertible to English and must be sufficient to explain the income and deductions in your return. The ATO can request records at any time during the retention period.
When do I need a registered tax agent in Australia?
Consider a registered tax agent when your affairs involve multiple income sources, business activity, investment properties, capital gains, or overseas income. Agents extend your lodgement deadline, provide safe harbour protection, and take professional responsibility for the advice given. Verify registration at tpb.gov.au.
How does the ATO calculate penalties for compliance failures?
The failure to lodge penalty is based on penalty units ($364 per unit from 1 July 2026), accruing per 28-day period for late returns and BAS lodgements. Incorrect information penalties range from 25% to 75% of the tax shortfall depending on whether the behaviour was careless, reckless, or intentional. Proactive disclosure before an audit begins typically results in significantly reduced penalties.
What is the difference between tax avoidance and tax minimisation?
Tax minimisation is the legal arrangement of your affairs to reduce tax — claiming all eligible deductions, using appropriate structures, and timing income and expenses. Tax avoidance involves arrangements that technically comply with the law but achieve outcomes parliament did not intend. The ATO can apply Part IVA anti-avoidance rules to cancel benefits from avoidance arrangements.
