Contractor vs Employee in Australia: The ATO and Fair Work Tests

Quick Answer

A contractor runs their own business and is paid to deliver a result, while an employee works in your business under your direction. In Australia, two separate tests decide which one a worker is. The Australian Taxation Office (ATO) gives most weight to the written contract when deciding tax and super, while the Fair Work Act 2009 (Cth) has looked at how the relationship works in practice since 26 August 2024. Even a genuine contractor who is paid mainly for their labour is owed 12% super, and misclassification penalties reach $21,840 per contravention for individuals and $546,000 for larger companies (2026 figures).

In our experience working with over 10,200 Australian businesses, most misclassification problems start with a well-meaning arrangement that drifted over time, not a deliberate decision to cut costs.

This guide explains both tests, where they disagree, and how to set up a contractor arrangement that holds up.

Click on any of the questions below to jump to that section of this legal guide.

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What is the difference between a contractor and an employee?

An employee works in and for your business, while a contractor provides services to your business through their own business. The label in the contract matters far less than the way the work is actually done.

	Employee	Contractor
Control	You decide how, when and where the work is done	They decide how the work is done
Tax	You withhold PAYG tax from their pay	They invoice you and pay their own tax
Super	You pay 12% super	Usually none, unless paid mainly for labour
Leave	Paid annual, personal and long service leave	No paid leave
Tools and insurance	You supply them	They supply their own
Commercial risk	Your business carries it	They fix their own mistakes at their own cost
Ending the arrangement	Notice, unfair dismissal rules apply	Ends under the contract terms

What classifies you as a contractor?

A person is a contractor when they run their own business, control how they do the work and carry the commercial risk of getting it wrong. Genuine contractors usually quote for a result, supply their own tools, hold their own insurance and can send someone else to do the job.

Working for several clients and advertising to the public points strongly to a contractor. Working set hours, for one business, doing the same job as your employees points the other way.

Is an ABN considered a contractor or an employee?

An ABN does not make someone a contractor. An Australian Business Number (ABN) is a registration for tax purposes, and neither the ATO nor the Fair Work Act uses it to determine a worker’s status.

Asking a worker to “get an ABN” before you pay them is one of the most common warning signs regulators look for. If the rest of the relationship looks like employment, the ABN changes nothing.

The ATO test: tax, PAYG and super

How does the ATO decide if someone is an employee or contractor?

The ATO decides by looking first at the rights and obligations in the written contract, then asking whether the worker is serving in your business or running their own. This approach follows two High Court decisions in 2022, CFMMEU v Personnel Contracting and ZG Operations v Jamsek, and is set out in Taxation Ruling TR 2023/4.

The ATO weighs six main factors:

• Control over how, when and where the work is done
• Independence, meaning whether the worker runs their own business
• Payment basis, whether for time worked or for a result
• Delegation, whether the worker can send someone else
• Commercial risk, including who pays to fix defective work
• Tools and equipment, and who supplies them

How the parties behave after signing only matters if it shows the contract was varied or is a sham. The ATO’s guidance on the difference between employees and contractors walks through each factor, and its decision tool gives a useful first view, but the tool’s result is not binding.

Do you have to pay super for a contractor?

Yes, you must pay super for a contractor who is an individual paid wholly or principally for their labour, even if they quote an ABN. This extended definition sits in section 12(3) of the Superannuation Guarantee (Administration) Act 1992 (Cth), and it applies regardless of the tax classification.

The rate is 12% of ordinary time earnings. Since 1 July 2026, Payday Super requires each contribution to reach the worker’s fund within 7 business days of payment. Our contractor superannuation guide covers the labour test in detail.

What is the 80% rule for contractors?

The 80% rule is a tax rule about personal services income, not a test of whether someone is a contractor or an employee. If 80% or more of a contractor’s personal services income comes from one client, they must pass the “results test” to be treated as a personal services business.

A contractor who fails both tests can still be a genuine contractor. The consequence is limited tax deductions for the contractor, not employee status. We see this confusion regularly: a business assumes that a contractor with one main client must be an employee, or that passing the 80% rule proves they are not.

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The Fair Work whole-of-relationship test

What changed on 26 August 2024?

On 26 August 2024, section 15AA of the Fair Work Act started requiring courts to look at the “real substance, practical reality and true nature” of the whole relationship. The Fair Work Legislation Amendment (Closing Loopholes No. 2) Act 2024 (Cth) introduced the change.

This reversed the 2022 High Court position for Fair Work purposes. The written contract still counts, but how the work is actually performed now counts too. Several guides still ranking in 2026 describe the 2022 “contract comes first” approach as current law, and for Fair Work purposes it no longer is.

For wages, leave, unfair dismissal and sham contracting, the Fair Work test applies.

Can a contractor opt out of the whole-of-relationship test?

Yes, but only a contractor who earns above the contractor high income threshold, which is $190,100 from 1 July 2026. The contractor, not the business, gives written notice that they want the relationship assessed under the older contract-based test.

If the business tells the contractor about the option first, the contractor has 21 days to give notice. The contractor can revoke the notice in writing at any time, and they can give only one notice per relationship.

Opting out does not make someone a contractor on its own. It changes the test, not the answer. Check the Fair Work Commission’s threshold page for the current figure, as it is indexed every 1 July.

When the ATO and Fair Work tests disagree

Can a worker be a contractor for tax but an employee under Fair Work?

Yes, a worker can be a genuine contractor under the ATO’s contract-focused test and still be an employee under the Fair Work Act’s whole-of-relationship test. The two tests start from different places, so they can reach different answers on the same facts.

Take a web developer engaged on a carefully drafted contractor agreement that allows delegation and payment by milestone. On paper, the ATO test points to a contractor. In practice, the developer works fixed hours in your office, uses your laptop, reports to your manager and has no other clients. Under section 15AA, that practical reality can make them an employee for wages and leave.

The result is a split obligation: you might get the tax right and still owe back pay, leave and penalties. This is where most of the risk lies, because businesses check one test and assume the other applies.

The contractor vs employee checklist

No single factor decides the question. Use this checklist to see which way an arrangement leans, and where the two tests put their weight.

Factor	Points to employee	Points to contractor	ATO weight	Fair Work weight
Control	You direct hours, methods and location	They decide how the work is done	High, as written in the contract	High, as it happens in practice
Own business	Works only in your business	Has other clients and advertises	High	High
Payment	Hourly rate or salary	Quote or fixed price per result	Medium	Medium
Delegation	Must do the work personally	Can subcontract or send staff	High	Medium, if actually used
Commercial risk	You pay for their mistakes	They fix defects at their own cost	Medium	Medium
Tools and equipment	You supply them	They supply their own	Low to medium	Medium
Integration	Wears your uniform, part of your team	Presents as their own business	Medium	High

“As written” versus “in practice” is the key difference. A contract clause giving the right to delegate carries weight with the ATO, but under the Fair Work test, a right that is never used carries much less.

When does a contractor become an employee?

A contractor becomes an employee when the way the work is actually done looks like employment, whatever the contract says. The usual pattern is gradual: fixed hours, then a single client, then your equipment, then no real ability to refuse work.

Under the Fair Work test, that drift matters because the whole relationship is assessed over time. Review long-running contractor arrangements at least once a year.

How long can a contractor work for the same company in Australia?

There is no legal time limit on how long a contractor can work for the same company in Australia. Duration alone does not change a worker’s status.

Length does matter indirectly. A contractor engaged exclusively for several years, working the same hours as your staff, is far more likely to be found an employee than one who delivers discrete projects for several clients.

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What misclassification costs your business

What are the penalties for misclassifying an employee as a contractor?

Misclassifying an employee as a contractor exposes your business to back pay, unpaid leave, unpaid super and tax, plus civil penalties under the Fair Work Act. The liabilities stack up:

• Wages and entitlements: award rates, penalty rates, overtime and accrued leave for the whole period
• Super: the super guarantee charge, which adds interest and administrative charges on top of the unpaid super
• Tax: unwithheld PAYG amounts and related penalties from the ATO
• Sham contracting penalties: up to $21,840 per contravention for individuals, $109,200 for businesses with fewer than 15 employees, and up to $546,000 (or three times the underpayment, whichever is greater) for businesses with 15 or more employees

These figures reflect the Commonwealth penalty unit of $364 that applies from 1 July 2026. Since 27 February 2024, a business can only defend a sham contracting claim by showing it reasonably believed the arrangement was a contract for services. Check the Fair Work Ombudsman for current amounts.

Our sham contracting guide explains the penalties and defences in full.

How to set up a genuine contractor arrangement

What should a contractor agreement include?

A contractor agreement should set out the result to be delivered and give the contractor real control over how they deliver it. The key terms are:

• A defined scope of work and deliverables, not open-ended duties
• Payment on invoice, by quote or milestone rather than by the hour where possible
• A right to delegate or subcontract
• The contractor supplies their own tools, equipment and insurance
• Intellectual property ownership and confidentiality
• A super clause for labour-only engagements

Then make sure the arrangement runs the way the agreement says. Under the Fair Work test, a contract only protects you if the day-to-day reality matches it.

When should you get a lawyer to check the arrangement?

Get a lawyer to check the arrangement before you convert an employee to a contractor, engage someone full-time for one business, or pay an individual mainly for their labour. These are the three situations where we most often see both tests fail at once.

A 30-minute call with a lawyer costs far less than defending a Fair Work claim. Book a call with Vanessa ($99 _^+GST), or have your existing agreements checked through our contract review service.

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Frequently Asked Questions

How much tax do you pay as a contractor in Australia?

Contractors pay income tax at their personal marginal rate on their business profit, not on their gross invoices. They pay it through quarterly PAYG instalments or their annual return, and must register for GST once turnover reaches $75,000. If a contractor does not quote an ABN, the business paying them must withhold 47% of each payment.

Can I change an employee into a contractor?

You can only change an employee into a contractor if the working relationship genuinely changes. Dismissing an employee, or threatening to, in order to re-engage them as a contractor for substantially the same work is prohibited under section 358 of the Fair Work Act.

Do contractors get paid leave?

No, genuine contractors do not get paid annual leave, personal leave or long service leave. If a worker labelled a contractor is found to be an employee, the business owes the leave they should have accrued.

Is a sole trader a contractor or an employee?

A sole trader can be either, depending on how the work is done. Being a sole trader describes a business structure. Whether that person is a contractor or an employee for a particular client still depends on the ATO and Fair Work tests.

Does calling someone a contractor in the contract make them one?

No, a contract label does not decide the question. The ATO looks at the contract’s actual rights and obligations, and the Fair Work Act looks at the whole relationship in practice, so a document that says “contractor” can still describe an employment relationship.

Is the ATO employee or contractor decision tool binding?

No, the ATO’s decision tool is not binding. It records your answers and can support your decision for tax and super purposes, but it cannot decide a worker’s status under the Fair Work Act.

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Further Information

• Contractor Agreement Template
• Contractor Superannuation: Who Pays and When
• Sham Contracting: Penalties and How to Avoid It
• Hiring an Independent Contractor in Australia
• Can You Hire Overseas Contractors in Australia?
• What Workplace Policies Do I Need for My Business?

References

• Australian Bureau of Statistics, Characteristics of Employment, Australia (August 2025)
• Australian Taxation Office, TR 2023/4 Income tax and superannuation guarantee: who is an employee? (2023)
• Australian Taxation Office, Difference between employees and independent contractors (17 December 2024)
• Federal Register of Legislation, Fair Work Act 2009 (Cth), sections 15AA and 357 to 359 (current)
• Federal Register of Legislation, Superannuation Guarantee (Administration) Act 1992 (Cth), section 12(3) (current)
• Fair Work Commission, Contractor high income threshold (indexed 1 July each year)
• Fair Work Ombudsman, Sham contracting (current)
• Fair Work Ombudsman, Sham contracting in the spotlight (joint release with the ATO) (13 March 2026)
• Fair Work Ombudsman, Doll House Training penalised $197,000 (30 July 2024)
• Federal Register of Legislation, Crimes (Amount of a Penalty Unit) Instrument 2026 (penalty unit $364 from 1 July 2026)

About the Author: Vanessa Emilio

Vanessa Emilio (BA Hons, LLB, ACIS, AGIA) is the Founder and CEO of Legal123.com.au and Practice Director of Legal123 Pty Ltd. Vanessa is a qualified Australian lawyer with 20+ years experience in corporate, banking and trust law. Click for full bio of Vanessa Emilio or follow on LinkedIn.

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