Subcontractor vs employee: ATO tests for Australian builders

What it is

The ATO and Fair Work treat the difference between an employee and a contractor as a question of substance, not labels. A worker with an ABN, an invoice and a "subcontractor" name on the contract can still be an employee at law if the working relationship looks like employment.

The consequences of getting it wrong are real. An incorrectly classified worker exposes the builder to back-paid PAYG, superannuation guarantee shortfalls, workers compensation premium adjustments, payroll tax catch-up and sham contracting penalties under the Fair Work Act 2009.

The multi-factor approach

After the High Court decisions in CFMMEU v Personnel Contracting [2022] HCA 1 and ZG Operations v Jamsek [2022] HCA 2, the test for distinguishing employees from contractors focuses on the rights and obligations in the written contract (where the relationship is wholly in writing). The earlier multi-factor "totality of the relationship" approach still informs ATO guidance, especially where the contract is silent or conduct contradicts the document.

The ATO sets out six core factors:

Control over work

An employee performs work under the direction and control of the employer (what to do, when and how). A contractor decides how to do the work to produce the agreed result, subject to the scope.

Ability to delegate

An employee performs the work personally and cannot delegate. A contractor can usually pay another person to do the work, subject to the agreement.

Basis of payment

An employee is paid for time worked (hours, days or weeks) or piece rates within an employment frame. A contractor is paid for a result (per square metre, per fix, per job).

Tools and equipment

An employee typically uses tools and equipment supplied or paid for by the employer. A contractor supplies their own tools and equipment.

Commercial risk

A contractor bears the commercial risk of profit or loss on the work, including the cost of fixing defective work at their own expense. An employee does not.

Integration into the business

An employee is part of the business. A contractor is running their own business, providing services to the principal as one of many possible customers.

No single factor is decisive. The whole picture matters, with the written contract as the starting point.

Sham contracting under the Fair Work Act

Section 357 of the Fair Work Act 2009 makes it unlawful for an employer to represent to a worker that an employment contract is a contract for services (a sham contracting arrangement). The defence is now a reasonableness test: the employer must show that, at the time of the representation, they reasonably believed the worker was engaged as a contractor.

Penalties

The Fair Work Ombudsman pursues sham contracting cases through the courts. For a business with 15 or more employees, the maximum civil penalty for a serious contravention can reach the greater of $495,000 or three times the underpayment amount per contravention. Individual penalties also apply to directors and officers involved in the conduct.

What turns on the classification

The classification affects:

• PAYG withholding. Employees have PAYG withheld from wages under the ATO tax tables. Contractors with a quoted ABN have nothing withheld unless a voluntary agreement is in place.
• Superannuation guarantee. Employees receive super (12% from 1 July 2025). Contractors who are paid wholly or principally for their labour also receive super under the extended definition of employee in section 12(3) of the Superannuation Guarantee (Administration) Act 1992.
• Workers compensation. Employees are covered under state workers compensation schemes. Genuine contractors arrange their own cover but may still be deemed workers in some states (for example, the deemed worker provisions in the icare NSW scheme).
• Payroll tax. Each state's payroll tax act treats certain contractor payments as wages for payroll tax (the relevant contract provisions).
• Annual leave, personal leave, redundancy. Employees accrue these statutory entitlements. Contractors do not.

The ATO decision tool

The ATO publishes an Employee or contractor decision tool that walks through the factors and produces a written outcome the builder can rely on. The Fair Work Ombudsman publishes parallel guidance. Both should be used when engaging a new worker, especially where the working relationship is going to last more than a few weeks or run on a regular weekly basis.

Practical patterns that fail

The classic red flags in residential construction:

• A worker on an ABN engaged five days a week for the same builder, doing only that builder's work
• A worker who turns up at 7 am with the rest of the crew, takes direction from the foreman and is paid hourly
• A worker using only the builder's tools, ute and materials
• A worker who cannot say no to a job or send a substitute
• A worker who has not invoiced anyone else in the last 12 months

Any one of these flags is not fatal. Two or three together usually mean the relationship is, at law, employment.