This is often not the question I hear. It is usually more the case of hearing “We have them engaged as a contractor, so we don’t need to worry.” Uh…maybe, but probably not.

Employee vs Contractor

Figuring out whether a new worker is an employee or contractor is one of the most confusing and potentially, risky questions that most small to medium sized businesses don’t properly consider. At the end of this article, you will hopefully be a little less confused than you already are.

What is the Difference Between a Contractor and Employee?

To put things simply, there is a saying that if it looks like a duck, walks like a duck and quacks like a duck – it’s a duck. The same can be said for employees. However, to help decipher whether a new worker is an employee or contractor, inspect some of the resources below.

Resources for Classifying Workers

Online Tests
There are online tests to help you determine the differences between contractor or consultants and employees. One is the, Employee/Contractor decision tool on the ATO website. By answering the questions on this site, it will help determine whether the person you have engaged is an employee or not. It may also help you down the track (if you save the results, you can then produce the result in defense of any claim). It is not foolproof, but helpful.
Charts, Tables & Fact Sheets
There are two useful tables to help you decipher between contractors and employees.
- Contractor vs Employee Fact Sheet
  Located on the Fair Work Australia website, this guide will identifies the key areas to address and help you come to your conclusion.
- Differences Between Employees and Contractors
  This table from the ATO outlines the difference between a contractor and employee as defined on the Fair Work Australia website.

So you may be wondering why deciding to hire a worker as a contractor or employee is such an issue in the first place. Well in not properly classifying workers, business owners are putting themselves at risk. How are they doing this? Let me explain.

Risks Associated with Improper Worker Classification

Enforcing the Wrong Types of Employee Contracts

Sometimes a person is in fact a genuine contractor and so they should be engaged as such. However, without the right contract in place, the situation can become blurred. To have the proper contracts in place, an employer must first, properly define the worker’s role. This can be incredibly confusing with all of the terminology.
For instance, there are:

Full-time and part-time employees, who should both receive a contract of employment.
Casual employees, who also should receive a contract of employment.
Fixed term contract employees, who also receive a contract of employment.
Consultants, who are engaged as independent contractors
Independent contractors who don’t refer to themselves as consultants – although the terms can be used interchangeably, they also need a contract – but of course this should not be an employment contract.

Also, if you engage them as a contractor then start treating them like an employee, you can run into trouble – I don’t mean if you offer them Pam’s home-baked cookies at morning tea. What I mean is that if they need to turn up regularly at particular times that you stipulate (or even full-time), work on your systems and don’t work anywhere else etc.
So as you can imagine, in order to have the proper contract in place for those working for you, it is important to first understand – what constitutes an employee vs contractor.

Unfair Dismissal Claims

Engaging an employee means that you have 6 months before they qualify to apply for unfair dismissal (or twelve months if you have less than 15 employees). This is more than enough time to determine if the person is right for the job. This doesn’t mean there is no risk of dismissing someone (there is always some risk), but it makes it less risky.

Enabling Employees to Avoid PAYG Withholding Tax

You will see often that an employee has a preference to be a contractor. Sometimes this is their own ignorance of what the difference is or perhaps they just want more cash in their pocket earlier (because there is no PAYG tax deduction and potentially no requirement for superannuation to be paid by the employer/customer). This arrangement might seem to work for both parties, but can be fraught with risk.

Breaking Superannuation Rules for Employers

One more complication in relation to this question, in that an independent contractor could be considered as an employee for superannuation purposes. The ATO stipulatesthat if the contract is “wholly or principally for labour then superannuation is payable”.
Specifically, they are eligible if the person:

is paid wholly or principally for their personal labour and skills
must perform the contract work personally and is not able to delegate
is paid for hours worked, rather than to achieve a result

So, what to do in all of this?

My view is that spending time trying to be cute on this topic is a waste of time. If it looks like a duck, walks like a duck and quacks like a duck – engage it as one, well, you know what I mean. Where you should be spending your time and energy on is ensuring you have the right person, providing them a set of clear expectations for performance, invest in the right development and be a good leader and communicator. Do these things well and you are far more likely to succeed in your business.

The information contained in this article is general information only and not legal or taxation advice. Every circumstance is different and you should consult an appropriate professional for your situation before proceeding.

You may be wondering … Are these the only options? What difference does it make? The answer of course depends (don’t you hate that?). Don’t worry; it’s not too complicated in the end, so here goes…

Understanding Unfair Dismissal

The first thing to be aware of is that in terms of unfair dismissal, the probationary period you state in your contract doesn’t hold much weight. Many managers and business owners believe that if the person is within their probationary period then they can terminate their employment with no risk. This is not correct in terms of the time period and also the words “no risk”, which I will explain later.

Qualifying Period for Unfair Dismissal

The most relevant factor in terms of timing is actually the “qualifying period” for unfair dismissal, which is determined by Fair Work Australia. For employers who have 15 or more employees, this is a 6 month period and for those with less than 15 employees it is a 12 months period. There also exists other factors that are important in terms of qualifying for unfair dismissal; such as if they are an employee at all. However, I won’t go into depth on that given we are talking mainly about probationary periods, so for this purpose we will assume the person is a permanent employee (I always find that term funny, what is “permanent” anymore these days anyway?).

Probationary vs Qualifying Periods

So essentially, employees who have worked for less than the qualifying period are not eligible to apply for unfair dismissal. This has nothing to do with the probationary period and stands independently. If you had a 9 month probationary period and you have 15 or more employees (therefore having a 6 month qualifying period) and you terminate before 9 months but after 6 months they can still bring a claim for unfair dismissal against you. If you have a probationary period of 3 months and terminate at 4 months, they cannot bring an unfair dismissal claim against you. In both cases, the relevant factor is the qualifying period, not the probationary period. What you do need to be mindful of is any notice period difference in your contracts if they exist in relation to their being in their probationary period or not. If you are paying out their notice period, it needs to be what you have stipulated in their contracts (assuming they are legally compliant). If there is no contract, you should revert to the relevant modern award. The question therefore is,

Should you align your probationary period to the qualifying period for unfair dismissal or not?

My thoughts are that you should be mindful of the legislation, but you should run your business and manage you people based on what works best for your company. In most instances, it does not take 6 months to determine if someone is going to be suitable. It definitely shouldn’t take 12 months. The other thing is, most employees are not aware of the legislation around unfair dismissal, but they are acutely aware of their probationary period, because they read it in the contract you provided. That can be good or bad depending on what impact it has on their behaviour. But generally for good employees they want to feel they have passed their probation period and often is a source of frustration (especially when this is not acknowledged by their manager) and their preference is always for a shorter time period.

I tend think that 3 months is plenty of time to determine if the employee is suitable. The only downside is if you have a 4 week notice period for people not on probation and you don’t manage to your 3 months, it will cost you more if you need to terminate someone. The argument I hear against this is sometimes that in certain roles it takes longer to work out, such as in business-to-business sales roles. I challenge that notion if you have good leading indicators in place and measure them regularly. “He just needs to land that one big deal and he will be performing”. Well, how is he going with his activities? Have you been out on joint visits? How effective is he at running those meetings? How is his follow up? Do his proposals meet the mark? How well does he follow those up?

Whether you have 3 or 6 months from a contractual or policy perspective is up to you. Legally, you mainly need to be mindful of the qualifying period for unfair dismissal, whether it is 6 or 12 months. But you should be managing to 3 months or even sooner regardless. It’s achievable, saves you time, money and is more engaging for the better employees anyway.

Avoiding Claims of Unfair Dismissal

One final word of caution: terminating an employee is never without risk. Unfair dismissal is just one avenue and there other avenues they can take for other reasons (e.g. if they believe they are being unlawfully discriminated against). The best thing is to be objective, provide clear performance measures, specific and regular feedback, relevant and effective training and development and to make difficult decisions earlier after giving the employee reasonable chances to improve. This is whether they have been there for 3 days, 3 months or 3 years. Be very mindful of the law, but don’t let it run your business for you.

Employee Probationary Periods

So, to answer the question about having a 3 month or 6 month probationary period.

3 Month Probationary Period
Choose 3 months if you know you will be vigilant about managing performance early on.

6 Month Probationary Period
Choose 6 months if you want a buffer in there, but try to manage to 3 months to determine whether they are likely to work out or not

12 Month Probationary Period
Choose 12 months if you have less than 15 employees, are incredibly risk averse and want to frustrate your new people (hopefully you noted the sarcasm in there)
Regardless of your decision, always remember to:

Be vigilant in performance management, and even more so with new employees. With a strong performance management system in place, you should be able to determine very swiftly whether you have hired the right person for the role or not.
Know your qualifying period for unfair dismissal (which is independent from a probationary period) see below:

Qualifying Periods

o Employers with 15 or more employees = 6 month qualifying period
o Employers with less than 15 employees = 12 month qualifying period

Recognise that terminating an employee is never without risk, it’s up to you to minimise it.

Disclaimer: The information contained within this article is based on our best knowledge and we believe all facts to be true at the time of writing. We take no responsibility for any application of this information, as it does not constitute legal advice (and should not be taken as such).