Contractor or Employee? Why One Worker Can Be Both — and What Misclassification Now Costs

“They invoice us. They have an ABN. They’re a contractor.” 

That reasoning has never been enough, and in 2026 it is actively dangerous. A single worker can be a contractor at common law, an employee for superannuation purposes, and a deemed employee for payroll tax — all at the same time, under three different tests. 

Misclassification is now one of the largest unfunded liabilities on many Australian balance sheets: unpaid superannuation, PAYG withholding penalties, back payroll tax across multiple states, lost deductions, and personal liability for directors. 

What’s the real issue? 

The real issue is that there is no single test — and the tests have been moving in different directions. 

• For tax and superannuation, the High Court’s 2022 decisions pushed the analysis back to the four corners of the contract. 
• For the Fair Work Act, Parliament pushed it the other way, restoring an inquiry into the practical reality of the relationship. 
• For payroll tax, correct classification is only the starting point, because the “relevant contract” provisions can capture genuine contractors anyway. 

So the honest question is not “is this person a contractor?” It is “under which Act, for which purpose, and what happens if we are wrong on one of them?” 

What this looks like in practice 

An anonymised composite drawn from matters we see regularly. 

A Queensland organisation engaged six workers as contractors — individuals, each with an ABN, each invoicing monthly, each working substantially set hours under supervision using the organisation’s equipment. The arrangement had run for four years. Nobody had reviewed it since it began. 

A single trigger — one worker lodging a superannuation complaint after leaving — opened everything up: 

• Superannuation. Even if the workers were genuine contractors at common law, their contracts were principally for their labour, so they were employees for superannuation purposes. Four years of unpaid contributions, plus charge, interest and uplift. 
• PAYG withholding. No amounts had been withheld. Because ABNs had been quoted, deductions were preserved — but administrative penalties were not. 
• Payroll tax. The contractor fees became taxable wages, and the superannuation shortfall formed part of them. A voluntary disclosure was required going back five years, in two jurisdictions. 
• Directors. The unpaid superannuation guarantee charge and PAYG withholding sat squarely within the director penalty notice regime. 

One classification decision, made once and never revisited, produced four separate liabilities. 

What does the law say — and how must it be applied? 

1. For tax and super: the contract governs

The ATO’s approach is set out in Taxation Ruling TR 2023/4, which replaced TR 2005/16 and SGR 2005/1 following Construction, Forestry, Maritime, Mining and Energy Union v Personnel Contracting Pty Ltd [2022] HCA 1 and ZG Operations Australia Pty Ltd v Jamsek [2022] HCA 2. 

The framework is: 

• There is no checklist. Whether a person is an employee is a question of fact and degree, determined by an objective assessment of the totality of the relationship. 
• The assessment has regard only to the legal rights and obligations that constitute the relationship — that is, the terms of the contract, express or implied. 
• The contract is construed at the time it was entered into, not by reference to how the parties later behaved. 

That last point cuts both ways. A well-drafted contract carries real weight. But it will not save you where the contract has been varied, discharged or waived, where conduct has effectively rewritten it, or where it is a sham. 

The classic indicia still do the work of characterising the contractual rights: control; the right to delegate, subcontract or assign; whether the worker is paid for a result; who provides tools and equipment; who bears risk; and who generates the goodwill. The distinction remains that an employee serves in the business of another, while an independent contractor provides services to a principal’s business in furthering their own. 

2. For the Fair Work Act: practical reality is back

Since the Closing Loopholes reforms, the Fair Work Act directs attention to the real substance, practical reality and true nature of the relationship — considering the totality of the relationship, including how the contract is performed in practice, not just how it is written. 

The consequence is uncomfortable but important: the same worker can be characterised differently for tax purposes and for Fair Work Act purposes. A contract-focused analysis may support contractor status for withholding, while a practical-reality analysis exposes you to award coverage, entitlements and unfair dismissal risk. Do not assume one answer covers both. 

3. For superannuation: the extended definition catches more

Section 12(1) of the Superannuation Guarantee (Administration) Act 1992 (Cth) adopts the ordinary meaning of employee. Subsections 12(2) to (11) then substantially extend it. The provision that catches most employers is section 12(3): if a person works under a contract wholly or principally for that person’s labour, they are an employee of the other party. 

Following Dental Corporation Pty Ltd v Moffet [2020] FCAFC 118, three elements must be satisfied: there must be a contract; it must be wholly or principally for the labour of the person; and the person must work under that contract. 

Other extensions catch company directors receiving payment for their duties (s 12(2)), performers and sportspeople and those providing services in connection with them (s 12(8)), and holders of public offices (s 12(9)). Section 12(11) excludes people paid to do work wholly or principally of a domestic or private nature for not more than 30 hours a week. 

This is the trap. You can be entirely correct that someone is a contractor at common law, and still owe them superannuation. 

4. The ATO’s risk framework: PCG 2023/2

Practical Compliance Guideline PCG 2023/2 rates arrangements from very low to high risk and allocates compliance resources accordingly. Broadly, the features that move an arrangement toward the lower-risk zones are: evidence that both parties intended the same classification; a comprehensive written agreement; evidence both parties understood the tax and superannuation consequences of that classification; no significant deviation between the contract and performance; meeting the tax, super and reporting obligations that arise for the classification; obtaining specific advice confirming the classification under both the ordinary and extended definitions of employee; and addressing the extended meaning of employee with the worker. 

An arrangement that does not qualify for very low, low or medium falls into the high-risk zone — highest priority for review, and higher penalties where misclassification is found. 

5. PAYG withholding: what misclassification costs

Withholding applies to salary, wages, commission, bonuses and allowances paid to an employee, to retirement and employment termination payments, and to some contractors where an ABN is not quoted. Where you fail to withhold: 

• You lose the deduction for amounts on which you failed to withhold, or withheld but failed to remit. Importantly, the deduction is preserved where the contractor quoted their individual ABN and is later held to be an employee. 
• An administrative penalty equal to the amount that should have been withheld can be imposed, arising at the time of the failure. 
• Prosecution is available, and the ATO can estimate unpaid amounts and issue notices on those estimates. 

6. Payroll tax: correct classification is not the end of it

Payroll tax is a state and territory tax, self-assessed, and harmonised across all jurisdictions except Western Australia since 2008. In Queensland the current rates are 4.75 per cent for employers or groups paying up to $6.5 million and 4.95 per cent above that, with a mental health levy of 0.25 per cent where Australian taxable wages exceed $10 million (and an additional 0.5 per cent above $100 million), on a threshold of $1.3 million in Australian taxable wages. 

Three compliance risks dominate: 

• Misclassification. Contractor fees become taxable wages. Any superannuation shortfall also forms part of taxable wages. 
• Relevant contracts. Even a correctly classified contractor can be caught by the relevant contract provisions, which reach most arrangements where a person supplies services relating to the performance of work. There are exemptions — including services provided for no more than 90 days in a financial year, services required by your business for less than 180 days, services performed by two or more people, services ancillary to the supply of goods, services not ordinarily required by your business, owner-drivers, door-to-door sales, insurance selling, and services approved as exempt by the Commissioner — but they are narrower than most employers assume. 
• Remediation payments. Payroll tax arises when wages are paid or payable, whichever is first. Underpaid wages are generally taxable when they should have been paid; additional superannuation on those wages when the contributions are paid; historical superannuation remediation when the superannuation was payable. Disclosures typically reach back five years, and where more than one jurisdiction has taxing rights over the same wages you may need to disclose in each, or seek to appoint a lead jurisdiction. 

7. Director penalty notices

Under Division 269 of Schedule 1 to the Taxation Administration Act 1953 (Cth), directors — and former directors — can be made personally liable for the company’s unpaid PAYG withholding, superannuation guarantee charge and GST. The penalty is imposed automatically once the company’s liability is unpaid at the due date, including where the ATO has estimated the amount. 

The distinction that matters is: 

• Non-lockdown notice — issued where lodgements were made within three months of their due date but amounts remain unpaid. Directors can avoid personal liability by causing the company to pay, or by placing it into voluntary administration, appointing a small business restructuring practitioner, or liquidation. 
• Lockdown notice — issued where the company failed to lodge its BAS, IAS or superannuation guarantee statements within three months of the due date. The only escape is payment. Administration and liquidation do not help. 

Lodging on time, even when you cannot pay, is therefore one of the most valuable protective steps a director can take. 

What are the risks and pain points for employers? 

• Compounding exposure across four heads at once — superannuation, PAYG withholding, payroll tax and Fair Work entitlements — from a single decision. 
• Divergent tests. Being right for tax does not make you right under the Fair Work Act, and vice versa. 
• Long tails. Payroll tax disclosures typically reach back five years. Superannuation shortfalls compound under a harsher charge regime since 1 July 2026. 
• Multi-state duplication. Where workers cross borders, more than one jurisdiction may claim the same wages. 
• Set-and-forget arrangements. The contract is construed at formation — but arrangements drift, and drift can amount to variation, waiver or a sham. 
• Transaction risk. These liabilities surface in due diligence, and they move price, warranties and indemnities. 
• Personal liability. Directors carry the superannuation and withholding exposure whether or not they were involved in the classification decision. 

Our top five tips: what every employer should do 

1. Run a classification audit, not a contract review. Start with a list of every worker who is not on payroll: contractors, consultants, labour hire, gig arrangements, sole traders, interposed companies and trusts. For each, work through the three questions separately — employee at common law? employee under the extended superannuation definition? deemed wages for payroll tax? Record the answer and the reasoning for each. 
2. Assume section 12(3) applies until you have proved it doesn’t. Where an individual is engaged principally for their own labour, superannuation is the default expectation, whatever the contract says about contractor status. Deal with it expressly: either pay the superannuation, or document a properly advised basis for concluding the extended definition is not engaged. 
3. Get your written agreements comprehensive — and keep performance aligned to them. The contract is construed as at formation, so a comprehensive written agreement recording the parties’ shared intention, the scope of the right to delegate, the allocation of risk and the basis of payment is genuinely valuable. Then audit performance against it periodically, because significant deviation is exactly what pushes an arrangement into the high-risk zone. 
4. Lodge on time, even when cash is tight. The difference between a non-lockdown and a lockdown director penalty notice is whether BAS, IAS and superannuation guarantee statements were lodged within three months of the due date. Lodging preserves your directors’ options; not lodging removes them entirely. 
5. If you find a problem, project-manage the fix. Do not correct one head of liability in isolation — a superannuation catch-up payment has payroll tax consequences, and a payroll tax disclosure invites scrutiny of classification generally. Quantify the whole exposure first, decide the disclosure strategy across jurisdictions, and take advice before you write the first letter. 

Frequently asked questions 

Does having an ABN make someone a contractor? 

No. An ABN is a registration, not a characterisation. Quoting an ABN affects your entitlement to a deduction if you fail to withhold, but it says nothing about whether the person is an employee at common law, under the extended superannuation definition, or for payroll tax. 

Can a genuine contractor still be owed superannuation? 

Yes, and this is the most common expensive surprise. Under section 12(3) of the Superannuation Guarantee (Administration) Act, a person working under a contract wholly or principally for their labour is an employee for superannuation purposes even if they are a genuine independent contractor at common law. 

Can the same worker be a contractor for tax and an employee under the Fair Work Act? 

Yes. The tax analysis focuses on the legal rights and obligations in the contract as at formation, while the Fair Work Act directs attention to the real substance and practical reality of the relationship. The two can produce different answers on identical facts. 

Does a written contract settle the question? 

It carries significant weight for tax purposes, but not conclusively. A contract can be varied, discharged, waived, or found to be a sham, and conduct that departs significantly from the written terms undermines the document you are relying on. 

What is PCG 2023/2 and does it matter to us? 

It is the ATO’s practical compliance guideline rating worker classification arrangements from very low to high risk, which determines how much compliance attention an arrangement attracts. It matters because the features that place you in a lower-risk zone — a comprehensive written agreement, evidenced mutual intention, obtaining specific advice, and no significant deviation in performance — are all things you can put in place before a review, not during one. 

We correctly classified our contractors. Are we safe on payroll tax? 

Not necessarily. The relevant contract provisions can deem payments to genuine contractors to be taxable wages. Exemptions exist — including the 90-day and 180-day exemptions and services performed by two or more people — but they must be applied to the facts of each engagement, not assumed. 

How far back can a payroll tax disclosure go? 

Typically five years, and potentially longer in some jurisdictions where the Commissioner is satisfied there was an underpayment of wages. Where more than one state or territory has taxing rights over the same wages, you may need to disclose in each. 

Can directors really be personally liable? 

Yes. Unpaid PAYG withholding, superannuation guarantee charge and GST are all within the director penalty notice regime, which reaches current and former directors. Where lodgements are more than three months overdue, a lockdown notice leaves payment as the only way to avoid personal liability. 

We’re a not-for-profit or a council — does any of this change for us? 

The classification tests apply the same way. Some payroll tax exemptions and thresholds differ by entity type and jurisdiction, so the quantum can change even where the analysis does not. Take advice on your specific structure. 

How Harrisons can help 

Get worker classification wrong and the bill arrives from four directions at once — unpaid superannuation with charge and interest, PAYG withholding penalties and lost deductions, five years of back payroll tax, and Fair Work entitlements — with your directors personally exposed to part of it. Get it right and you engage the workforce you actually need, with certainty. 

We help Australian employers — SME business owners, Queensland local government councils, and community and not-for-profit organisations — do exactly that: 

• Audit your contractor arrangements against the common law, the extended superannuation definition and the payroll tax relevant contract provisions. 
• Draft comprehensive engagement agreements that will bear scrutiny at the time they were made, and align performance to them. 
• Quantify and remediate historical exposure, including coordinating multi-jurisdiction payroll tax disclosures. 
• Protect your directors with lodgement discipline and clear advice on personal liability. 

Don’t wait for one departing contractor to open five years of history. Get in touch with our team today and start with a worker classification and contractor risk review. 

This article provides general information for Australian employers and is not legal advice, and does not constitute taxation advice. Rates, thresholds and rulings change, and how they apply depends on your specific circumstances and jurisdiction. For advice tailored to your organisation, contact Harrisons.