Key Differences Between Employee vs Independent Contractor vs Outsourcing

For employers in Australia, knowing the distinction between an employee and an independent contractor is crucial for making informed hiring decisions — especially with the recent amendments to the Fair Work Legislation.  

Choosing between an employee and an independent contractor can determine which legal obligations apply to you. For instance, working with employees means taking care of their salaries, payroll taxes, superannuation, redundancy pay, leave benefits, and work health and safety, among others. 

Meanwhile, misclassifying employees as contractors — be it intentional or not — may subject you to potential fines and lawsuits.  

Prevent this from happening by learning what sets an employee apart from an independent contractor. At the same time, discover how you can use outsourcing as an alternative to manage the risks and complexities of hiring a worker in Australia. 

What’s in this article? 

1. Key differences between an employee, an independent contractor, and outsourcing

a. Hiring an employee

b. Working with an independent contractor

c. Outsourcing to a third-party service provider

2. A safer and more cost-effective way to expand your company’s operational capacity 

Key differences between an employee, an independent contractor, and outsourcing 

An employee refers to a person who performs their work as a representative of a business. Meanwhile, an independent contractor is an individual who provides services to a business and completes their work independently. 

Outsourcing, on the other hand, is the practise of delegating certain business functions to another company. Under this arrangement, the outsourcing company bears the responsibility of managing its employees — making it a potential alternative for mitigating workplace risks. 

An employee, independent contractor, and outsourcing company have one thing in common: all of them can provide you with the necessary work (or service) to keep your company operational.  

However, there are also key characteristics that set them apart, as detailed below: 

1. Hiring an employee

Ideal for businesses that need in-house expertise and support.

The Australian Taxation Office (ATO), the country’s statutory agency and principal revenue collection body, clarified on their website the key indicator of what being an employee means in Australia, as follows: 

“An employee serves in your business and performs their work as a representative for your business.” 

On top of this main characteristic, the ATO also pointed out the seven common indicia of an employee: 

1. Control over work: You have legal control over your employee’s work.

2. Integration within the business: Your employee performs their work as a representative of your business.

3. Basis of payment: You pay your employee either a set amount per period (e.g., weekly, bi-weekly, monthly), a price per item or activity, or a commission.

4. Ability to subcontract or delegate: Your employee must perform the work themselves — they cannot delegate or subcontract their work to another person.

5. Provision of tools and equipment: Your business is contractually responsible for providing the equipment, tools, and other equipment needed to complete the job. It also applies when your employee buys the tools and equipment but you either reimburse the amount they spent, or you give them an allowance.

6. Risk: Your employee bears little or no risk since your business is responsible for any defect or injury at work.

7. Generation of goodwill: Your business benefits from the goodwill made by the employee at work.   

As an employer, you’re responsible for knowing which award applies to your employees, including the minimum pay rates and workplace entitlements. Equipping yourself with this knowledge can keep you off serious — and hefty — penalties. 

Depending on their type of employment, employees can get different entitlements outlined in the National Employment Standards. Some of these minimum entitlements are annual leave, public holidays, superannuation contributions, overtime pay, and maximum weekly hours. 

2. Working with an independent contractor

Ideal for completing one-time or short-term projects. 

An independent contractor is an individual who “provides services to your business and performs work to further their own business,” the ATO defines. They can either be a sole trader or someone who runs their own company, partnership, or trust. Because of this, they’re required to have their own Australian Business Number (ABN). They’re also responsible for their tax, super, and relevant business tax registrations.  

Unlike employees, they have full control over how they complete their work. Independent contractors also have the right to negotiate their fees and preferred working arrangements.  

Similar to an employee, seven common indicia set out the unique characteristics of an independent contractor. 

1. Control over work: The independent contractor has full control over their work. But of course, their output will be based on the requirements and specifications you’ll provide.

2. Integration within the business: The independent contractor is independent from your business. You can think of them as another entity that provides services to “further their own business.”

3. Basis of payment: The independent contractor negotiates their fee and usually gets paid upon project completion. 

4. Ability to subcontract or delegate: The independent contractor has the right to delegate or subcontract their work to other professionals.

5. Provision of tools and equipment: The independent contractor uses their own tools and equipment to complete the job.

6. Risk: The independent contractor bears the risk of any defect or injury that may arise while doing their work.

7. Generation of goodwill: You don’t benefit from the goodwill made by the independent contractor. 

Worker misclassification risks usually stem from classifying a worker as an independent contractor when their “work conditions are more like an employee.” This arrangement is known as sham contracting, a practise used by some employers “to avoid certain taxes and responsibility for employee entitlements.” 

If found guilty, businesses that engage in sham contracting risk receiving penalties and charges: 

• Courts can impose fines of up to $18,780 for individuals; $93,900 for businesses with fewer than 15 employees; and $469,500 for businesses with more than 15 employees 

• PAYG withholding penalty 

• Super guarantee charge based on missed superannuation payments, interest charges, and admin fee 

• Additional super guarantee charge of up to 200% 

With the continuous rollout of the Fair Work Legislation Amendment (Closing Loopholes No. 2) Act 2024, employers can expect a tighter implementation of proper worker classification. 

Read next: What Australia’s Amendments to its Fair Work Legislation Means 

3. Outsourcing to a third-party service provider

Ideal for companies that need to fill vacant roles without the complexities of hiring, classifying, and managing workers. 

If you’re still new to this concept, outsourcing is the practice of delegating specific tasks, operations, or projects to third-party companies. 

The staff you’ll be working with under this setup are the legal employees of your chosen service provider — thus, reducing the risk of misclassifying workers. It also minimises your responsibilities because you’re not tied to any employer obligations under Australian law. Instead, what you must adhere to are the terms and conditions outlined in the outsourcing contract you signed. 

You can either work directly with your outsourced staff or entrust the management of the entire operation to the service provider. It all depends on the arrangement you choose from the onset.

Outsourced services are also scalable and flexible. Because of these features, you can start an engagement with only one staff member who works full-time, part-time, or hourly. If your company needs more hands onboard, you can ask your service provider to increase the headcount of your outsourced team. 

Related: Your Comprehensive Guide to Outsourcing in Offshore Locations 

While outsourcing does not tie you up with any employer responsibilities, you’re still responsible for making this initiative work.  

Choosing a credible outsourcing company is the first step. To do this, you can send a request for proposal (RFP) to your shortlisted vendors. Doing so gives you an extensive overview of their service packages, projected costs, and timeline.  

You must also conduct due diligence before starting an outsourcing engagement to guarantee a partnership that’s grounded in accountability, transparency, and trust. 

Advantages of outsourcing 

Outsourcing is a safer and more cost-effective option for Australian businesses affected by the ongoing skills shortages. When you outsource to the right outsourcing company, you can achieve the following benefits: 

1. Lower risk of misclassifying workers. Outsourcing to specialized service providers instead of hiring an independent contractor or freelancer helps you keep any worker misclassification risks at bay. In fact, as early as the 1990s, many companies have been using outsourcing to limit potential industrial relations issues, a briefing paper from the Parliament of New South Wales revealed. The said resource also expounded that “the contractor bears the responsibility of managing its employees and dealing with the relevant unions,” thus making outsourcing an effective risk mitigation tool. 

2. Higher cost savings. Working with offshore outsourcing companies also lets you save costs. Due to price differences between nations (e.g., cost of services in Australia vs the Philippines), you can avail services at a lower price tag without compromising quality. 

3. Wider access to qualified professionals. With outsourcing, you’re no longer limited to working with professionals from the same country. It expands your reach to top-notch talents. Simply outline the qualifications you’re looking for and the service provider will prepare everything — such as recruitment, onboarding, and management — from the back end.  

4. Shared responsibility of managing staff. You also have the option to determine the level of control and involvement you want over your outsourced staff. For instance, you can participate in selecting potential candidates and manage their tasks regularly. On the other hand, you can also entrust the management of the entire operations to your service provider and set regular meetings so you can be updated on your outsourced team’s progress and performance. 

5. Access to technology, equipment, and office space. Before onboarding an employee, you must ensure that all necessary equipment and office space are already in place to give them a proper head start. This spells an additional expense for you, especially if you must procure new equipment and tools to cater to the employee's needs. Outsourcing helps you address this concern. Service providers have the needed technology, equipment, and office space for their employees, which you can leverage upon starting an engagement with them. 

Disadvantages of outsourcing 

Despite its benefits, outsourcing also has its own set of risks, as outlined below: 

1. Data security and confidentiality issues. Outsourcing to a service provider with poor data security measures can put your sensitive and confidential data at risk. Your first line of defense to prevent this from happening is to strengthen your internal data security measures. Next is to choose a service provider with the same level — or even stricter — data security policies as yours. And once you’ve started an outsourcing engagement, make sure to continuously monitor your provider’s security procedures through periodic cybersecurity audits.

2. Substandard service quality. Your service provider may also fall below your expectations. Such a compromise to quality is unacceptable and may even negatively affect your internal operations and your consumers’ perception of your brand.   

3. Loss of control. Becoming too dependent on outsourcing may lead to a loss of sufficient in-house expertise in your company who can “oversee the process of contract management, including the capacity to assess and monitor each contractor’s work,” according to this briefing paper. To prevent this occurrence, it’s always best practice to balance out the number of tasks you outsource and the roles you retain in-house. 

Looking for a case study on outsourcing? Discover how an Australian health company recovered from a negative outsourcing experience by partnering with a credible outsourcing company: Assist Group Case Study. 

A safer and more cost-effective way to expand your company’s operational capacity 

If you’re looking to expand the operational capacity of your accounting department, consider outsourcing with D&V Philippines — a business process outsourcing company that specialises in finance and accounting services. 

Contact us today to learn more about our services. You can also download our whitepaper, D&V Philippines: Your Talent Sourcing Partner, to find out how we source and develop accounting professionals who can be a good fit for your company.