FAQs: Frequently Asked Questions when an
employee is considering becoming a subcontractor
It’s a common pathway for many tradies. You’ve done your apprenticeship time, you’re qualified, have some good experience under your belt and have got a feeling for the type of work you enjoy and want to do more of.
In this article we’ll answer the Frequently Asked Questions we get from tradespeople when they’re considering transitioning from employee to contractor.
This article will give you a complete insight to the issues you need to consider.
- There are obviously many different trades, but for the sake of simplicity this article is written with the scenario of a carpenter working for a builder. All the same answers apply whether you are a painter, landscaper, plumber etc.
- In this article we consider two business structure options:
- There are other business structures besides these two types—for example, a family trust—but again, for the sake of simplicity we haven’t included mention of other business structures in this article. If you have any questions about business structures, please just reach out to us.
Employee vs Contractor: The two main reasons tradies want to switch
From our experience, there are two reasons that cause tradespeople to want to make the jump from employee to contractor:
Reason 1: Your current or prospective employer doesn’t want to employ you. Instead, they want you to contract to them. This is usually a misguided attempt to simplify things for themselves—not for you—saving them on-costs (such as superannuation, annual/sick leave and insurance) by pushing those costs on to you. In addition to these extra costs, a contractor takes on the burdens of compliance, tax and cash flow management.
For these reasons, if you’re not ready to start growing a genuine business and are only looking for hourly pay, we recommend you resist the move to contractor.
Reason 2: You’re looking to do some of your own jobs, and it would make for an easier transition to running your own fully fledged business if you could contract a few days of the week (or as needed) to keep busy while starting out.
When does it make sense to be an employee and not become a contractor?
We’ll answer the following Frequently Asked Questions by continually covering the above two reasons, but just to make the point clear – if you are only going to earn hourly pay from a builder or head contractor, then it is almost certainly better to remain an employee.
Setting up as a company vs operating as a sole trader?
Summary: Sole trader is the cheaper option, but it carries some risk.
- This is the simpler and cheaper option. The setup costs are minimal (perhaps just registering a business name and applying for an Australian Business Number (ABN)). The ongoing accounting and compliance costs each year are less than they would be for a company.
- However, as a sole trader your personal assets will be exposed to legal action because the business is in your personal name. This means, for example, if you were sued for any reason and lost the case, not only are your business assets on the line (such as your vehicles, equipment and the cash in your business bank account), but also your personal assets (such as your personal savings, family home and any investments).
- Head contractors may be reluctant to use you as a sole trader due to the way the ATO and Fair Work Australia have cracked down in recent years on what head contractors can and can’t do in this regard.
- You cannot obtain workers compensation insurance as a sole trader. Perhaps your builder or head contractor will be covering you on their workers comp policy, but they may not. In some ways, avoiding the cost of workers compensation premiums might sound attractive, but it also means you don’t have the cover to fall back on if an accident happened.
Summary: A company structure is more costly and requires more administration, but it protects your personal assets much more and also reduces certain business risks.
- A company is a clean option. It separates you personally from the activities of the business so that if something were to go wrong, your personal assets are generally much better protected.
- If you run a business—and not simply subcontract to a single builder—there’s always the risk your business will fail. When that happens, generally there are bills left unpaid – often including ATO debts. If you have a company set up you can be better protected from needing to pay these sorts of debts from your personal savings. This could save your family home and other personal assets.
- Having a company structure does come with more costs and administration. We’ll outline these costs later in this article.
- Your company will need to obtain all the necessary insurance cover, including workers compensation.
Why is my builder trying to encourage me to have my own company (rather than allow me to contract as a sole trader)?
This relates to the Reason 1 scenario outlined above. In short, when you have your own company and don’t just contract as a sole trader, the builder’s costs are reduced and their compliance requirements are simplified. This shifts these costs and compliance responsibilities to you, essentially protecting the builder at your cost.
When you are an employee the builder is responsible for:
- paying your superannuation
- covering you within their insurance policies (professional indemnity, public liability, workers compensation and others)
- setting aside your income tax, and so on.
This makes sense; after all, you’re an employee.
But when you are a sole trader (meaning you don’t have a company structure in place), the builder can still be held liable for these superannuation and insurance costs. This is because you can still be “deemed” to be an employee if most of your working week is spent with this particular builder.
Clearly, builders don’t like this contingent liability (potential cost) hanging over their head.
That’s why they like you to use a company, so they cannot be held responsible to pay your superannuation or insurance. Instead, you will need to organise and pay these. This incurs not just the actual financial outlay, but the administration time and overhead costs.
Keep in mind too, that insurance within the construction industry is not cheap.
What are the costs of having my own company? And what are the benefits?
Operating your own company is certainly more expensive than if you were a sole trader or employee. Not only do you need to prepare an extra set of financial statements and a company tax return, there are additional responsibilities and compliance requirements.
That being said, these extra costs could be well worth it if the company provides you with valuable asset protection and potential tax saving benefits. We’ll explore the potential benefits in a separate article, but as for the costs:
- Establishing a company: Eagle Financial can do the complete setup of your company, including all ATO registrations, ABN (Australian Business Number) registration, and ASIC forms (Australian Securities & Investments Commission). We’re basically a one-stop-shop in this regard. Our fees for the company setup are $600 + GST. The necessary ASIC and legal fees are generally a further $700.
- Maintaining a company: There are a few different elements you’ll need to be aware of:
- ASIC renewals: Each year you will need to pay a renewal fee to ASIC of approximately $300.
- ATO requirements: Your company will have to lodge its own tax return. This is quite a bit more complicated than a sole trader as the company will need to tax-effectively declare (pay) wages and superannuation to you
- Have financial statements prepared (a Balance Sheet and Profit and Loss)
This is our bread and butter and we can make this a pain free exercise for you. The annual accounting fees start from $2,800 + GST, depending on your specific circumstances.
- Insurance: Your company will be obliged to obtain workers compensation insurance to cover you as an employee. You could view this as a positive thing because, in comparison, as a sole trader you are unable to protect yourself with workers compensation insurance.
However, workers compensation insurance premiums generally aren’t cheap within the trades industry and could be as much as 4-5% of your own annual wages. For example, if you draw a $100,000 wage from your company, your insurance premiums could be $4,000 to $5,000 per year.
This aspect alone is one reason that builders generally prefer their subcontractors to be companies, because it puts the onus of workers compensation on the subcontractor, not on the builder.
- Trade licensing: You’ll need to obtain a company license, likely at an additional fee above your current trade license.
- Shutting down a company: It’s reasonably common to see a tradesperson set up a company in order to work for a particular builder and then a few years later when they leave that job to start elsewhere as an employee, they want to shut down the company.
The company windup costs should really be taken into account when you first decide to set up the company. A rough estimate might be $1,500 + GST, but it really depends on the situation. (The windup includes things such as finalising tax lodgements for the last tax year, preparing ASIC forms to deregister the company and cancelling the ABN and other tax registrations.)
What is Personal Services Income (PSI) and when will it apply to me?
The ATO has a set of rules known as Personal Services Income. These PSI rules could apply to you if you are being paid on an hourly or daily basis by a builder or head contractor.
Why do these PSI rules matter?
Sometimes we see tradesmen who believe they’ll be able to save tax by becoming a sole trader or a company so they can “run their own business”. They tend to believe they’ll be able to claim extra deductions and potentially benefit from a lower company tax rate. It might even occur to them that they’ll be able to split income with their spouse.
The reality is that business deductions, company tax rates and the possibility of splitting income only really arise when you are running a fully-fledged business and not simply “a one-man band”. For example, when you reach a stage where you have lots of clients of your own, you have your own subcontractors or employees, or your work is generally quoted jobs as opposed to being paid an hourly or daily rate.
The ATO believes that if your role looks like an employee—for example, the builder tells you what to work on and when, you can’t delegate your work to someone else and you are paid on an hourly or daily basis—then it does not matter if you are a sole trader or a company, you should still be taxed as if you were an employee.
The Personal Services Income rules are therefore designed to prevent a sole trader or company structure looking more enticing than employment, if you are only thinking about tax.
After all, if all the workers of Australia could simply set up a company and then access an array of tax-saving measures, the ATO would quickly lose out.
We regularly help contractors work through these rules and determine what can and cannot be done in their specific circumstances.
Other tips for subcontractors in building and construction:
- QBCC: If you are in QLD, the QBCC has quite strict financial requirements for tradespeople. These are tested annually and the choice of business structure can have an impact on how easily you meet these requirements. Therefore, if you are in QLD we highly recommend you get in touch with us before you set up anything.
- GST: It’s highly likely that you will need to register for GST and report Business Activity Statements to the ATO every quarter. We can help you set up the registration, show you how to include GST on your invoices, and how to set aside the necessary money to ensure you have it when the payment falls due.
- Income tax: As a subcontractor you’ll be responsible for putting aside your own income tax. It’s important that you understand this from the very beginning, because if you forget to save the money for your tax it can become difficult to play catch-up later. We can help you work out how much to set aside in a separate bank account so you avoid that unnecessary stress.
- Superannuation: As a subcontractor the builder won’t be paying your superannuation. (An exception to this may be if you are a sole trader and your builder has realised that they probably should pay it to minimise their own risk). We’ve seen many subcontractors over the years kick themselves after having 4 to 5 years of no super contributions. Therefore, you need to be aware of what super contributions you must make and what ones you can We’ll make sure you’re crystal clear on this.
- If you are set up in a company then you’ll have mandatory superannuation to pay on your own wages—that is, your company will pay you wages plus 10% super.
- If you are set up as a sole trader, then you can make voluntary payments to your super fund.
Note: Unfortunately, due to strict financial regulations, we can’t provide specific advice about how much you should contribute to superannuation.
- Home loans and finance: It’s worth noting that it can be more difficult to get a mortgage when you are a subcontractor (as opposed to an employee). That’s because a subcontractor generally needs to provide 2 years’ of tax returns demonstrating contracting income, whereas an employee generally only needs to provide a few months’ of payslips.
As you can see, the answer to the question, “Should I set up a company as a subcontractor in the building and construction industry?” has a number of aspects to it. That’s why it always pays to have an experienced tax and business advisor guide you in making the decision for where you are right now, so that you are aware of all the various pro’s and con’s.
If you’d like to have an initial no-obligation chat about your circumstances, get in touch with us. We’ll help you make an informed decision that makes sense for you, and then we can help you put in place the paperwork that needs to be done from there.