According to the ATO (Australian Taxation Office), an Employee works in your business and is part of your business while a Contractor is running their own business technically.
Below are the factors/functions that ATO has defined to clearly differentiate between an Employee and a Contractor:
1. Ability to delegate/sub-contract
An Employee cannot sub-contract or delegate (i.e. pay someone to do the job) while a Contractor can.
2. Basis of payment
An Employee is paid based on the time they worked, or a commission, or price per item. While a Contractor is paid for a result achieved based on the quote they provided.
3. Assets, equipments and tools
For an Employee, the business provides all of the tools and equipments to get the job done. While the Contractor needs to bring their own tools and equipments to complete the task.
Should an Employee brings their own tools and equipments to complete the task, the business provides them with an allowance or reimburses them for the cost of the equipment, tools and other assets.
4. Commercial risks
An Employee takes no commercial risks. The business is legally responsible for the work done by the Employee and is liable for the cost of rectifying any defect in the work, while it is the opposite for a Contractor.
5. Control over the work
The business has the right to direct the way in which an Employee does their work. However, the Contractor has freedom in the way the work is done, subject to the specific terms in any contract or agreement with the business.
An Employee does not operate independently from the business. They work within and are considered part of the business. The Contractor operates their own business independently. They performs services as specified in their contract or agreement and is free to accept or refuse additional work.
Source: Australian Taxation Office (ATO) Official Website