Firstly, why does it matter whether someone is an employee or a contractor? What is all the hype about?
Let's look at a simple example. John is a contractor of Mick’s Carpentry Pty Ltd. John is paid $100 per hour and works about 38 hours per week.
*based on an average rate for trade related industries.
As a contractor it's nice and simple. He receives $3,800 per week, with no further obligations.
However, it looks quite different if you had already paid John his $3,800 and the ATO deemed him to be an employee. On top of his fee you are liable for PAYG tax withheld, Super and workers comp. As an estimate, that $3,800 suddenly becomes nearly $7,300, representing an increase of 91%.
In addition, this doesn’t include the penalties and denial of tax deductions that can occur if you are found to be non compliant. It also fails to take into account public holidays and leave entitlements that you could also be liable for, if John was considered to be an employee. Plus there could also be payroll tax if your wages bill is high enough.
The trickiest part here is that additional liability all rests with the employer. You cannot recover the additional costs from the employee.
This is a quite technical area of tax law. The details are important.
To make things more complicated, there are different definitions for different areas of law. There is no definition of ‘employee’ in tax legislation, so the definitions come from cases (called ‘common law’). Additionally, this means that the definition of an employee for PAYG, superannuation and workers comp may vary slightly.
Firstly we'll look at the definitions within the PAYG legislation. Historically, the courts have relied on a ‘multi-factorial approach’ This looked at a number of factors of the arrangement to determine if the relationship as a whole was more that of an employee, or a contractor.
While these factors remain relevant, recent cases now focus more closely on the contract between the business and its worker as the most important factor. These cases stress that it is not necessary to review all dealings between the parties over the entire history of their relationship. However, examination of the actual conduct is permissible, especially where the contract may be considered a ‘sham’.
There are a number of examples included in PCG 2023/2 that can assist to understand how the ATO intends to apply these provisions in practical cases. It categorises cases into low, medium and high risk categories.
Click here for the full details on the ATO website.
Click here to download the PDF from the ATO.
In 2024 the Fair Work Act 2009 (Cth) (FWA was amended to provide guidance on when someone is considered an employee. It requires a comprehensive assessment of the ‘real substance, practical reality and true nature’ of the relationship, considering all aspects of the working relationship. This includes what is actually occurring in practice. This essentially reinstates the original multifactorial test focusing on the entire relationship rather than just the terms of the contract. This means that it is possible for someone to be considered a contractor for tax purposes and an employee for fair work purposes. This means that the two approaches are essentially running side by side and both need to be considered.
For superannuation, different statutory tests apply. For the superannuation guarantee an employee includes common law employees (as discussed above) as well as employees under the ‘extended definition’ which is contained in the legislation as well as TR 2023/4.
The extended definition includes employees who are:
It is important that this is properly considered as the penalties for non-compliance of super guarantee can be high with an automatic 60% uplift if paid late. This means that $100 of unpaid super automatically becomes $160.
When determining if superannuation is payable, the following factors are relevant:
It is important to note that inserting clauses into a contract stating that the employer is not responsible for superannuation on behalf of a worker will not effectively satisfy the employer’s SG obligation.
One option that can successfully avoid SG obligations is contracting via a company or a trust. The ATO’s view is that superannuation guarantee is not payable to a contractor engaged through an entity as there is no employer-employee relationship for the purposes of the SG Act because it is the entity entering into the contract, not the individual.
There have however been cases where this has failed, because the contract was between the individual and the employer rather than the entity. The fact that the payments were received by the entity made no difference in this instance.
This is an area that the ATO is applying increasing compliance resources. With Single Touch Payroll and the requirement to lodge Taxable Payment Annual Reports in many industries, the ATO’s data matching resources have vasty improved.
Additionally, the following workers are always treated as employees:
The most important takeaway here is that what we call someone (employee or contractor) is not definitive. Simply having an ABN or issuing invoices does not make someone a contractor. Mistakes can be costly!
All employers using contractors should seek legal advice on their specific circumstances. They should look at the factors listed and consider how risky their arrangements are.
It is important to have a comprehensive contract in place covering the relevant factors listed, but it is also important to be able to show that the worker is actually performing their duties in accordance with the contract.
At the end of the day, the only way to reduce the risk all together is to insist on an employee relationship or to contract with entity structures only.
Since 1989 Hillier’s Advisors have been delivering financial services to individuals, businesses and business owners across Newcastle and the wider Hunter Region. A major focus for the Hillier’s Advisors team and the work we do is providing the right financial advice when our clients need it, not just when they ask for it.
