Employee or Contractor – An Updated ATO perspective
Engaging a new team member is a complex process.
Apart from negotiating pay rates and conditions, you also need to assess whether they are the correct ‘fit’ for your organization and culture.
One of the boxes to be ‘ticked’ as part of this process is for both parties to agree on whether you are engaging the person as an employee or as a contractor.
How can you correctly determine whether the person you engage is an employee or a contractor?
While a person can’t be considered a contractor by simply labelling them so, two High Court decisions in early 2022, in relation to Fair Work Act 2009 matters, have indicated that the written agreement between the parties is a significant determinant of the relationship, on the basis that it is not a sham agreement, the parties have operated under the agreement and there have not been material changes to the agreement. These cases were Construction, Forestry, Maritime, Mining and Energy Union v Personnel Contracting Pty Ltd [2022] HCA1 and ZG Operations Australia Pty Ltd v Jamsek [2022] HCA2.
Both decisions related to past employees/contractors that were keen to alter the relationship under which they had previously been engaged after their employment/contractor agreement ceased.
The ATO issued TR 2023/4 Pay As You Go Withholding – Who is an Employee? on 6 December 2023, which takes into consideration this recent case law.
This ruling is a departure from the ‘totality of the relationship’ previously considered by the ATO as determinative when identifying the differences between employees and contractors. TR 2023/4 focuses on the nature of the contractual and legal understanding between the parties at the commencement of their engagement.
From paragraph 9 of the ruling:
- Where the worker and the engaging entity have comprehensively committed the terms of their relationship to a written contract and the validity of that contract has not been challenged as a sham, nor have the terms of the contract otherwise been varied, waived, discharged or the subject of an estoppel or any equitable, legal or statutory right or remedy, it is the legal rights and obligations in the contract alone that are relevant in determining whether the worker is an employee of an engaging entity.
While it is the intention of the parties at the time of entering into the agreement that is initially determinative, how the agreement is actually performed may assist in establishing the actual agreed terms and where this differs from the contractual or legal terms, may result in the validity of the written agreement being challenged.
The ruling also notes that engaging someone with their own business and ABN does not guarantee that the person should be considered a contractor – an independent contractor may also be an employee of another business.
If the agreement was an oral agreement, or where the agreement was incomplete or had been contested by either of the parties, the Court may look at the previous ‘multifactorial’ approach, as evidenced in the Australian Taxation Office employee/contractor decision tool.
The ATO have considerable resources available to assist those engaging workers to determine the correct relationship – following is from their website showing the key differences between employees and contractors, with the Common Indicia being the more traditional ATO approach to be applied to each contract entered into:
The critical differences between an employee and independent contractor are:
- an employee serves in your business, and performs their work as a representative of your business
- an independent contractor provides services to your business and performs work to further their own business.
Common indicia
Analysis of the indicia must be done by reference only to the legal rights and obligations
that arise from the contract you enter into with your worker.
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Employee |
Contractor |
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Control: your business has the legal right to control how, where and when the worker does their work. |
Control: the worker can choose how, where and their work is done, subject to reasonable direction by you. |
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Integration: the worker serves in your business. They are contractually required to perform work as a representative of your business.
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Integration: the worker provides services to your business. The worker performs work to further their own business. They may choose to present themselves as part of your business. |
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Mode of remuneration: the worker is paid either: · for the time worked · a price per item or activity · a commission.
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Mode of remuneration: the worker is contracted to achieve a specific result, and is paid when they have completed that result, often for a fixed fee.
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Ability to subcontract or delegate: the worker must perform the work themselves and cannot pay someone else to do the work for them. |
Ability to subcontract or delegate: the worker is free to delegate to others who the worker will pay to complete the work on their behalf. |
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Provision of tools and equipment: your business provides all or most of the equipment, tools and other assets required to complete the work, or the worker provides all or most of the tools, but your business provides them with an allowance or reimburses them for expenses incurred. |
Provision of tools and equipment: the worker provides all or most of the equipment, tools and other assets required to complete the work, and you do not give them an allowance or reimbursement for the expenses incurred. The work involves the use of a substantial item that your worker is wholly responsible for. |
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Risk: the worker bears little or no risk. Your business bears the commercial risk for any costs arising out of injury or defect in their work. |
Risk: the worker bears the commercial risk for any costs arising out of injury or defect in their work. |
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Generation of goodwill: your business benefits from any goodwill arising from the work of the worker. |
Generation of goodwill: the worker’s business benefits from any goodwill generated from their work, not your business. |
Authorised by the Australian Government, Canberra.
This list is not meant to be a ‘box ticking’ exercise to determine whether a person is correctly engaged as an employee or a contractor, but each element is to be considered as part of the totality of the arrangement, given a weighting to determine the overall outcome.
So, if you are planning to engage a new person as an employee or contractor, we recommend that you seek legal advice to ensure that you enter into an agreement (either employment or contracting) that reflects the agreed terms of the relationship, and the actual work undertaken is consistent with the legal agreement.
Why is the employee/contractor label important?
The main ATO payment obligation that sets employees apart from contractors is the requirement to withhold PAYGW from salary and wages, although in some industries there are also PAYG withholding obligations for contractors.
The other major employer on-costs - federal superannuation guarantee, state Workcover/workers compensation and payroll tax – can also apply to contractors where ‘mainly labour’ is supplied – you need to check the specific definitions under each of these pieces of Federal and State legislation to determine whether there is a liability for your contractors.
The ATO have announced that Single Touch Payroll (STP) Phase 2, which not only shares the business payroll information with a number of Government agencies (such as Services Australia), mandates reporting of salary and wages, payments to directors etc, and also enables employers to voluntarily report where there is a voluntary agreement or labour hire arrangement. Other reporting of contractor payments is not currently mandatory. Some further reporting information to be supplied is in the following link:
If this article raises any questions in relation to your business, please contact our office.
January 2024
