Employee versus Contractor

On 9 February 2022, the High Court handed down two landmark decisions regarding the distinction between employees and independent contractors. In response, the Australian Taxation Office (ATO) released Draft Taxation Ruling TR 2022/D3: Income tax: pay as you go withholding – who is an employee?

TR2022/D3 explains when a worker is an ‘employee’ of a business. If a worker is classified as an employee, the business will be responsible for withholding and remitting Pay-As-You-Go (PAYG) withholding tax on their behalf. Employers must also pay Superannuation Guarantee (SG) contributions and may be liable for other employment-related expenses, such as leave entitlements and workers’ compensation insurance.

On the other hand, if a worker is classified as an independent contractor, the business will not be required to withhold PAYG withholding tax, pay SG contributions or provide other employment-related entitlements. However, the contractor may be required to pay their own tax and insurance obligations.

Under the updated ATO guidelines, the relationship between an employer and an individual engaged to work will be based on the contractual terms of the agreement. This means that businesses can more easily determine the nature of the relationship, provided all relevant information is included in the agreement. If the ATO finds evidence that the contract is not being carried out as per the agreement, other factors may come into consideration, such as the date the contract was established, contractual terms, subsequent agreements, or whether the contract was a sham.

To determine whether a worker is an employee or independent contractor, the ATO will assess the following factors:

  • Whether a worker presents themselves as being part of the engaging entity’s business – i.e., wearing the employer’s uniform, etc.
  • Whether the engaging entity has the right to control a person – The more control the engaging entity can exercise over how, when and where the worker performs their work under the contract, the more likely the worker is to be an employee of the engaging entity.
  • The person’s ability to delegate their work – If a worker has an unlimited power to delegate the work to others, this is an indication that the worker is being engaged as an independent contractor.
  • The basis on which the person’s remuneration is calculated – Where the substance of a contract is to achieve a specified result, there is a strong indication that the contract is one for services. However, a worker whose level of remuneration is determined by producing a specified outcome, will not always be an independent contractor.
  • Whether a person is required to support their own tools and equipment – The provision of assets, equipment and tools by a worker, and the incurring of expenses and overheads, may be an indicator that the worker is an independent contractor. However, a worker bringing their own tools is not automatically inconsistent with an employment contract. The nature, scale and cost of the tools and equipment must be considered.
  • The amount of risk a person bears when carrying out their work – where the worker bears little or no risk of the costs arising out of injury or defect in carrying out their work, they are more likely to be an employee. On the other hand, an independent contractor bears the commercial risk and responsibility for any poor workmanship or injury sustained in the performance of the work.
  • The person’s ability to generate goodwill – Where a contract between a worker and engaging entity prevents any goodwill from accruing for a worker’s possible business, this may indicate that the worker is instead serving in the engaging entity’s business. If a person does not generate goodwill, but not specifically prevented from doing so in the written, they may still be an independent contractor.
  • How a person engages with the engaging entity – Where a worker engages to perform work for the business as a partner of a partnership or through an entity such as a company or trust, this may indicate an intention by all parties to not create an employment relationship. However, a different conclusion may be reached if a worker uses an interposed entity but is also directly a party to the contract with the engaging entity.

It also outlines various factors within a written contract that are not determinative of whether a person is an employee or independent contractor:

  • Whether or not the work conducts their own business.
  • Labels given to parties in the contract and other descriptors of their relationship.

Therefore, it’s crucial for businesses to correctly classify their workers to avoid potential tax liabilities and penalties. With the ATO’s updated guidelines based on the contractual terms of the agreement, businesses need to ensure that their contractor agreements accurately reflect the nature of the relationship between the business and the worker.

If you have questions in relation to the above, or any other matters, please do not hesitate to contact our office on 1300 620 345.