The ATO has recently released TR 2023/4 – Income tax: pay as you go withholding – who is an employee? (Ruling), as well as Practical Compliance Guideline 2023/2 (PCG) to provide additional guidance in respect of the distinction between an employee and independent contractor.
This is part 6 of our series of articles focusing on the employee versus contractor distinction. The other articles are linked under the Related Articles section at the end of this article.
Overview
The relatively brief, legally binding portion of the Ruling (paragraphs [6] – [14]), confirms the ATO’s interpretation of the definition employee and independent contractor. Importantly, the ruling explains when an individual is an ’employee’ of an entity for pay as you go (PAYG) purposes with respect to s 12-35 of Schedule 1 of the Taxation Administration Act 1953 (Cth) (TAA); which imposes an obligation on a paying entity to withhold amounts from salary, wages, commission, bonuses or allowances it pays to an employee. However, while the ATO note that the Ruling may assist in understanding the ordinary meaning of an employee in regard to s 12(1) of the Superannuation Guarantee (Administration) Act 1992 (Cth) (SGAA), the Ruling is not binding on the Commissioner in this respect.
The Ruling
Some notable points of the Ruling:
- Whether a worker is an employee of an entity … is a question of fact to be determined by reference to an objective assessment of the totality of the relationship between the parties: [7].
- Where the worker and the engaging entity have comprehensively committed the terms of their relationship to a written contract … 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: [9].
- Evidence of how the contract was performed, including subsequent conduct and work practices, cannot be considered for the purpose of determining the nature of the legal relationship between the parties: [9].
- Conversely, evidence of how a contract was actually performed may be considered to establish the contractual terms or to challenge the validity of a written contract consistent with general contract law principles: [10].
- The terms of the contract between the parties must be considered holistically: [11].
- The ‘label’ which parties choose to describe their relationship, whether within a written contract or otherwise, is not determinative of, or even relevant to, that characterisation: [13].
The Ruling broadly reflects the High Court’s decisions in Construction, Forestry, Maritime, Mining and Energy Union v Personnel Contracting Pty Ltd [2022] HCA 1 (Personnel Contracting) and ZG Operations Australia Pty Ltd v Jamsek [2022] HCA 2 (Jamsek). In Part 2 of our series of articles we provided a more in-depth analysis of these High Court decisions.
Consistent with these High Court decisions, a clear emphasis is placed on the legal rights and obligations of each party as determined with reference to the terms of the comprehensive written agreement.
The Fair Work Act 2009 (Cth) was recently amended by the insertion of new s 15AA(1) of the Fair Work Legislation Amendment (Closing Loopholes No. 2) Act 2024 (Cth). This section focuses on the real substance, practical reality and true nature of the relationship between the individual and the person. This determination should have regard to the totality of the relationship including not only the terms of the contract but also how the contract is performed in practice.
This provision was inserted by the Labor Government to supposedly close the ‘loophole’ created by the High Court in Personnel Contracting and the Jamsek decisions, discussed above. It should be noted, however, that this change is limited to the Fair Work Act 2009 (Cth) and does impact the status of the test for tax and superannuation purposes nor for the multitude of other legislative provisions where a distinction between an employee and contractor arises. Unfortunately, Australia has a very complex industrial system in world standards which is beyond the reach of many small to medium businesses as a determination is required having regard to the particular legislation being considered or other relevant criteria.
Explanation to the Ruling
The lengthy non-binding explanation to the Ruling describes in greater detail the factors that should be considered when deciding if an individual is an employee for PAYG purposes. Below we set out a brief summary of some the key factors.
Totality of the relationship (and steps to determining a worker relationship)
The appendix provides further detail on this concept:
[22] The totality of the relationship between a worker and an engaging entity comprises the legal rights and obligations they have in respect of each other – that is, the contractual relationship between the parties. To determine the nature of the contractual relationship between a worker and an engaging entity, it is the terms of the contract alone, whether express or implied, which are to be taken into account.
A two-step process is then provided for determining whether an employment relationship exists. Firstly, identify the contract between the parties. Secondly, identify the terms of the contract. It is these terms alone that are relevant to a determination of the nature of the relationship. However, evidence surrounding the formation of the contract may be considered to assist with the identification of the purpose of a contract, establish evidence of equitable rights (eg, estoppel and rectification) or to show the contract was a sham.
Core distinction and employment test
At paragraph [39] the core distinction between an employees and independent contractors is summarised as follows:
- an employee serves in the business of an employer, performing their work as a part of that business;
- an independent contractor provides services to a principal’s business, but the contractor does so in furthering their own business enterprise; they carry out the work as principal of their own business, not part of another.
The relevant test is stated as ‘is the worker an employee of the engaging entity?’ Again, this is with regard to the terms of the contract and the contractual relationship between the parties.
Indicia of employment
Paragraphs [45] – [75] then set out the factors or indicia of employment as identified in the relevant case law to assist in ascertaining whether a worker is an employee or independent contractor. Importantly, these factors must be weighed in relation to the totality of the relationship between the parties. Below we set out a summary of some of these factors.
Presenting as an emanation of the business
A distinction is noted between workers who voluntarily wear uniforms or other logos that bear their employers insignia and those who are contractually obliged to do so. The latter of which will tend towards a finding of employment.
Control and right to control
The focus of this factor is not in the actual exercise of control but the contractual right of the employer to exercise control. Such a contractual right will tend towards a finding of employment.
The ability to delegate, subcontract or assign work
An unfettered right to delegate, subcontract or assign work to others will be a very strong indicator against the worker being an employee (ie, being an independent contractor).
Results contracts
A contract to achieve a specified result is a strong indication that the contract is one for services and consistent with an independent contractor relationship. Nevertheless, there are non-hourly remuneration models that are still consistent with employment.
Provisions of tools and equipment
Workers providing their own equipment, assets and tools, incurring expenses and other overheads may be an indicator of an independent contractor relationship, but regard must be had to the nature, scale and cost of the tools and equipment.
Risk
A clause requiring a worker to take out public liability/indemnity insurance will likely be a neutral factor unless the totality of the relationship suggests that a worker is an independent contractor, in which case such a clause will support that finding.
Generation of goodwill
While not all businesses generate goodwill, it would be common for an independent contractor to generate goodwill for their own business.
Despite the distinct ambiguity of many of the above indicia of employment, it is relatively clear that such indicia are only suggestive of the type of relationship involved. The Ruling stresses on multiple occasions that regard must always be had to the totality of the relationship relevantly determined by the terms of the contract. Similarly, certain labels and clauses in a contract may be consistent with a contractor or employee relationship (eg, a clause requiring a worker to provide invoices suggests a contractor relationship) while again not being determinative by themselves.
Practical Compliance Guideline
Released in conjunction with the Ruling, the PCG specifically highlights when the ATO will investigate a worker’s classification (eg, employee or independent contractor) in an arrangement between an engaging entity and a worker. The PCG details how the ATO will allocate its compliance resources based on seven risk factors using the — now relatively standard — ATO system of no, low, medium, and high risk.
Importance of obtaining specific legal and tax advice
In addition to the ordinary meaning of employee under common law, an independent contractor may still meet the extended definition of an employee under s 12 of the SGAA. Notably, criterions 6 and 7 deal with obtaining specific advice confirming the classification of employee under s 12-35 of Schedule 1 of the TAA and the expanded definition of an employee under s 12 of the SGAA respectively. This advice must be from an appropriately qualified professional (eg, solicitor, tax professional or specific advice from the ATO).
Criterion 6: The party relying on this Guidelines obtained specific advice confirming the classification was correct.
Criterion 7: An engaging business relying on this Guideline also obtained specific advice confirming the application of the extended meaning of employee under the SGAA, and communicated this outcome to the worker.
The definition for the high-risk zone for each criterion also states:
Any arrangements that do not fall within the 3 other risk zones.
The implication is clear. A failure to obtain specific advice in relation to worker classification will automatically place an entity in the high-risk category. Notably, an engaging entity minimises risk by obtaining legal and tax advice.
The PCG notes that the Commissioner will be satisfied with regards to criterion 6 and 7 if the advice was at least reasonably arguable. A reasonably arguable position (RAP) must be cogent, well-grounded and considerable in its persuasiveness.
DBA Lawyers, among other things, review any employee/contractor agreements and prepare written tax opinions and where the facts and law support the position, can prepare a RAP. Moreover, legal and tax advice from a law firm like DBA Lawyers is covered by legal professional privilege.
Conclusions
The Ruling and the PCG reflect the ATO’s revised position in view of the High Court’s decisions in Personnel Contracting and Jamsek. These ATO materials summarise the various factors in determining a worker’s classification as employee or contractor. In accordance with the High Court decisions, the primary focus is on the totality of the relationship as evidenced by the terms of a comprehensive written contract.
The PCG highlights the need for, in addition to a comprehensive written agreement, a RAP by an engaging business to minimise risk. The PCG notes that professional advice is required from a lawyer or tax professional.
Naturally, if requested DBA lawyers would be pleased to assist.
We provide access to our prior articles below and, to register for our recent SMSF Online Update webinar on the employee versus contractor distinction held on 17 November 2023, click here.
Related articles
- Employee or independent contractor –– PAYG & SG –– Part 1
- Employee or contractor — High Court focus on contract v. multi-factors — Part 2
- Employee or contractor – Payroll Tax considerations — Part 3
- The application of SG to contractors clarified — Part 4
- Payroll tax crackdown on medical, healthcare and similar arrangements — Part 5
- Reconsidering Incorporated Contractors in an SG Context
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This article is for general information only and should not be relied upon without first seeking advice from an appropriately qualified professional. The above does not constitute financial product advice. Financial product advice can only be obtained from a licenced financial adviser under the Corporations Act 2001 (Cth).
Note: DBA Lawyers presents monthly online SMSF training. For more details or to register, visit www.dbanetwork.com.au or call 03 9092 9400.
For more information regarding how DBA Lawyers can assist, visit www.dbalawyers.com.au.
By Daniel Butler ([email protected]), Director, and Fraser Stead ([email protected]), Lawyer, DBA Lawyers
DBA LAWYERS
16 February 2024
