Getting it right is imperative!
The classification of workers as either employees or contractors has long been an area of interest to the ATO and other government organisations, with many businesses getting it wrong. The cost of incorrectly classifying a worker can be significant, resulting in employers being liable for unpaid superannuation, leave entitlements, PAYG withholding and potentially other amounts under the relevant state employment laws.
Last year , two High Court cases fundamentally changed the common law distinction between an employee and contractor, placing importance on the terms of written contracts. These cases highlight the importance for employers in drafting written contracts for both employees and contractors. Previously, the Courts applied a multi-factorial approach when determining the relationship, with the contract being just one factor taken into account, but not the decisive factor. The ATO has recently released TR 2022/D3 and PCG 2022/D5 which is discussed further below.
“CFMMEU v Personnel Contracting Pty Ltd ” involved an individual engaged via a labour hire firm (‘LHF’) as an “independent contractor” working in a construction business. The individual worked under the supervision and direction of the construction business and the LHF would invoice the construction business weekly using an hourly rate. The worker provided their own protective equipment. The written agreement between the LHF and the worker described the worker as a self-employed contractor, however it also gave the company the right to determine who the individual would work for. This loss of right of control is a key factor in determining whether a worker is an employee or a contractor. The above factors strongly suggests an employee/employer relationship, despite any agreement labelling it an independent contractor relationship.
The High Court held that they were an employee, focusing on the terms of the written contract between the parties. They also held that the worker was not carrying on a business on his own account, and the LHF retained right of control over the worker and was entitled to determine who the worker would work for. The fact that the written agreement referred to the worker as an independent contractor is not sufficient and did not change the character of the relationship.
“ZG Operations & Anor v Jamsek & Ors ” involved two individuals engaged as truck drivers for a company. Initially the relationship was that of an employer and employees. In 1986 the company told its workers that it would no longer employ individuals unless they were to purchase their own trucks and enter into an agreement with the company. The two individuals in this case agreed and established partnerships with their spouses, and the partnerships purchased trucks from the company and executed written agreements for the provision of delivery services. The partnerships invoiced the company for the work performed.
The High Court again referred to the rights and obligations under the written agreements, and found that it was the drivers’ partnerships, and not the individual drivers, who owned and operated the trucks and were running a business of their own and contracted with ZG Operations for the provision of delivery services. It was also noted that the partnerships took advantage of the tax benefits of the structure, splitting the income with their spouses, which would not have been possible in an employee relationship.
In light of the above two cases, the ATO released a decision impact statement regarding these cases, and TR 2022/D3 in December 2022 which explained how to determine whether a worker is an employee, as per the ordinary meaning of the term.
The determination requires an objective assessment of the totality of the relationship between the parties having regard only to the legal rights and obligations which constitute that relationship. As such, the contract at the time it is entered into must be considered. If the parties have agreed to the terms of the working relationship via a written contract, it is the rights and obligations in the contract that are relevant in determining the relationship. The ATO further indicates in the ruling that the key distinction between employees and contractors is that a contractor provides services to the business but does so in carrying on their own business, whereas an employee serves in the business of the employer as a representative of that business and does not carry on their own business. The other usual tests such as control, the ability to delegate work, whether the worker is paid to achieve a specific result, who provides the tools and equipment, who bears the risk etc must be assessed.
In addition to the above draft tax ruling, the ATO also released PCG 2022/D5 (‘PCG’) which explains how the ATO will allocate compliance resources in relation to the classification of workers as contractors or employees. The guide uses a risk framework to assess the risk of these arrangements. An arrangement is considered low risk if there is evidence to show all the following are met:
- the parties agreed to be classified in a certain way,
- the arrangement has not significantly changed from the contractual rights and obligations agreed to by the parties (i.e. the original written contract)
- the parties both understood the tax and superannuation consequences of treating the relationship that way
- the party relying on the PCG obtained specific advice confirming the classification was correct under common law definition of employee and the extended definition (this may include advice from a solicitor, accountant or the ATO), and;
- the party relying on the PCG is meeting their obligations for tax, superannuation, and reporting requirements for that classification.
The arrangement will be considered high risk under the PCG if the following factors are present;
- the parties did not agree on the classification
- one of the parties forced the other party to accept the classification.
- one party made false or misleading representations to the other party,
- the party relying on the PCG did not turn their mind to the manner in which the worker was classified.
The above highlights the importance of carefully drafting written agreements which reflect the rights and obligations of the parties involved. The updated ATO guidance in light of these cases detailed above should be carefully considered, with the ATO likely to allocate significant resources to taxpayers with medium to high risk arrangements. The cost of getting it wrong can be significant, so proper advice should be sought early, prior to commencing payments, and written documentation prepared accordingly.
For any assistance, please contact your Hall Chadwick QLD advisor.