Clements Dunne & Bell Melbourne

News
Contractor versus Employee - Complexity, Compliance and Risk Management

19 September 2012

When engaging contractors, businesses must navigate a complex web of rules and obligations that encompass Federal and State taxation obligations, Fair Work Act obligations and WorkCover obligations.

The complexity of the issues coupled with the increased compliance focus create a significant risk exposure for many businesses.  These risks can take the form of taxes and penalties along with the imposition of additional requirements that can have significant impact on the profitability of a business.

As an example, the following is a brief list of recent activity in the employee versus contractor arena that highlight the need for an active approach to compliance.

  • The decisions in the Roy Morgan Research Pty Ltd, Associated  Translators & Linguists Pty Ltd and On Call Interpreters and Translators Agency Pty Ltd court cases focused on the employer's/principal's obligation to make superannuation contributions for some contractors;
  • The ATO's 2012-13 Compliance Program nominating continued activity around contractor issues and their audit of 1,100 business in 2011-12 that identified that 48% of businesses were wrongly treating individuals as contractors;
  • The Fair Work Australia ruling in the Jiang Shen Cai trading as French Accent v Michael Anthony Do Rozario case involving an unfair dismissal claim of a contractor;
  • The Fair Work Ombudsman’s “Sham Contracting Operational Intervention” focussing on misclassification of workers in the cleaning services, hair and beauty and call centre industries;
  • The Fair Work Ombudsman Prosecuting a NSW transport business in July and a QLD beauty and photography business in June over allegations of sham contractor arrangements;
  • The new contractor provisions in the Victorian Accident Compensation Act (WorkCover) that have effect from 1 July 2011;
  • The new reporting regime for payments to contractors in the building and construction industry that commenced on 1 July 2012; and
  • The Victorian State Revenue Office running Payroll Tax education sessions throughout the 1st half of 2012 and the introduction of an incentive for voluntary disclosure of non-compliance.
The purpose of this newsletter is to provide an overview of the various compliance obligations that have application to contractor arrangements and to highlight the complexities around the employee versus contractor issue.

Pay As You Go Withholding and Superannuation Guarantee

Employers are required to withhold tax from wages paid to employees and to make superannuation contributions on behalf of those employees at a minimum prescribed rate.

Failure to meet these obligations can result in significant tax obligations accompanied by penalties and interest.

In both the Pay As You Go (PAYG) and Superannuation Guarantee (SG) legislation, the definition of employee is derived from the term’s common law meaning.  An analysis of the historical case law demonstrates that despite the label attached to the relationship and the intentions of the parties, contractors can sometimes be regarded as employees for the purposes of the law. 

Furthermore, the SG legislation extends the definition of an employee to include a person who enters a contract wholly or principally for their labour.  This captures arrangements where:

  • The contractor is remunerated (either wholly or principally) for their labour and skills;
  • The contractor must perform the work personally; and
  • The contractor is not paid to achieve a result (E.g they are paid for hours worked).

The ATO summarises the case law and sets out its views as to when a contractor will be regarded as an employee in TR 2005/16 and SGR 2005/1.  They nominate the following as the relevant factors for consideration.

The terms and the circumstances of the formation of the contract
The PAYG and SG legislation take a substance over form approach.  This means that the label attached to a relationship is not determinative of its true legal status.

In determining the true legal status of the relationship, the terms of the contract and the intentions of the parties must be considered.

Control
The term “control” refers to the extent to which the contractor is bound to follow the instructions of the principal in organising and carrying out their work.  A high level of control is indicative of a true contractor relationship.
 
Whether the worker operates on their own account or in the business of the payer
Where a person operates their own discrete business, rather than simply operating within the business of the principal, it is more likely that there will be a true contractor relationship.
 
Paid to achieve a result
A strong indicator of a contractor relationship is where the contractor is paid to achieve a result rather than simply by reference to hours worked.
 
Ability to delegate or subcontract

Where a contractor is entitled to delegate or subcontract their work, there is a strong indication of a true contractor relationship.

Who bears the risk
Where the contractor bears little or no risk of the costs arising from injury or defect in carrying out their work, they are less likely to be held to be in a true contractor relationship.  

Maintaining business insurance policies may support a finding of contractor versus employee.

Provision of tools and equipment and payment of business expenses
Providing tools and equipment and incurring expenses in the course of carrying out work is an indication that there is a true contractor relationship in place.

Other factors to consider
Other factors that should be considered include:

  • The principal's right to suspend or dismiss the contractor;
  • The principal's right to exclusive services;
  • The provision of benefits that are usually associated with employees.  Eg annual leave, sick leave; and
  • A requirement to wear the principal's uniform.

The fact that most contractors will have an Australian Business Number (ABN) has no bearing on the determination of the person’s status as employee versus contractor.  In fact, the person may be stripped of their ABN if they are not seen to be a bona fide contractor.

Where a contractor is engaged through a structure such as a company or trust, the PAYG and SG legislation will not have application. In this respect, it is important to ensure that the documentation surrounding the arrangement clearly demonstrates that the engaged party is the company or trust.

Fringe Benefits Tax

Where employers (and/or their associates) provide non-cash private benefits to employees (and/or their associates), an obligation to pay Fringe Benefits Tax (FBT) may arise.  

Again, the definition of “employee” is taken from the common law and as such, FBT may be payable in respect of benefits provided to contractors.

Workcover Insurance

From 1 July 2011 new provisions of the Accident Compensation Act 1985 apply to contractor relationships in Victoria.

The general contractor provisions are included in Section 8 and the provisions relating to incorporated contractors are contained in Sections 9 & 10.

Under the general contractor provisions, a person is deemed to be a worker and amounts paid to them must be included in rateable remuneration for the purpose of calculating the hirer's premiums, where:

  1. The provision of materials is not the principal object of the arrangement; and
  2. At least 80% of the work is performed by the same individual; and
  3. At least 80% of the contractor’s overall services income is earned from the hirer.

The contractor is also entitled to make a claim for WorkSafe compensation with the hirer where they sustain a workplace injury whilst performing work under that arrangement.

A hirer can seek a determination from WorkSafe that the arrangement is part of the contractor’s independent trade or business.  Factors that will be considered include:

  • The use of a business name by the contractor;
  • The history of the formation of the contractor’s business;
  • The extent and nature of advertising undertaken by the contractor;
  • The range of clients serviced by the contractor;
  • The extent and nature of plant and equipment provided by the contractor in execution of the services;
  • The engagement of staff or sub-contractors;
  • The use of business premises;
  • The method of operation of the business. E.g. tendering for jobs;
  • The contractor’s entrepreneurial risk;
  • The nature of contracts entered into;
  • Whether work is performed under separate contracts at the same time;
  • The nature of the contractor’s business and the type of services provided;
  • Whether the contractor quotes competitively for jobs on an all inclusive basis (labour & materials); and
  • Whether the contractor merely charges for services on an hourly rate and adds on the cost of materials.

The above is not an exhaustive list of factors and no one factor is conclusive taken on its own.

The provisions for incorporated contractors apply when there is a deemed worker, as determined above, under a contractual arrangement between a hirer and an incorporated contractor.

Under the incorporated contractor provisions, the hirer must include the contractor’s remuneration when calculating their rateable remuneration.  Also, where the deemed worker sustains a workplace injury whilst performing work under that arrangement, they are only entitled to make a claim for WorkSafe compensation with the hirer.

Where the incorporated contractor is required to maintain its own policy, they are not required to declare as rateable remuneration any amount that is required to be declared by the hirer under the incorporated contractor provisions.

Each State and Territory operates its own WorkCover system and the rules may vary between jurisdictions.  Businesses engaging contractors outside of Victoria should not rely upon the above and should seek advice specific to those other jurisdictions.

Payroll Tax

In Victoria, where a contractor is a common law employee, the principal is required to pay Pay-roll Tax on the remuneration paid to that contractor.  Additionally, the Pay-roll Tax applies to services provided under a “relevant contract”.

Generally, a relevant contract exists where the contractor provides labour under the contract.  However, there are six exemptions that apply to relevant contracts to exclude them from Pay-roll Tax.  There are also exemptions for owner drivers, insurance agents and door to door sellers.

The six exemptions are:

  1. The contractor provides services to the one principal on no more than 90 days in a financial year;
  2. The contractor engages others to do all or part of the work under the contract;
  3. The provision of labour is ancillary or secondary to the supply of materials or equipment;
  4. The contractor’s services are of a kind not ordinarily required in the principal's business and the contractor usually provides those services to a range of clients;
  5. The contractor’s services are of a type ordinarily required in the principal's business for less than 180 days in a financial year;
  6. The Commissioner is satisfied that the contractor ordinarily renders their services to the public generally in a financial year (a determination is required).

Note – the Commissioner has approved certain deductions for classes of contractors to reflect the deemed amount for materials and equipment.  Further details of these amounts can be supplied upon request.

Each State and Territory operates its own Payroll Tax regime and differences may arise from jurisdiction to jurisdiction.  Where a business engages contractors outside of Victoria, specific advice on the application of that jurisdiction's Pay-roll Tax should be sought.

Reporting of Payments to Contractors in the Building & Construction Industry

From 1 July 2012 a new reporting regime has commenced that will require participants in the building and construction industry to report details of payments to contractors during the 2013 financial year by 21 July 2013.

Further details of the requirements can be found in the following ATO fact sheet.
http://www.ato.gov.au/content/00319801.htm

Effected businesses will need to ensure that systems are in place to capture the information that is to be reported.

The purpose of the new reporting regime is to address the lack of compliance with tax obligations within the building and construction industry.  Given the higher level of scrutiny the reporting regime will facilitate, it is essential that businesses ensure that their house is in order on contractor issues.

Fair Work Act, etc.

If a contractor is considered to be a common law employee, they will be entitled to the minimum standards contained in the Fair Work Act, Awards and/or industrial agreements.

Furthermore, employers can face very significant penalties if the Fair Work Ombudsman finds that they have misrepresented an employment relationship as an independent contracting relationship.

Where it appears that a contractor is a common law employee, we recommend that specific advice be sought as to the obligations under the Industrial Relations system.

An example of the risk exposures faced by businesses can be taken from the recent Fair Work Australia decision in the case of Jiang Shen Cai trading as French Accent v Michael Anthony Do Rozario, where a contractor was held to be entitled to a remedy for unfair dismissal.

Tax Issues for Contractors

Contractor relationships often appear attractive to the contractor as there may be an opportunity to achieve better tax outcomes.  In this respect, we urge caution as the Personal Services Income (PSI) regime may act to deny those favourable tax outcomes.

Furthermore, even if a contractor can avoid the PSI regime, the general anti-avoidance provisions contained in Part IVA of the Income Tax Assessment Act may be applied by the ATO in order to deny the taxation benefits.

The substantial history of case law (that is ever growing) in this area suggests that it can be difficult for some contractors to achieve better tax outcomes than employees.  As such, we recommend obtaining professional tax advice prior to entering any contractor arrangements.

Lastly, the compliance obligations and associated costs for a contractor are generally more onerous than for a salary/wage earner.

Disclaimer

This document has been prepared for general information purposes and should not be relied upon as a substitute for professional advice.

We encourage you to contact your regular CDB advisor to discuss your specific circumstances and how the relevant laws apply to you.

 

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Contact:

Daniel Clements
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Paul Clements
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T: + 61 3 8618 2222