Clements Dunne & Bell Melbourne

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Engaging Contractors

2010 has seen two high profile court cases - Roy Morgan Research Pty Ltd v FCT and Re Associated  Translators & Linguists Pty Ltd v  FCT, that highlight complexities and dangers associated with contractor arrangements.

In essence the danger lies in the definition of an “employee” for the purposes of Pay As You Go (PAYG) Withholding, Superannuation Guarantee (SG) and other legislation covering WorkCover, Payroll Tax and Fringe Benefits Tax (FBT).  Additionally, there are provisions that impose obligations on businesses that engage certain types of contractors. 

Where a contractor is considered to be an employee or is otherwise “caught”, there are far reaching consequences for both the principal and the contractor.  Read more for a brief outline of how contractor arrangements are treated.  This outline covers:

  • Pay As You Go Withholding;
  • Superannuation Guarantee;
  • Fringe Benefits Tax;
  • WorkCover;
  • Payroll Tax;
  • The Fair Work Act; and
  • Tax issues for contractors.

PAY AS YOU GO WITHHOLDING AND SUPERANNUATION GUARANTEE

Under the Pay As You Go (PAYG) and Superannuation Guarantee (SG) regimes an employer is required to make superannuation contributions and withhold tax from payments made to employees.  The term “employee” refers to the common law definition of employee and as such payments to contractors can be subject to PAYG and SG. 

The ATO sets out its views on when a contractor will be an employee in TR 2005/16 and SGR 2005/1.  The relevant factors for consideration from these rulings is set out below.  Furthermore, under SG the definition of an employee has been statutorily expanded to include a person who enters a contract wholly or principally for their labour.  This means:

  • 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 (ie paid by reference to hours worked).


The following are the factors for consideration from the Australian Taxation Office (ATO) rulings:

The terms and the circumstances of the formation of the contract
The terms of the contract and the intentions of the parties will influence the determination of contractor versus employee.  However, it is the substance of the relationship that matters and it is not possible for the parties to simply label a relationship to be that of principal and contractor.

Control
Where the contractor has a high degree of control over their work and their working arrangements it is less likely that they will be held to be an employee.

Whether the worker operates on their own account or in the business of the payer
Where a contractor operates their own business rather than simply operating within the business of the principal, they are more likely to be a bona fide contractor.

Paid to achieve a result
Where the contractor is paid to produce a result there is a strong indication that they will not be held to be an employee.  Whereas, payment on say an hours worked basis may point towards a finding of employee.

Ability to delegate or subcontract
An indication of a bona fide contractor is the ability to delegate or subcontract their work.  If the contractor is personally required to complete the work, there is an indication that they are an employee.

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 more likely to be held to be an employee.  A true contractor will often carry their own insurance and indemnity policies.

Provision of tools and equipment and payment of business expenses.
Providing your own tools and equipment and incurring expenses and overheads is an indicator of a contractor rather than an employee.

Other factors may also be considered such as:

  • the principals right to suspend or dismiss the person;
  • the principals right to exclusive services;
  • the provision of benefits such as annual leave, sick leave, etc that usually relate to employees; and
  • a requirement to wear the uniform of the principal.

Most contractors will have an Australian Business Number (ABN).   This will not have an impact on the assessment of contractor versus employee.

It should be noted that the ability to deem a contractor to be an employee only applies where the contractor is an individual.  This excludes persons contracting through an entity such as a company or trust.

However, it should be noted that the ATO will seek to look through a company or trust structure where they believe it to be sham or a mere re-direction of salaries or wages.  This can be a very “grey” area.  In our view, if a person would be a deemed employee but for the use of a company or trust, then the arrangement requires further review.

FRINGE BENEFITS TAX

Where a contractor is considered to be a common law employee, Fringe Benefits Tax(FBT) may apply to any non cash benefits provided by the principal to the contractor.

WORKCOVER INSURANCE

Each Australian state operates its own separate WorkCover system.  In Victoria, a principal may be required to include remuneration to contractors when reporting to their insurer and this will cause an increase in their WorkCover insurance premium.  They will also be responsible as an employer for any such contractor who sustains a workplace injury.

Common law employees are covered for WorkCover purposes (see above).  Additionally Section 8 of the Accident Compensation (WorkCover Insurance) Act 1993 may treat certain individual contractors as workers for WorkSafe purposes where all of the following applies:

  • the principal in the course of, and for the purposes of a trade or business, hires a natural person (contractor) to perform certain work; and
  • the contractor agrees to perform the work, which is not incidental to a trade or business regularly carried on by that contractor (in the name of the contractor or under a business name); and
  • the contractor does not subcontract the work or employ anyone to perform the work or, if they do employ someone, the contractor performs some of the work personally.

An indicative test for the above has been published by WorkSafe Victoria to assist in identifying if contractors are covered by Section 8 as follows:

  1. Did the contractor perform the same services to two or more businesses as a contractor?
  2. Did the contractor usually enter into work agreements where the contractor was free to work for more than one business at at a time?
  3. Did the contractor usually employ staff or subcontractors?
  4. Did the contractor usually provide significant tools, equipment or materials?
  5. Was the contractor usually legally liable for rectifying faulty materials or workmanship?
  6. Did the contractor usually quote competitively for work?
  7. Did the contractor usually quote a business name?
  8. Did the contractor usually advertise a business or promote their services to two or more businesses?
  9. Did the contractor usually submit invoices for the contracted work?

Questions 1 to 6 each carry two points for a yes answer and zero for a no answer.  Questions 7 to 9 each carry one point for a yes and zero points for a no.  WorkSafe Victoria will generally be satisfied that a contractor is not covered by Section 8 if the score is at least 9 points for the given year,  or where they score at least 4 points for the given year and 9 points or more points for the preceding year.

However, there is a proviso that there is no clear inconsistency between the contractors working arrangements and the intention of Section 8.

Even if a contractor is not caught as a common law employee or by Section 8, they can still be caught by Section 9.  Section 9 not only applies to natural persons but companies, trusts, etc.

Under Section 9, the legislation seeks to include services provided under a “relevant contract”.  It then provides for seven exemptions.  The effect of Section 9 is to capture the majority of arrangements and then to specifically exclude certain kinds.

A relevant contract is one where a person in the course of their business:

  • supplies services to another person for or in relation to the performance of work; or
  • receives services from another person for or in relation to the performance of work; or
  • giving out goods to natural persons for work to be performed by that person on those goods and for re-supply to the first person.

The seven exemptions are:

  1. Contracts where the provision of labour is ancillary to the provision of materials and/or equipment;
  2. Contracts where the services are not ordinarily required by the principal, and the contractor ordinarily renders those services to the public generally;
  3. Contracts for the provision of services of a kind ordinarily required by the principal for less than 180 days in a financial year;
  4. Contracts where services are provided for a period that does not exceed 90 days in a financial year;
  5. Contracts where WorkSafe is satisfied that services are rendered by a person who ordinarily renders services of that kind to the public generally in that financial year;
  6. Contracts where the contractor engages subcontractors or employees to perform some or all of the work required under the contract; and
  7. Contracts under which the contractor provides services for or in relation to the door to door sale of goods.

Further, under Section 10A a contractor can be liable for subcontractors and will be required to include their remuneration when reporting for premium calculation purposes unless the subcontractor is a self insurer or holds their own WorkCover insurance policy.

It is only the labour component of remuneration that is included when calculating insurance premiums for contractors caught under Section 8 or 9.  Regulation 13 of the Accident Compensation Regulations 2001 prescribes deductions for particular classes of contractors where the contractor provides materials and/or equipment that are to be used in determining reportable remuneration.

Insurance premiums aside, a principal should ensure that all contractors are performing work in a safe manner and that they follow Occupational Health & Safety policies and procedures.

PAYROLL TAX

Where a contractor is a common law employee, the principal is required to pay Payroll Tax on the remuneration paid to that contractor.  Additionally, the Payroll Tax legislation seeks to include services provided under a “relevant contract” (see definition above).

In practical terms, a relevant contract exists where the contractor provides some labour services under the contract.

However, there are six exemptions that apply to relevant contracts to exclude them from Payroll 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 principals 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 principals 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.  We can supply details if required.

The above discussion is based on the Victorian Payroll Tax legislation.  There may be some differences in the way contractors are treated under the Payroll Tax legislation of other states.

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.

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.

TAX ISSUES FOR CONTRACTORS

Contractors themselves should be mindful of the Personal Services Income (PSI) regime as this may limit the deductions they can claim and prevent them splitting income with family members, etc.

Even, if a contractor can “pass” the PSI tests they must then contend with the general anti-avoidance provisions contained Part IVA of the Income Tax Assessment Act.  Essentially, arrangements to divert a contractor’s personal exertion income can be set aside.

The result of the PSI regime and Part IVA is that a contractor will often be on a similar footing to an employee for taxation purposes.

We recommend that contractors seek tax advice specific to their circumstances to ensure that they are complying with their requirements and are not at risk of an audit.  Additionally, to assess any opportunities that may exist to maximise their tax position.

We hope this newsletter provides some useful background to the issues associated with engaging contractors.  As always, please feel free to contact us if you have any questions or require clarification.