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Do you know the difference between a contractor and an employee?

In December 2022 the ATO issued an updated draft ruling (TR 2022/D3, providing guidance on who is an employee for the purposes of PAYG Withholding) in response to two recent High Court decisions. The High Court cases once again raised the complex issues involved in determining whether a “contractor” is a genuine independent contractor, or is actually an employee of the business that engages their services.


The High Court stresses that using the “label” of “contractor” does not make the worker an independent contractor – the Court, and the ATO, will examine the “totality of the relationship between the parties”.


The ATO indicates that the key distinction between an employee and an independent contractor is that:

  • An employee serves in the business of an employer, performing their work as a representative 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 a representative of another

Whether a worker is an independent contractor or an employee has tax & superannuation implications for both the worker & for the business that engages their services.


Employee

The “engaging entity” must:

  • report via Single Touch Payroll (STP)

  • withhold and pay PAYG withholding

  • make superannuation guarantee (SG) contributions

  • meet Fringe Benefits Tax obligations (if applicable)

The “worker” is not entitled to an ABN in relation to that employment, and is not entitled to register for GST.


Independent contractor

The “engaging entity” must:

  • report via Taxable Payments Annual Reporting (TPAR), if their industry is covered by TPAR

  • if the engaging entity and the worker are both registered for GST, claim eligible Input Tax Credits

  • if the worker does not provide a valid ABN, or there is a voluntary withholding agreement in place, withhold amounts from payments to the worker under the PAYG Withholding regime

  • make superannuation guarantee (SG) contributions, if the worker satisfies the “extended definition of an employee” for SG purposes. This applies to workers whose contract is “wholly or principally for their labour”. Note: Even if the worker is a genuine contractor you may still have SG obligations if the payments made to the contractor are “principally for their labour”.

The ATO’s advice on this is that you:

  • “Make super contributions for contractors if you pay them:

  • under a verbal or written contract that is mainly for their labour (more than half the dollar value of the contract is for their labour)

  • for their personal labour and skills (payment isn't dependent on achieving a specified result)

  • to perform the contract work (work cannot be delegated to someone else).”

If the worker is a genuine “independent contractor”, they:

  • should make provision for income tax, through PAYG instalments, if required

  • are entitled to apply for an ABN

  • should register for GST if required (currently, GST registration is required for a turnover of more than $75,000 per year but some workers must register for GST regardless of turnover e.g. taxi and Uber drivers)

  • consider the personal service income (PSI) implications


Unfortunately there are no hard and fast rules to follow, or a simple checklist to tick off, when determining whether a worker is an employee or an independent contractor. The ATO DOES provide guidance on the factors to consider. See ATO website for further information; Difference between Employees and contractors.



It is recommended that a written contract is entered into when engaging the services of a contractor. Note that you CANNOT contract out of superannuation (SG) obligations if the worker is classified as an employee at common law or under the extended definition.


While a written contract does not necessarily guarantee that the ATO and the Courts will agree with the business, as to whether the worker is a contractor or an employee, the absence of a written agreement makes it very difficult to justify the position that has been taken should the arrangement be reviewed at a later time.


It is important to have evidence that both parties have agreed for the worker to be classified in a particular way, and that both parties understand the tax and superannuation consequences of that classification. This is more likely to place the arrangement in the “very low risk zone” in terms of ATO compliance activities.


SG Liabilities – how far back can the ATO go?


There is no real time limit on the recovery of outstanding SG obligations. In theory, the ATO can go back as far as it wants to recover unpaid superannuation contributions for workers who are classified as employees for SG purposes.


Practically, you could look at a limit of 5 years given business are only required to keep their employment records for 5 years. However, if the worker can provide evidence to support claims for earlier periods (e.g. payment summaries and super fund statements) the ATO may be able to pursue claims for these earlier periods.


For more information visit the ATO website or contact your Client Manager.





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