01/01/2013

Whether your business engages employees or contractors it is incumbent on you as a business owner to classify the relationship correctly to avoid additional payments to the employee or contractor and the PAYG tax, penalties and interest being imposed by the ATO.

In the ATO Compliance Program 2012-2013, the ATO states as follows:

“In 2011-12 we conducted approximately 1,100 audits on businesses where we suspected that the business may have incorrectly treated employees as contractors. From our audits we have collected details of approximately 51,000 payments made to around 41,000 contractors, about 18,000 of which were individuals. We found that 48% of businesses that engaged contractors were wrongly treating individuals as contractors. These workers were legally employees but were missing out on employee entitlements such as superannuation.” [underlining added]

As the ATO is focussing on this issue we suggest it is important all business owners review their current arrangements and consider the issue in any new engagements of personnel.

In addition, the Fair Work Ombudsman also has the powers to investigate these arrangements and can take action where it is determined that the arrangement is a “sham contract”.  That is where an employer is calling its employees - contractors to avoid paying superannuation, tax and workers compensation premiums.

The distinction between who is an employee and who is a contractor is a difficult one and is not determined by one single feature (such as supplying an ABN).

The relationship is determined by looking at the particular facts and weighing up all the features to conclude whether the person is an employee or contractor.

The ATO and Fair Work Ombudsman both provide assistance in the form of lists of features of both arrangements.  In summary, the main features to consider include:

• Control over work – employer will exercise control over the employee’s work whereas a contractor can exercise their own discretion to achieve the agreed task.

• Independence – the employee performs the role designated by the employer whereas the contractor performs the services in their own way and has the right to refuse work.

• Payment – employees are paid a salary, wage or piece rate and entitlements including leave and workers compensation whereas a contractor is paid when the service or stage of the service is complete and provides an ABN, arranges their own workers compensation and may need to have insurance to cover the work.

• Tax – employees will have tax taken out of the pay by the employer whereas a contractor usually pays tax through the PAYG system and issues tax invoices for the work done.

• Risk – the employee bears no financial risk whereas a contractor bears the legal and commercial risk for the work performed under the contract (subject to the terms of the contract).

• Ability to delegate the work – an employee cannot subcontract their work or engage a third party to complete a task whereas a contractor has the ability to engage others to complete tasks (subject to the terms of the contract).

• Tools of trade – the employee generally uses tools provided by the employer whereas a contractor will use their own tools to complete the tasks.

The features including those outlined above have been applied by Fair Work Australia in a number of decisions including the following statement:

“a consideration of the indicia is not a mechanical exercise of running through items on a check list to see whether they are present in, or absent from, a given situation. The object of the exercise is to paint a picture of the relationship from the accumulation of detail. The overall effect can only be appreciated by standing back from the detailed picture which has been painted, by viewing it from a distance and by making an informed, considered, qualitative appreciation of the whole. It is a matter of the overall effect of the detail, which is not necessarily the same as the sum total of the individual details. Not all details are of equal weight or importance in any given situation. The details may also vary in importance from one situation to another.”

As the consequences of getting the arrangement wrong can be dramatic, we suggest all businesses examine their current engagement practices and ensure the personnel arrangements are properly characterised.

If you need assistance or have any questions in relation to this article, please contactTOWNSENDS BUSINESS & CORPORATE LAWYERS on (02) 8296 6222.