Who is classified as an ‘employee’ and why does it matter?

Contracting is becoming more popular as an alternative to the traditional employment relationship. As contracting and employee mobility become more sought-after, the difference between what constitutes an employee and a contractor becomes less clear. However, there are dangers in engaging a worker as a “contractor” without having a proper understanding of the various employer obligations.

You may find that a worker should be characterised as an employee at common law, and this brings with it a range of obligations and liabilities if you get it wrong.

Where a worker is deemed an “employee” the employer is required to:

  • Withhold and remit PAYG withholding from the employee’s wages.
  • Pay superannuation guarantee on behalf of the employee.
  • Report and pay fringe benefits tax (FBT) if fringe benefits are provided.

Where a worker is deemed a “contractor”:

  • The contractor will generally look after their own tax obligations.
  • The principal may still have to pay superannuation for individual contractors if the contract is principally for their labour.
  • There are no FBT obligations.

PAYG withholding

There is no definition of an “employee” in any tax legislation. The relevant test for determining whether an individual is an employee for PAYG withholding is the common law test.

Courts have traditionally assessed the relationship against a range of indicia (known as the ‘multi-factor’ test), all of which, when combined, determine whether a relationship is one of independent contract or employment.

The table below outlines the indicia that the courts have considered.

The-multi-factor-test-indicia

The outcome of this test is subjective in nature and is not determined mathematically by reference to the total number of factors pointing to the existence of one type of relationship versus the other. It is equally important to note that no one factor will be conclusive. In addition, the position for an individual is not affected by whether or not the individual has supplied an ABN.

Generally, PAYG does not need to be remitted where payments are made to a contracting entity that is a partnership, trust or company, provided that entity quotes an ABN and the arrangement is not a sham or a mere re-direction of an employee’s wages. The question as to whether an individual engaged through a contracting entity can be characterised as an employee was determined in the Full Federal Court in Ace Insurance Limited v Trifunovski [2013] FCAFC 3.

The Full Court upheld the decision that the sales agents were in fact employees of Ace Insurance Limited, despite providing services to Ace Insurance Limited through companies incorporated by each of them. The judges considered the indicia relevant in determining whether a person is an independent contractor or employee.

Even when an individual is deemed a contractor under common law, we suggest that the employer also consider whether the individual may be deemed an “employee” for superannuation guarantee and payroll tax purposes under the extended definition. These provisions are discussed in more detail below.

Superannuation Guarantee

The Superannuation Guarantee (Administration) Act 1992 (Cth) (SG Act) requires an employer to make superannuation contributions for the benefit of employees at common law and for persons who are captured by the extended definition of “employee,” where that person works under a contract that is wholly or principally for the labour of the person.

The ATO considers that an individual works under a contract that is ‘wholly or principally for the labour of the person’ where:

  • The individual is remunerated (either wholly or principally) for their personal labour and skills.
  • The individual must perform the contractual work personally (there is no right of delegation).
  • The individual is not paid to achieve a result.

The extended definition of “employee” means that, if you engage an individual as a contractor, you may need to pay superannuation contributions on their behalf, even if the written contract does not provide for this and the contractor provides an ABN.

Payroll Tax

In most States and Territories, there are specific contractor provisions which (subject to certain exemptions and concessions) deem payments to contractors to be ‘taxable wages’ for payroll tax purposes. The contractor provisions capture all payments to contractors as part of an employer’s taxable wages regardless of whether the contractor is an individual, or is engaged through a company or trust structure. Western Australia is the only State where there is no requirement to include payments to contractors. Payments to sole traders who are contractors will only be caught in Western Australia where the persons to whom the payments are made are, ‘in substance’, employees.

We recommend that available concessions and exemptions should be reviewed in each jurisdiction in which contractors perform services. The onus is on the employer to substantiate the exemption.

What if an employer gets it wrong?

If an employer incorrectly classifies a worker, the employer may be liable for:

  • Superannuation guarantee charges, where an employer fails to make superannuation contributions for the benefit of the individual either because they are an employee at common law or because they are an “employee” under the extended definition in the SG Act.
  • Additional payroll tax (including penalties and interest) where an employer has incorrectly claimed contractor exemptions on payments made to contractors for which there are no exemptions available.
  • Unpaid annual and long service leave, where you have incorrectly classified an individual as a contractor.

If you would like further clarification about these terms, or believe this information could be relevant to your employment situation, contact your financial adviser. If you are an employer, our Employment Tax experts can help you to keep your employment tax obligations under control. With severe penalties for non-compliance, we can provide solutions to help you fully comply with your employment taxes obligations.

Christopher Heyes – Associate Partner, Tax Advisory