The issue of whether a worker is properly classified as an employee or an independent contractor has taxation, legal and potential insolvency implications.
The ATO’s 2012 compliance program has a section aimed at “promoting a level playing field for Australian Business”, specifically targeting businesses that use sham contracting from gaining an unfair competitive advantage over businesses that put people (employees) on the payroll.
There are also State based payroll tax obligations to consider, plus the sham contracting provisions in the Fair Work Act 2009 and the various State/Territory workers compensation authorities.
The problem for businesses is that there are no clear cut definitions to distinguish employees and independent contractors. Instead, there are a number of different indicators that have been identified by the Courts which need assessment according to the individual circumstances of each case. What is clear, is that the intention of the parties is not the only thing taken into account, and the Courts (and government agencies) will look behind any intentions, whether documented or not, to look at the relevant circumstances of the arrangement. This creates uncertainty for businesses that potentially face insolvency if they get it wrong.
This article summarises the main issues and consequences of getting it wrong.
Perceived advantages of hiring a genuine contractor
- avoid unfair dismissal claims;
- avoid employment on-costs, including PAYG and superannuation guarantee contribution (SGC);
- avoid other employer obligations and employee rights under the Fair Work Act (FWA) and other legislation, including paid leave entitlements, Award conditions, overtime and the like;
- avoid workers’ compensation claims and increases to premiums; and
- avoid payroll tax.
Main indicators of employment
- the employer has substantial control over the worker, including the right to suspend or dismiss the worker;
- the substance of the work contract is not to achieve a specified result and the work is ongoing;
- the worker is required to provide the services personally and cannot delegate/sub contract to third parties;
- the worker/service provider is an individual and not a company;
- the worker wholly or mostly does work only for the employer (as opposed to providing services to a number of businesses);
- the worker does not conduct his/her own business;
- the worker’s hours are set by the employer;
- the employer provides the equipment/tools;
- the employer pays for the employees work-related expenses;
- the worker bears little or no risk of the costs arising out of injury or defects in carrying out the work;
- the employer is responsible for insurances including workers compensation and professional indemnity;
- the employer is responsible for paid leave/benefits; and
- the employee is paid based on the amount of time worked (as opposed to being paid to achieve a specified result – eg: a lump sum contract).
How things can go wrong
1. FWA and employee rights
- Labelling a worker a “contractor” and paying on receipt of a tax invoice, does not prevent a worker from making an unfair dismissal claim or suing for other employee entitlements/benefits, particularly if the relationship is terminated and the worker’s engagement is terminated;
- Starting an unfair dismissal claim is cheap and quick, although the threshold issue of determining whether the worker is a contractor or employee needs to be determined at an early stage;
- Likewise, workers can also start unlawful termination claims under the FWA (for example for discrimination) relatively quickly and cheaply and the onus is then on the business to disprove the allegation;
- Workers can claim for unpaid benefits/entitlements – a 2011 Federal Court case decided that five insurance agents engaged as independent contractors who were paid on a commission basis, had limited rights to employ others and who were not prevented from performing work for third parties, were found to be in fact employees entitled to accrued annual leave and long service leave. Key findings were that the insurer gave the agents sales leads and training and encouraged them to behave as part of the insurer’s business and that the agents were not conducting their own business but were clearly part of the insurer’s business. The contracts included indemnities by the agents in favour of the insurer which covered the cost of paid leave. The indemnities were held unenforceable as against public policy;
- Orders under the FWA for back pay and leave entitlements as employees, may impact on other legal liabilities, such as payroll tax, SGC and workers comp, which likewise need to be adjusted/paid as a result;
- The FWA prohibits sham contracting arrangements, which cover dismissing/threatening to dismiss an employee in order to re-engage them as a contractor and making false statements to an employee to persuade him/her to become a contractor. Penalties include fines of up to $51,000 for a company and $10,200 for individuals involved in the breach. There have been a number of successful prosecutions by the FWO including one against the sole director of a company employer and its human resources manager; and
- Even if the relationship is properly an independent contracting arrangement, contractors can still take advantage of the Independent Contractors Act. This permits the courts to review contracts on the grounds the contract is unfair or harsh and to make orders to fix any established unfairness. That includes compensation.
2. PAYG withholding
- Employers must withhold tax from salaries, wages, commissions, allowances and bonuses paid to employees, and remit that to the ATO. See Tax Ruling 2005/16;
- Failure to withhold and remit can result in the ATO charging a minimum penalty of 100% of the shortfall;
- If PAYG is unreported and unpaid for more than three months, then under the 2012 changes to the tax laws, the ATO can issue a Director’s Penalty Notice (DPN) and hold directors of a company employer personally liable. It is no longer a “defence” to place the company into liquidation or administration. The ATO has already started cracking down on directors, including a case where a company started being wound up before the DPN was issued. Failure to account for this potential personal liability can completely negate any restructuring of a business, even where a business is sold at valuation price or where a Deed of Company Arrangement (DOCA) has been proposed and approved by creditors; and
- The ATO can conduct audits of the past five financial years.
3. Super guarantee (SGC)
- Employers are required to make compulsory super contributions based on an employee’s ordinary time earnings. Ordinary time earnings is a wide definition and picks up salary, wages, bonuses, commissions, leave pay and the like;
- SGC is payable at least quarterly, by 28 days after the end of each quarter;
- Like PAYG, if SGC is unreported and unpaid for more than 3 months, then the ATO can also issue a DPN and hold directors of a company employer personally liable;
- In addition, under the Super laws, SGC is also payable to persons who are generally found to be independent contractors, if certain conditions are met, including if the person works under a contract that is wholly or principally for his/her labour; certain artists, musicians and sports persons and persons who are paid to do work which is wholly or principally of a domestic or private nature for more than 30 hours/week. See Super Ruling SGR 2005/1;
- Note however that SGC is not payable where the contractor is a company and has its own ABN; and
- Failure to pay SGC results in late payments not being tax-deductible and imposition of a superannuation guarantee charge which includes an admin fee and interest. Late lodgement of your super guarantee charge statement can make you liable for penalties up to 200% of the amount of the charge payable.
4. Workers compensation
- Workers compensation laws vary from State to State. They are all however aimed at covering an employer’s liability arising out of injuries to workers in the course of employment;
- Like SGC, the workers compensation regimes have extended concepts of what constitutes a “worker” and captures some contractors, in certain situations, for example where the work is under a contract or at peace work rates, for labour;
- Failure to include a relevant worker under your workers compensation policy can result in significant penalties, which may include the amount of damages paid out to an injured worker; and
- Workers compensation authorities also have significant investigation and auditing powers.
5. Payroll tax
- Payroll tax is a State/Territory based tax imposed on employers in respect of “wages”.
- In NSW, if your total wages, calculated over a business and any associated entities (the legislation is very wide in terms of what other entities are captured in a “payroll group”), is above the annual payroll tax threshold (currently $750,000.00 in NSW), then payroll tax is charged at 5.45% of the amount above the threshold.
- Like SGC and workers compensation, the payroll tax regimes have extended concepts of what constitutes an “employee” and in some situations captures some workers who are properly classified as independent contractors: and
- Payroll tax is paid on a self- assessment basis and there are significant penalties for non-disclosure. The penalties are reduced if voluntary disclosure is made.
Tips to minimise risk/liability
- If you are thinking about engaging workers on an independent contractor basis, get professional advice before you do so, in particular in preparing your contractor agreements;
- Keep a clear paper chain of evidence/records in relation to the considerations taken into account in looking at the relevant indicators;
- If you are going to engage a worker as an independent contractor, then make sure you engage them through a company, ensure that the company has a valid ABN, and that the company has appropriate workers compensation, public liability and professional indemnity insurances;
- Include a “set off” clause in the contract so that any amounts paid over and above minimum Award entitlements (if the worker had been an employee), are set off as against any subsequent claim or loss suffered in connection with claims that the relationship is that of employer/employee (although such a clause may be struck down for public policy reasons, similar to the indemnity above);
- Get professional help to conduct a risk analysis of your business if you already engage contractors; and
- Remember, that if you have a problem in one area, it will likely cause a problem in each of the other areas. Shortfalls in PAYG, SGC and workers compensation premiums can bring significant financial penalties. You may also become exposed to significant historical financial exposure, through backdated penalties which could put substantial financial pressure on your business.
