The below information covers legal and technical issues in a general way. It is not designed to express opinions on specific cases. It is intended for information purposes only and should not be regarded as legal advice. Further advice should be obtained before taking action on any issue dealt with in these questions.
Legal tests and employment label assessments
Determining if someone is a contractor
In summary, courts apply a multi-factor test to assess whether someone is an independent contractor, and some of the elements that courts take into account are:
- the degree of control exercised by the principal or employer
- whether the employee or contractor has the right to delegate
- how the employee or contractor is paid, for example, whether the employee or contractor is paid on an hourly basis or is paid to achieve a result
- whether the employee or contractor genuinely conducts their own enterprise as opposed to working in the business of the employer or principal.
Control is still considered one of the most important indicators in determining whether someone is an employee or contractor. If an individual is subject to direction about when, where and how they perform work, this is usually indicative of an employment relationship. If an individual can decide how they perform the work, as long as they deliver the “product” or “service” the subject of the contract, and when and where they do so, it is indicative of a contractor relationship. However, it is true that, in practice, principals often exercise a degree of control over their contractors. The courts have acknowledged that the existence of some control by the principal is not fatal, the fact that principals may exercise control does not automatically mean that the individual is not a genuine independent contractor.
Taxation Ruling TR 2005/16 (Income tax: Pay As You Go – withholding from payments to employees) refers to the case of Humberstone v Northern Timber Mills (1949) 79 CLR 389, where it was said “the question is not whether in practice work was in fact done subject to a direction and control exercised by an actual supervision or whether an actual supervision was possible, but whether ultimate authority over the man in the performance of his work resided in the employer so that he was subject to the latter’s orders and directions”. The important thing is whether the employer had the right to exercise control, as opposed to the actual exercise of it. Ultimately, although the control test is important, it is still only one of a number of factors that must be considered before a determination is made about the nature of the relationship.
Difference between accountants employed casually and a sub-contractor
You would need to apply the multi-factor test to the sub-contractor accountant to determine whether they are genuinely a contractor. For example, if they work as an individual and not through a company, if they work exclusively for your practice, and if they cannot advertise their services to the world at large or take on work for other clients, these are factors that might lead to a determination that it is an employment relationship.
Some factors that might indicate a genuine contractor relationship include:
- the person works for clients other than your practice or conducts their own business and you are only one of their clients
- the person uses their own tools to complete the work for example their own computer and administrative support.
Assessing for independence
When some tests for independence say yes and others say no, courts look at the “totality of the relationship” between the parties. In practice, this means that you look at each of the relevant factors and decide, for each, whether the indicators point to a contractor or employment relationship. It is not unusual for you to end up with a mixed result – some factors point to a contractor relationship and others to an employment relationship. Courts have said that “the object of the exercise is to paint a picture from the accumulation of detail. The overall effect can only be appreciated by standing back from the detailed picture, 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 the details are of equal weight or importance in any given situation. The details may also vary in importance from one situation to another.” (Hall (Inspector of Taxes) v Lorimer  1 WLR 939).
It has been said that the ultimate question, after looking at all the evidence, is whether the individual is, in reality, in business on their own account as opposed to working in the employer’s or principal’s business.
If a taxpayer or their tax agent is unsure of whether payments are being made to a contractor or an employee, then a private binding ruling can be sought from the ATO on behalf of the taxpayer, that is, you can seek clarification from the ATO if the multi-factor test is not conclusive.
The 80/20 rule
The 80/20 rule relates to personal services income and how a contractor reports their income in their own tax return and determines if they can claim some business-like deductions. It is not a factor that must be considered when determining whether an individual is a contractor or an employee at general law. Further, the 80/20 rule has little relevance where specific legislative tests now apply, such as for payroll tax.
Determining whether someone is a contractor or an employee
It is the responsibility of the employer or principal to determine whether someone is a contractor or an employee. This is because the obligations for employment entitlements such as wages, leave, statutory rights are the employer’s obligations, and the obligation to ensure compliance with workers compensation and taxation legislation are the employer’s or principal’s obligations. If an employer or principal fails to make a correct assessment of the relationship, they will be liable for their own non-compliance with legislation. The best time to seek advice about a relationship is at the commencement of that relationship. However, if the employer or principal has not done that, and is concerned about non-compliance, notwithstanding that the relationship is on foot, they should immediately seek advice.
There are a number of reported cases each year where “contractors” are held by courts to be employees. Those are only the cases that proceed all the way to hearing and are the subject of a judgment. It is reasonable to assume that there are many more cases that are settled prior to proceedings being commenced or prior to hearing.
Protection for microbusinesses exposed to superannuation costs
Microbusinesses need to carefully evaluate the true relationship that exists with workers to determine if they are making payments to employees or contractors. Workers who regard their superannuation entitlements as not having been paid can lodge a complaint with the ATO. If the circumstances of the arrangement are unclear, for instance, because there is no written agreement, then the ATO will often regard the relationship as an employment relationship, which can result in the employer being exposed to penalties. Actual payments to the worker will be taken into account to determine RESC entitlements, irrespective of whether the higher rates of payment had been calculated with the intention the worker was a contractor. If there is any doubt whether a worker is a contractor or employee, then the prudent approach would be to regard the payments as being to an employee and include these payments in calculating RESC.
Genuine rectification requirements
OSR seem to dismiss this as an indicator, especially in the building industry. Genuine rectification requirements are a key indicator that a worker is a contractor and not an employee, as an employee is generally not exposed to the risk or cost of rectifying defective works. It may, however, be difficult to provide appropriate evidence to satisfy auditors that the arrangements are not a sham and legal advice should be sought at an early stage to assist in compiling appropriate evidence to satisfy audit queries.
Government compliance and contracting
Compliance and government regulation
There are instances where workers are engaged due to compliance requirements or government regulations. However, practically, this is only one factor evidencing the relationship between the parties and revenue authorities may disregard or not place significant weight on this factor.
Tax agent obligations
Tax agents should document their advice and recommendations if they think a person should be an employee rather than a contractor (or vice versa), and the payer is treating the person as an ABN subcontractor, given there is a real risk the client is exposing themselves to penalties should they come under audit. Where it is clear that the position taken by the client is incorrect and yet the client continues to instruct the tax agent to adopt such a position, then the tax agent must consider whether they can continue to act for the client in light of their duties under the Tax Agents’ Code of Professional Conduct.
In a situation where a client has a signed contract from an individual contractor stating that they want to be classed as a contractor and understand that they have negotiated a higher rate of pay than they would receive if they were an employee (in lieu of employment benefits such as superannuation) a written contract is strong evidence of what the parties intended the relationship to be. However, if the relationship has changed over time, for instance, implementation of set working hours, requirements to wear uniform, and the factors indicate the nature of the relationship has changed to that of an employer or employee, then the ATO may regard the relationship as having changed so that payments to the worker should be included in determining RESC obligations. Clients should monitor their relationships with workers on an ongoing basis to determine if the nature of those relationships changes over time.
Delegation and contracting
The ability to delegate is a key indicator of an independent contractor relationship. However, a distinction should be made between a right to delegate under the contract and whether the individual is actually able to delegate. Just because a contract gives an individual a right to delegate, the reality might be that the individual is told that they are expected to provide the services personally, or that the nature of the work makes delegation very difficult. In these circumstances, the fact that there is a power to delegate in the contract will not prevent a court from finding that the relationship is one of employment. If there is both a right to delegate in the contract, and there is a genuine expectation on the part of the parties to the contract that the contractor may delegate the work as they see fit, this is likely to be a contractor relationship.
From a superannuation perspective, according to Superannuation Guarantee Ruling SGR 2005/1 “where the terms of the contract in light of the subsequent conduct of the parties indicates that … the individual must perform the contractual work personally (there is no right of delegation.)” this will contribute towards a finding that the contract is wholly or principally for the labour of the individual, thereby entitling them to superannuation. In other words, if there is a genuine right to delegate both in terms of the contract and in light of the conduct of the parties, then the individual will be a contractor.
How someone is paid impacts on their status: Piece rates
Being paid by piece rate does not conclusively determine whether someone is an employee or contractor. Although being paid for a result (which might include piecework), is usually an indicator of a contractor relationship, some awards contemplate that employees can be engaged as pieceworkers, albeit with conditions, for example Horticulture Award 2010. Pieceworkers can also be employees, even if they are not covered by an award. The Fair Work Regulations 2009 (Cth) define a (non-award covered) pieceworker as an employee who is paid a rate set by reference to a quantifiable output or task and who is not paid a rate set by reference to a period of time worked. For example, a pieceworker could be a person paid by reference to the number of articles they produce, the number of kilometres travelled, the number of articles delivered, the number of articles sole or the number of tasks performed by them.
From a payroll tax perspective, there are now statutory tests in most Australian jurisdictions. You would need to look at the specific contractor provisions in each jurisdiction. If an apple picker, the relevant exemption available in at least some jurisdictions is that their services are required for less than 180 days or the services provided by the picker are for not more than 90 days.
Award systems by state or territory
For private sector employers in all Australian States other than Western Australia, there is only one award system – the Federal system. All awards can be found on the Fair Work Commission website. The starting point for identifying the correct award is to consider the industry in which an individual works, for example the meat industry. In Western Australia, private sector employers that are not constitutional corporations and partnerships remain subject to state laws and awards. Public sector employers and their employees are covered by State laws and awards in each State.
Hourly pay rates
Being paid an hourly rate can be an indicator of an employment relationship because it suggests that the individual is being paid for their own labour and skills, but of its own is not conclusive. It has been recognised that some genuine contractor relationships can be based on payment for time worked. If the contractor is an individual, and is paid for time worked, there is a greater risk that the relationship will be found to be one of employment.
From a superannuation perspective, SGR 2005/1 one of the factors that will contribute to a contract being considered “wholly or principally for the labour of the individual engaged” thereby entitling the individual to superannuation is that the “individual is not paid to achieve a result”. That is – if the contractor is an individual and is not paid on a results basis, but rather is paid by reference to a unit of time, then they will be an employee for superannuation purposes, assuming the other tests are also met and there is no right of delegation and remunerated for their personal labour and skills.
From a payroll tax perspective, the distinction between employee or contractor when a remunerated independent director who invoices a company is no longer relevant. Payments to directors would still be taxable in most jurisdictions. A company director can be an employee as well as an officer of the company. Whether an employment relationship exists will usually be obvious by reference to matters such as the duties performed by the individual, whether their service to the company is exclusive, whether they are entitled to leave. The situation may not be as obvious in the case of small private companies where the director is the only person engaged in company business. In this case, the multi-factor test would have to be applied.
If the individual issues invoices is a factor indicative of a contractor relationship, but not conclusive. Regardless of the position at common law, from a superannuation perspective, an individual will be deemed an employee if they are entitled to payment for the performance of duties as a member of the executive body for example, a board of a body corporate. This captures company directors.
PSI and independent contractor scenarios
The personal services income (PSI) rules are a specific statutory test for income tax purposes. Whether a relationship is a principal or contractor or employer or employee relationship is a separate issue and depends on the particular circumstances of each case.
Contracting through entities
If you have an employee who contracts through a company or trust, based on current case law, the risk of that contractor being found to be an employee is typically considered to be low. This is because the company is a distinct legal entity, and there can be no employment relationship between an employer and a Pty Ltd company.
Courts have acknowledged, however, that if the Pty Ltd company is merely a corporate vehicle which allows fees to be received by the company and the entity contracted to perform work is actually an individual, then because the Pty Ltd company is not the entity engaged to perform the work, the individual could be an employee (see for example ACE Insurance Ltd v Trifunovski  FCA 1204). That is if a contractor relationship is, for all practical purposes, a traditional employment relationship, other than that the individual works through a Pty Ltd company, there is a risk that the relationship could be found to be a sham, notwithstanding the existence of the Pty Ltd company.
To try to avoid such an inference being drawn, we recommend always ensuring that a written contractor agreement is in place, and that contractor agreement should include, among other things, a term specifically appointing the Pty Ltd company as the contractor who will be providing services and a term allowing delegation of work by that contractor. The more indicators of a contractor relationship that genuinely exist and are represented in the written contract, the more likely it will be that the principal will be able to argue successfully that the relationship is one of principal and independent contractor.
The Fair Work Act 2009 (Cth) contains prohibitions against sham contracting. For example, section 357 provides that a person (employer) who employs, or proposes to employ an individual must not represent to the individual that the contract of employment under which the individual is, or would be, employed by the employer is a contract for services (that is, a contractor agreement) under which the individual performs, or would perform, work as an independent contractor. It is uncertain whether this provision (and others like it) is capable of applying to a contract with a Pty Ltd company, as the provision refers to an individual and to a contract of employment with that individual.
From a superannuation perspective, note that there is a specific provision in Superannuation Guarantee Ruling SGR 2005/1 (paragraph 13) that provides that “where an individual performs work for another party through an entity such as a company or trust, there is no employer-employee relationship between the individual and the other party” for the purposes of the superannuation guarantee legislation. From a payroll tax perspective, in most jurisdictions with specific contractor provisions, all payments to companies would be taxable unless one of the specific exemptions apply.
Not all jurisdictions recognise the same exemptions for payroll tax purposes that potentially apply to payments to contractors. Accordingly, an analysis needs to be undertaken of which jurisdiction payments are potentially taxable in and then determine whether an exemption applies. Most jurisdictions recognise payments as exempt if the contractor engages labour to provide services under the contract, if services are required for less than 180 days by the payer, and if the worker provides services on less than 90 days. Revenue authorities in each jurisdiction generally publish useful summaries of the available exemptions, which should be reviewed on a case by case basis.
Determining a sham contracting arrangement
When considering whether an arrangement is a sham contracting arrangement, the court will consider whether an employer has attempted to disguise an employment relationship as an independent contracting relationship. There are specific provisions in the Fair Work Act 2009 (Cth) prohibiting certain “sham” behaviour. Generally speaking, a contracting agreement would be considered a sham if acts done or documents executed by the parties are intended by them to give third parties or the court the appearance of creating between the parties legal rights and obligations different from the actual legal rights and obligations which the parties intended to create.
Superannuation guarantee obligations
Generally, under the ATO’s current administrative position, if someone uses a company to provide a service, this precludes the payer from having a superannuation guarantee obligation. In paragraph 13 of Superannuation Guarantee Ruling SGR 2005/1 the ATO accepts that in such a situation there is no employee or employer relationship between the payer and the individual providing the services under either the common law conception of an employment arrangement or the extended definition of an employee for superannuation guarantee purposes. It would be expected that the company would then have the superannuation guarantee obligations in relation to the individual who actually provides the services. See our further comments below under Superannuation in respect of the Hall plumbing contractors case. SGR 2005/1 has an effective date from 23 February 2005. If you have any issues with superannuation before this date, it will be necessary to look to other guidance from the ATO discussed below.
Paying superannuation to a contractor
If after applying the multi-factor test you are able to determine that the contractor is actually an employee at common law, they are entitled to superannuation contributions. If you cannot conclusively determine the nature of the relationship at common law, or you think they may be a contractor, you need to consider the extended definition of “employee” under the Superannuation Guarantee (Administration) Act 1992 (Cth). In particular, the Act provides that a person who works under a contract that is wholly or principally for the labour of the person is deemed to be an employee for superannuation guarantee purposes. An individual works under a contract that is wholly or principally for their labour if the individual is remunerated (wholly or principally) for their personal labour and skills, they must perform the work personally (may not delegate it) and where they are not paid to achieve a result, that is, they are paid on some other basis, such as per hour of their time without regard to the quality of their work. See Superannuation Guarantee Ruling SGR 2005/1 for further explanation and examples.
The ATO takes the view that “principally” takes its ordinary meaning – that is “chiefly” or “mainly”. The term is intended to restrict the types of contracts caught by the extended definition of an employee for superannuation guarantee purposes. To the extent that a contract is partly for labour and partly for something else, for example, the supply of goods, materials or hire of plant or machinery, it will only fall under the extended definition if it is principally for labour.
Voluntarily paying superannuation
You can voluntarily pay superannuation to a contractor as part of an agreement however, you still need to determine whether the contractor is an employee or an employee under the extended definition of an employee for superannuation guarantee purposes. This is because GST will apply to payments made to a contractor for their services including voluntary superannuation contributions that form part of those payments. However, GST does not apply to superannuation guarantee support provided to employees or a person who falls under extended definition of an employee for superannuation guarantee purposes see ATO ID 2002/22.
Contractors’ positions and the Hall plumbing contractors case
In light of the Hall plumbing contractors case (Case 3-2014), it appears that it is no longer appropriate to disregard superannuation for contractors solely on the basis that they may use a company or trust structure.
This case suggests that merely adopting a strategy of contracting through entities will not be enough to avoid superannuation guarantee obligations. This is despite the ATO’s current administrative position in SGR 2005/1 that no superannuation guarantee obligations should fall on the payer in this situation, since those obligations would fall on the contractor company or trust.
The plumbing contractors in this case were for all intents and purposes employees when one looked at the totality of their relationship with the plumbing business. This was because, amongst other things, the contractors all had the same contractual arrangements, which is unusual as you would expect there to be contractual differences if the contractors were truly carrying on their own businesses, their right to delegate was illusory because it was never exercised, the contractors rarely exercised their right to refuse work, the contractors were not required to correct defective work at their own costs and the contractors generally had similar hours as employees and represented themselves as employees. In such a situation one can understand the Administrative Appeals Tribunal’s (AAT) decision that they were common law employees. The entity structure factor was outweighed by these other factors.
The Hall plumbing contractors case is not a binding legal precedent because it is a decision of the AAT. Whilst the AAT considered that the contractors were also employees under the extended employee definition for superannuation guarantee purposes, there was little detailed analysis on this point and in particular how the AAT’s position married up with view that the contractors’ family trusts should have had the burden of paying superannuation guarantee for the workers. For these reasons we do not consider that the case definitively means that a payer has superannuation guarantee even where they contract through an entity structure. Rather the case indicates that where the situation is that the workers are truly employees, then trying to dress up the situation as an independent contractor relationship by adding a few features is unlikely to be successful. For proper structuring of an arrangement you should seek appropriate expert advice.
Non-resident obligations: At home and overseas
Generally there are no superannuation obligations for someone who is a non-resident and who performs work for you overseas. There is an exception where the employee is temporarily seconded by an Australian employer to a country that has a bilateral superannuation agreement with Australia and the employee is covered by a certificate of coverage that provides that the Australian employer is not required to provide social security support in that foreign country, provided that the Australian employer continues to provide superannuation guarantee support in Australia.
Salary sacrifice arrangements between employers and contractors
Where the contractor is not a common law employee nor deemed to be an employee under the extended definition of employee for superannuation guarantee purposes, then the salary sacrifice amount should be included in the invoice given to the employer. This is because the superannuation contribution forms part of the consideration paid to the contractor for their services for GST purposes. That is, the contractor is not an employee and the payments they receive are payments for services for services and not salary.
Where the contractor is a common law employee or deemed to be an employee under the extended definition of employee for superannuation guarantee purposes, then the salary sacrifice amount should not be included in the invoice given to the employer. This is because the ATO does not consider superannuation guarantee support to form part of the consideration for the contractor’s services in this situation: ATO ID 2002/22.
For the salary sacrifice arrangement to be effective for income tax purposes the parties must have a prospective salary sacrifice agreement in place and the contractor would need to be regarded as an employee for superannuation guarantee charge (SGC) purposes. Provided these conditions are satisfied, then the employer would need to report these amounts as part of their SGC reporting to the ATO. It would be up to the parties to determine appropriate arrangements to document the amount paid on behalf of the worker.
Services to the general public
For SGC purposes, it does matter if the employee or contractor also provides services to the general public. Providing services beyond those provided to a principal or employer may indicate that the individual is operating on their own account and therefore a contractor. This would need to be considered in the context of whether these additional services were being advertised for, whether they were in a distinct trade or calling from the principal or employer and whether the remuneration being derived was anything more than incidental to their engagement by the principal or employer.
Superannuation and directors
Directors who receive salary, wages or director's fees are entitled to receive superannuation contributions from the company, which is regarded as their employer for superannuation guarantee purposes.
An individual contractor who makes and deducts their own superannuation that is not paid by the company contracting them, and the ATO decides that the superannuation should have been paid by the company, then the individual contractor is likely to lose the tax deductions because they cannot meet the requirements for a tax deduction as a substantially self-employed person. Broadly, amongst other things, the individual contractor can only claim a substantially self-employed tax deduction for self-made superannuation contributions where less than 10 per cent of their assessable income, fringe benefits and RESC come from employment activities. Where the individual contractor cannot deduct their superannuation contributions because they fail this 10 per cent test, then the contributions become classed as non-concessional contributions for superannuation purposes. This is as opposed to concessional contributions if the deduction could be claimed. This re-characterisation of the contributions may cause the individual contractor to breach their non-concessional contributions limit if they have made other contributions to superannuation out of after tax income. Where this limit is breached the individual contractor may be liable to pay non-concessional contributions tax at the rate of 49 per cent.
Bankruptcy and your entitlements
If a company goes bankrupt and doesn't pay its superannuation obligations, the prospect of claiming outstanding superannuation is not likely. Only contractors that are truly independent contractors, not common law employees or deemed employees under the extended definition for superannuation guarantee purposes, who have such superannuation entitlements in their contractual arrangements can lodge a proof of debt against the liquidating company. However, in such a situation they would rank alongside other secured creditors for payment of this debt.
Superannuation guarantee entitlements of contractors who are employees or deemed employees is treated differently. Superannuation guarantee amounts rank equally with employee entitlements such as unpaid wages and annual leave, and generally are to be paid to employees after priority creditors’ and liquidators’ fees are paid and before payments to ordinary unsecured creditors. Only the ATO has standing to prove a superannuation guarantee entitlement debt, and so contractors in this situation would need to contact the ATO. The ATO has the capacity to issue director penalty notices to directors of companies with unpaid PAYG and superannuation obligations. The effect of these notices is to make the directors personally liable for the unpaid obligations, so that workers may not necessarily lose their superannuation entitlements.
Issues prior to SG Ruling 2005/1
The issues dealt with in SG Ruling 2005/1 were previously addressed in Superannuation Guarantee Ruling SGR 93/1 which was withdrawn on 25 August 2004.
Generally it would be expected that a contractor provides the tools, plant and equipment necessary to perform their work. If they are provided by the party engaging the worker, this is indicative of an employment relationship. Provision of equipment and tools of trade is still only one factor to be taken into account. Also, the significance of the equipment or tools provided must be considered in the context of the contract. If the equipment is substantial and valuable, for example items of plant, such that it would not be reasonable to expect that an individual contractor would have the means to provide this equipment themselves, the fact that the principal provides the equipment is likely to be of less significance and therefore will not prevent a finding that there is a contractor relationship. However, if equipment is less valuable and more common such as a work vehicle or carpenters tools, such that it would not be unreasonable to expect an individual contract to have the means to provide those items for his or her own business, the provision of these items of equipment by a principal is more likely to be considered a factor counting towards an employment relationship.
The above information has been developed in consultation with McCullough Robertson Lawyers, which partners with CPA Australia in the provision of workplace guidance for members.