Employee v contractors (a new approach to ATO reviews)
Employee v Contractors – what’s the difference and what do you need to do to mitigate risk?
The legislation governing the definition of employees and the obligations of employers hasn’t changed. But in recent years the compliance focus by the ATO on potential misclassification of workers as contractors v employees has increased resulting in confusion for business owners who haven’t changed how they operate but who have found themselves subject to ‘employer obligation audits’ and potentially liable for superannuation and withholding tax penalties in relation to workers they had understood were bona fide contractors.
In 2022 we saw two landmark High Court decisions which have significantly impacted ATO advice and guidance in relation to classifying workers. Previously the classification was very much a ‘substance over form’ approach reviewing a number of factors and essentially defined workers as employees if their services were for their labour which they could not delegate, regardless of if they also provided services to other businesses nor if a contract was in place stating they were a contractor and not an employee.
The decisions in the recent court cases placed more credence on the nature of the contract (whether written, oral or hybrid) between the business owner and the worker than has been previously. Where both parties have agreed and understood the ramifications of the arrangement being of contract/contractor relationship rather than employer/employee then the risk of misclassification is significantly less than it has been.
As of 15 December 2022, we now have some clarification from the ATO in the form of a ‘Draft Practical Compliance Guideline’ (PCG 2022/D5) for businesses engaging contract workers. Typically a Draft ruling is finalised within 6 -12 months with limited amendment.
Employees work in and are part of your business. Contractors are running their own business.
When a business engages a worker, the arrangement will generally be one of:
- employment, where the worker is an employee and the engaging business is their employer, or
- independent contracting, where the worker performs the work in the course of carrying on their own business.
A business’ tax and superannuation obligations, and a worker’s tax obligations and entitlement to an ABN, can vary greatly depending on how the worker is classified.
Correctly determining whether a worker is an employee or independent contractor is important to ensure that both the business and the worker get their tax, superannuation, ABN registration and reporting obligations right.
Key Differences between obligations for business owners engagement of employees v contractors:
|Withhold amounts under the pay as you go (PAYG) withholding regime||A valid ABN is required prior to payment for services (unless 47% ABN withholding tax is withheld and remitted to the ATO)|
|Meet fringe benefits tax (FBT) obligations for benefits provided||Valid Tax Invoices are required for services|
|Single Touch Reporting of payroll information to the ATO||Taxable Payment Annual Reporting (TPAR) is required to report payment to all contractors each year|
|Make superannuation contributions or be liable for the superannuation guarantee charge||If the worker satisfies the extended definition of employee, make superannuation contributions or be liable for the superannuation guarantee charge*|
|Not entitled to claim input tax credits (GST) on wages paid||If the engaging entity and worker are both registered for GST, claim eligible input tax credits|
*In certain circumstances bona fide contractors may be deemed to be employees under the extended definition of an employee and requires ‘employer’ superannuation to be paid on behalf of these workers. These circumstances include workers working under a contract that is solely, or principally for their labour. And here is where the issue has led to misclassification of workers from a superannuation perspective and has resulted in compliance issues for businesses to date.
Finally, however, we have some clarity and relief for business operators in the new draft tax ruling (PCG 2022/D5) clarified how ATO will approach compliance reviews regarding potential worker misclassification. The ruling sets out a risk framework which categorises arrangements as follows for unpaid superannuation queries:
|Risk zone||ATO Approach|
|Very low||No further compliance resources will be applied|
|Low||Compliance resources will be applied to test whether worker meets the extended definition in the employer superannuation legislation|
|Medium||Compliance resources will be applied to test the correct worker classification for the arrangement but will be given lower priority than arrangements that are rated high risk.|
|High||Compliance resources will be applied to test the correct worker classification for the arrangement and will be given the highest priority resourcing.
Businesses may be subject to higher penalties if it is found they failed to correctly classify their workers.
Ultimately, if you engage contractors for labour then you should be ensuring your arrangements would have a ‘very low’ risk profile should any review be undertaken with regard to the classification of the contractor arrangement. This would mean you have taken all reasonable steps to correctly classify the worker and it is then very unlikely your business would be held liable for any unpaid superannuation. This is a new approach and a welcome one for businesses in the accommodation industry.
I strongly recommend business operators engaging contractors review all arrangements without delay and consider the following to mitigate risk of falling outside of the ATO’s deemed ‘low risk’ category:
- Engage an employment specialist to review arrangements and assist with preparation of clear contracts setting out the terms of the arrangements which I would recommend are signed by both parties (note – a written contract isn’t required but certainly helps to mitigate risks inherent in only having verbal agreements)
- Ensure agreements clearly stipulate the understanding that the arrangement is different to that of an employment arrangement, clarifying the contractor is responsible for their own superannuation and payment of tax liabilities
This welcome change in approach shouldn’t result in operators rushing to change their arrangements from employee to contract in nature, by any means, but should result in some peace of mind where existing and new contract arrangements can exist without fear of non-compliance provided terms are appropriate, clear and agreed upon by all parties.
As always, always reach out to your accountant and business advisors to assist before making any material changes in your employment arrangements to ensure you understand any potential tax, and other, implications.
IMPORTANT DISCLAIMER: This article is published as a guide to clients and for their private information. This article does not constitute advice. Clients should not act solely on the basis of the material contained in this article. Items herein are general comments only and do not convey advice per se. Also changes in legislation may occur quickly. We therefore recommend that our formal advice be sought before acting in any of these areas.