Myth or fact -
Are your contractors really employees?
Sally Preston
Does your business engage with contractors? Have you ever considered whether they may be considered employees for the purposes of superannuation, PAYG withholding, payroll tax, or workers compensation? It may be that they are, and if so, you could be falling short of your tax and legal obligations.
This article explores some of the factors to consider when making an assessment and the ATOs guidance on this.
As a business owner, you need to be aware of your obligations when it comes to paying staff or contractors and the flow-on effect of things like superannuation, PAYG withholding obligations, payroll tax and workers’ compensation insurance.
To explain this further, under the tax law, if you are an employer, you must withhold amounts from the salary, wages, commissions, bonuses or allowances to a person made as a consequence of their employment, in their capacity as an employee.
For superannuation purposes, if a worker is an employee, you must pay superannuation on their ordinary time earnings.
The term employee is not defined in the tax law, and therefore has its ordinary meaning. When ascertaining what is the “ordinary meaning” we refer to how this has been interpreted by the courts.
This is an area of law that has recently evolved and in December 2023, the ATO updated their view in the form of a public ruling, on what is considered an employee for the purposes of PAYG withholding obligations. This view also helps us interpret who may be considered an employee for the purposes of superannuation payment obligations, however, the ruling makes it clear that to the extent it is used for this purpose, it is not binding on the ATO.
For the purposes of super it is important to note that, whilst it refers to the ordinary meaning of employee, it expands the term to say that if a person works under a contract that is wholly or principally for the labour of that person, they are considered an employee for super purposes. It does offer several exclusions, including where a person is paid to do work wholly or principally of a domestic or private nature for less than 30 hours per week. In this case they are not regarded as an employee for super purposes.
If we look at the ATO view:
“Whether a person is an employee of an entity under the term’s ordinary meaning is a question of fact to be determined by reference to an objective assessment of the totality of the relationship between the parties, having regard only to the legal rights and obligations which constitute that relationship”.
“At its core, the distinction between an employee and independent contractor are:
an employee serves in the business of an employer, performing their work as a part of that business
an independent contractor provides services to a principal’s business and performs work, but the contractor does so in furthering their own business enterprise; they carry out the work as a principal of their own business, not as part of another.”
There are indicators that are relevant in considering whether the worker is working in your business or providing services to your business.
Common indicators
Some indicators are relevant in considering whether the worker is a contractor or correctly treated as a contractor. An analysis of these indicators should be undertaken in forming your view. However, we note that the case law surrounding this distinction is ever-evolving, so, as always you are better to get advice than continue down the wrong path.
Let’s also look at the ATO view (on their website) on some common myths to dispel:
Myth: If a worker has an ABN they're a contractor.
Fact: Having an ABN makes no difference to whether a worker is an employee or contractor for a job. Businesses sometimes request or pressure a worker who is an employee to obtain an ABN in the belief this will make the worker a contractor. Often these businesses attempt to disguise the employment arrangement and make it look like contracting to avoid their PAYG withholding and super obligations. If the working arrangement is employment, an ABN will not make the worker a contractor.
Myth: Everyone in my industry takes on workers as contractors, so my business should too.
Fact: Just because other businesses treat workers as contractors doesn't mean they have got it right. Ignore common industry practice when determining whether your worker is an employee or contractor.
Myth: Employees can't be used for short jobs or to get extra work done during busy periods.
Fact: The length of a job or regularity of work makes no difference to whether a worker is an employee or contractor. Both employees and contractors can be used for:
casual, temporary, on-call and infrequent work busy periods short jobs, specific tasks and projects.
Myth: A worker cannot work more than 80% of their time for one business if they want to be considered a contractor.
Fact: The 80% rule, or 80/20 rule as it is sometimes called, relates to personal services income (PSI) and can change how a contractor:
reports their income in their own tax return claims some business-like deductions.
It's not a factor a business considers when they work out whether a worker is an employee or contractor.
Myth: My business has always used contractors, so we don't need to check whether new workers are employees or contractors.
Fact: Before hiring a new worker, you should always check whether the worker is an employee or contractor by examining the working arrangement. Unless a working arrangement (including the specific terms and conditions under which the work is done) is identical to a previous arrangement you've already checked, the outcome could be different. Hiring workers without checking the working arrangement could mean the business is incorrectly treating all future workers as contractors when they are employees.
Myth: If a worker has a registered business name, they're a contractor.
Fact: Having a registered business name makes no difference to whether a worker is an employee or contractor.
Myth: If a worker is a contractor for one job, they will be a contractor for all jobs.
Fact: The working arrangement and specific terms and conditions will determine whether a worker is an employee or contractor for each job. A worker could be an employee for one job and a contractor for the next job.
Myth: My business should only take on contractors so we don't have to worry about super.
Fact: Businesses may be required to pay super for their contractors. If you pay an individual contractor under a contract that is wholly or principally for the person's labour, you have to pay super contributions for them.
Myth: Workers used for their specialist skills or qualifications should be engaged as contractors.
Fact: If a business takes on a worker for their specialist skills or qualifications it doesn't automatically mean they're a contractor. A worker with specialist skills or qualifications can be either an employee or contractor depending on the terms and conditions under which the work is done.
Myth: My worker wants to be a contractor, so my business should treat them as one.
Fact: Just because a worker has a preference to work as a contractor doesn't mean your business can engage them as a contractor. Whether a worker is an employee or contractor is not a matter of choice, but depends entirely on the working arrangement and the specific terms and conditions. If you give into pressure and agree to treat an employee as a contractor, you can face penalties and charges for not meeting your tax and super obligations.
Myth: If a worker submits an invoice for their work, they're a contractor.
Fact: Submitting an invoice for work done or being 'paid on invoice' doesn't make a worker a contractor. To know whether a worker is an employee or contractor, you need to look at the whole working arrangement and examine the specific terms and conditions.
Myth: If a worker's contract has a section that says they are a contractor, then legally they're a contractor.
Fact: If a worker is legally an employee, a contract saying the worker is a contractor will not make the worker a contractor at law. Businesses and workers will sometimes include specific words in a written contract to say that the working arrangement is contracting in the mistaken belief that this will make the worker a contractor at law. If a worker is legally an employee, a contract specifying the worker is a contractor makes no difference and will not:
override the employment relationship or change the worker into a contractor change the PAYG withholding and super obligations a business is required to meet.
Payroll tax
Payroll tax also has similar considerations to the above when assessing whether an entity is an employee or a contractor to calculate payroll tax liability.
If the entity is considered an “employee” then payments made to the contractor, plus any superannuation and PAYG withholding amounts, may be subject to payroll tax as wages.
In addition, payments made to contractors may be subject to payroll tax even where the contactor is a genuine independent contractor for income tax purposes. The payroll tax law includes amounts paid to contractors in the definition of “wages” unless a specific exemption applies.
Contractor exemptions
In QLD there are 9 exemptions for payments made to genuine contractors. We list these below:
The same or similar services provided by the contractor to the business do not exceed a total of 90 days in a financial year. For example, payments to a fitness instructor who provides services to the business once per week (52 times throughout the year) would be exempt
The type of services provided by a contractor are required by the business for less than 180 days in a financial year. For example, a landscaper is hired by a gym to perform landscaping services to work on a specific project. The landscaper provides services for 120 days in the financial year to complete the project. As the gym does not usually require landscaping services, payments to this contractor would be exempt
The services are performed by two or more people. For example, a gym’s contract with a bookkeeping business for ongoing bookkeeping, and two employees of the bookkeeping business provide the services
The services provided are ancillary to the supply of goods. For example, where gym equipment is set up by a technician, the installation services will be exempt as they are ancillary to the supply of the goods
The services provided by the contractor are normally also provided to the public generally. To be able to rely upon this exemption, the business will need to apply to the Commissioner for approval.
Services approved by the Commissioner as exempt.
Services provided by an owner-driver. If a contractor carries goods in their own vehicle and only provides incidental services, the contract is exempt. The main purpose of the contract must be to deliver goods.
Services related to door to door sales. If you are a business hiring a contractor to sell goods door to door for domestic purposes, amounts you pay that contractor may be exempt.
Services related to selling insurance. If you are an insurance company and hire a contractor to sell insurance for you, commissions paid to that contractor—for the sale of insurance—are exempt.
Business owners should keep sufficient records and evidence to support the application of the above exemptions. If a contractor is a deemed employee, the above exemptions are not available.
Where a business has not included payments to contractors in its taxable wages that should have been included, penalties and interest on top of any payroll tax liabilities apply.
Workers’
compensation insurance
Let’s not forget an important ancillary matter – workers compensation insurance. Whilst not a tax it is a legal obligation. Employers must insure their employees against work-related injuries. If employees are not properly insured by their employer, penalties may apply.
Contractors who are deemed employees must be included in wages for workers’ compensation purposes. Genuine contractors do not generally need to be insured as they are responsible for their own insurance.