ATO updates guidance on employee vs contractor relationships

The Australian Taxation Office (ATO) has recently updated its guidance on the employee v contractor classification following the High Court decisions in CFMEU & Anor v Personnel Contracting [2022] HCA 1 (Personnel Contracting) and ZG Operations Australia Pty Ltd & Anor v Jamsek & Ors [2022] HCA 2 (Jamsek).

On 15 December 2022, the ATO released a draft ruling, TR 2022/D3, which aims to explain when an individual is an “employee” for the purposes of the PAYG provisions. The previous ruling TR 2005/16 was withdrawn with effect from the same day. In conjunction with the draft ruling the ATO also released a draft practical compliance guideline, PCG 2022/D5.

TR 2022/D3

TR 2022/D3 only applies in the context of PAYG withholding but is said to also aid in understanding the ordinary meaning of an “employee” for the purposes of section 12(3) of the Superannuation Guarantee (Administration) Act 1992.

As expected, TR 2022/D3 discusses the need to focus on the contractual arrangements between the entity and the individual. In Personnel Contracting the High Court held that whether or not a worker is an employee of the engaging entity 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. If the terms of a written agreement are not in dispute, characterisation of the arrangement is done by reference to the rights and obligations of the parties under that contract.

Therefore, the general position will be that it is not necessary to look beyond the contractual terms unless:

• The worker and the engaging entity have not committed the terms of their relationship to a written contract;
• The validity of the contract has been challenged as being a sham; or
• The terms of the contract have been varied such that the contract no longer represents what is happening in practice.

The former ruling looked at a number of indicia to determine if a worker is an employee. TR 2022/D3 also analyses the various indicia, which are summarised below. Although, following the decisions in Personnel Contracting and Jamsek the analysis needs to be done in the context of the contractual terms.

Importantly, it is not enough to look at the labels in the contract which attempt to describe the relationship. The High Court stated in Personnel Contracting that a label in the contract is generally irrelevant and the situations in which a label will be helpful is rare.

Control

The ATO notes that an employer generally has a right to control how, where and when its employee performs their work. According to TR 2022/D3, control in this context is the contractual right of the employer to exercise such control, not in the actual exercise of control. It is also noted in the draft ruling that a “broad, unfettered right to terminate a worker’s contract may confer a capacity to control that worker, as the engaging entity can use the prospect of termination as a tool to control performance.”

Ability to delegate

Generally, where a worker has an unlimited power to delegate the work to others, its an indication the worker is engaged as an independent contractor. If a right to delegate is not unlimited or is subject to the consent of the engaging party, then it will be necessary to consider this along with the other indicia.

“Results” contracts

If the substance of a contract is to achieve a specified result, there is a strong (but not conclusive) indication that the contract is one for services. It is important to note that consideration for a specified result is often a fixed sum paid on completion of the particular job as opposed to an amount paid by reference to hours worked, activities performed or a commission. The ruling states “A payment is more likely to be for a result if it bears little or no reference to the time spend working to produce the outcome”. In our view, this would depend on the type of work being performed. For example, those working in professional services may still be paid an hourly rate but not be an employee.

Provision of tools and equipment

The draft ruling acknowledges that the provision of assets, equipment and tools by a worker, and the incurring of expenses and other overheads, may be an indicator that the worker is an independent contractor. But importantly, the nature, scale and cost of the tools and equipment must be considered. It is unlikely a worker using their own mobile phone and / or laptop would be considered significant in this context.

Risk

If the worker bears little or no risks of the costs arising out of injury or defect in carrying out their work, they are more likely to be an employee. But a clause in the contract that requires the worker to take out public liability or indemnity insurance may not hold much weight if an overall analysis of the rights and obligations demonstrates the engaging entity bears the risk.

Generation of goodwill

If the worker’s business is one where it would be expected goodwill could be generated, it would be common for an independent contractor to generate goodwill for their own business rather than the goodwill of the engaging entity’s business.

Non-individual entities

The ATO acknowledges that where the engagement is through an entity such as a company or trust, it may indicate the parties’ intention not to create an employment relationship. However, it notes that a different conclusion may be reached if a worker uses an interposed entity but is also directly a party to the contract with the engaging entity.

PCG 2022/D5

As mentioned above, the ATO has also released PCG 2022/D5. It outlines the Commissioner’s compliance approach for businesses that engage workers and classify them as employees or independent contractors. Its sets out how the ATO allocates compliance resources based on the risk associated with the classification.

PCG 2022/D5 has 4 different risk zones as set out below. The ATO approach is also impacted by whether the review is due to an unpaid superannuation query or proactive case selection where particular risk factors and information known to the ATO warrants a review.

ATO approach
Risk zone	Unpaid superannuation query	Proactive case selection
Very low	No further compliance resources will be applied.
Low	Compliance resources will be applied to test whether the worker meets the extended definition of employee under the SGAA.	No further compliance resources will be applied.
Medium	Compliance resources will be applied to test the correct worker classification5 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.

 

Determining the relevant risk zone?

Different criteria are set out for each risk zone as set out below.

Very low-risk zone

To fall within the very low-risk zone, all of the following must be met:

• there is evidence to show that both parties agreed for the arrangement to have a given worker classification;
• there is evidence the parties both understood the tax and superannuation consequences of that classification and intended for that to be the classification;
• the performance of the arrangement has not deviated significantly from the contractual rights and obligations agreed to by the parties;
• the party relying on this Guideline obtained specific advice confirming that their classification was correct under both the common law definition of employee and the extended definition in section 12(3) (the advice must be professional advice from the engaging entity’s in-house counsel or an appropriately-qualified third party, such as a solicitor or tax professional, an administrative body or client-specific written advice from the ATO); and
• the party relying on this Guideline is meeting the correct tax, superannuation and reporting obligations that arise for that classification, including voluntarily reporting under TPAR where a business satisfies the turnover threshold test.

An arrangement can also fall into the very low-risk zone if the engaging entity voluntarily decides to meet employer obligations regardless of their view of the classification. Presumably this may apply where the engaging entity and the worker believe the worker is an independent contractor but the engaging entity treats the worker as an employee and for example, makes SGC contributions. Depending on how payments under the contract are determined, this could be a 10.5% impost the engaging entity is not required to make under legislation.

Low-risk zone

Where the requirements to be in the very low-risk zone are satisfied, except there is no evidence the parties both understood the tax and superannuation consequences of that classification and intended for that to be the classification, the arrangement will fall into the low-risk zone.

Where the arrangement is in the low-risk zone, compliance resources will only be applied to test whether the worker is an “employee” for Superannuation Guarantee purposes.

Medium-risk zone

To be in the medium-risk zone:

• there must be evidence to show that both parties agreed for the arrangement to have a given worker classification;
• the party relying on this Guideline must have obtained specific advice as per the above.

High-risk zone

If an arrangement does not fall within the above zones, it will be in the high-risk zone.

Indicators of high-risk include, but are not limited to arrangements where there is evidence that:

• the party looking to rely on this Guideline did not turn any attention to the manner in which the worker in the arrangement was classified;
• the parties did not agree on a classification;
• the performance of the arrangement has deviated significantly from the contractual rights and obligations agreed to by the parties;
• one party coerced the other to accept the arrangement as being a particular classification; or
• one party made false or misleading representations to the other or deceived them into believing the arrangement had a particular classification.

Some of the indicators of high-risk arrangements are significantly more egregious than those arrangements that did not fall within one of the other zones, e.g., coercion of the other party. However, the failure to obtain advice automatically puts the arrangement in the high-risk zone.

Next steps

PCG 2022/D5 refers to the party relying on the guideline, suggesting both engaging and entities and workers will want to rely on it. In reality it is the engaging party who will need to ensure they satisfy the requirements to be in their desired risk zone, preferably the very low-risk or low-risk zone.

There are some unanswered questions arising from PCG 2022/5, including the FBT implications of an incorrect classification, and a need for more detail regarding sufficient evidence to document that the parties agreed for an arrangement to have a particular classification. Hopefully there will be some clarification in the final version.

Assuming the obligations in the final PCG are similar to the draft, it will be necessary to obtain professional advice on the classification to avoid being in the high-risk zone. As the PCG will apply from the date the PCG is finalised, it is recommended advice be sought sooner rather than later.

Engaging entities should also start thinking about modifying their onboarding procedures and processes to ensure workers are aware of their classification and the tax and superannuation implications of that classification.

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