The Contractor Myth - When your contractor is really an employee

06-May-2013

Contractor or Employee?

I am amazed to hear about examples of businesses continuing to engage so called contractors on dodgy and sham arrangements, despite there being tax, employment and specific contractor legislation governing the rules around this issue.

Perhaps there is just too much information out there and deciding which law or regulation applies is the problem but the fact remains that businesses that engage contractors and believe that they are doing so lawfully need to understand the risks they run.

For example, I have been engaging a company to provide an annual service at my property for almost a decade now.  I won’t mention what they do and for obvious reasons, I won’t name them but their service technician has spoken to me on more than one occasion about his “contractual” relationship. 

His vehicle is sign written to the company, he wears their uniform and he is not permitted, due to his “contract” to do any work other than the work that he does for them.  He says that he is not a ‘franchisee’; he is compensated for the service that he provides at a set percentage of the value of the invoices that he generates.  What amazes me is that this company is an Australia-wide business, probably with several hundred, so-called “contractors”!  Keep reading and come to your own conclusions about whether this fellow is really a contractor.

Here is a checklist of some of the things that can determine whether your contractor is really a contractor. 

(NB: No individual point will determine the answer – several or all of the points collectively may be required to make a determination. Regulators may impose other considerations to individual circumstances. Even then, where the person doing the work falls under taxation rules of “Personal Services Income (PSI)”, some or all of the following may negate any defence of “contractor”.  This is general information only for guidance, please seek specific specialist or legal advice regarding your situation)

1.  If they work to your business’s roster?

Employee

2.  Where a “scope” of works has been agreed?

Contractor

3.  Your business sets out “how” the work is to be done?

Employee

4.  They wear a uniform provided by your business?

Employee

5.  Payment via invoice at “commercial” rates?

Contractor

6.  Payment via invoice at “pay-type” rates?

Employee

7.  Contractor can delegate to their employees?

Contractor

8.  “Avoidance” or type tactics involved in negotiations?

Employee

9.  Where the contractor provides tools, materials and other resources?

Contractor

10. Does the contractor work mostly for your business (PSI rules apply**)?

Employee

(**80/20 rule or alternatively the Results Test as prescribed by the PSI legislation)

My colleague Neil Fairley from Workforce Advisors Group focuses all his time and attention on assisting businesses to get it right.

Here is an excerpt from information that Neil provides his clients:

“The totality of the relationship is a critical factor in ensuring contractor compliance and many factors must be taken into consideration in making a determination.

As a manager you must ask if the contractual terms and the substance of the arrangement or assignment reflect the common law characteristics of an Independent Contractor and does it comply with the raft of current legislation?

  • Is the arrangement potentially a Sham Contract (Fair Work Australia Act)?
  • Is the arrangement fair to both parties (Independent Contractors Act)?
  • Is the arrangement compliant from a taxation perspective within the Personal Services Income (PSI) provisions of the Income Tax Assessment Act?
  • Does the arrangement comply with the Superannuation Guarantee Act?
  • Is there a Payroll Tax obligation?

Research indicates that most businesses would have difficulty answering these questions.  

Some businesses will endeavour to mitigate their business risk by engaging contractors via third party Labour Hire companies, or by having contractor engagement agreements documented and put in place. However, recent ATO prosecutions have refuted the vast majority of written contractor agreements and labour hire arrangements in common use today.

The ABN Myth!

It is a common misconception that the provision of an ABN by an individual is sufficient to establish their status as an independent contractor.  Many companies wrongly believe that anyone providing an ABN automatically relieves the company of statutory responsibilities for PAYG tax, superannuation guarantee contributions and, in some cases, payroll tax.

On its own, the holding of an ABN simply means that the individual can register with the ATO for the purposes of collecting and remitting GST.

Specific taxation and superannuation rulings defer to common law principles for determination of an individual’s status as an employee or independent contractor, and those rulings make it quite clear that an ABN is not an automatic presumption of contractor status and brings with it obligations to deduct PAYG tax installments and pay the Superannuation Guarantee Charge.

PSI Legislation

The Personal Services Income (PSI) legislation is very clear in that an individual providing skilled labour or services only is automatically subject to provisions of the Personal Services Income (PSI) Legislation.

However, an individual can be deemed an Independent Contractor under the legislation if they comply with either the 80% Rule, commonly known as the 80/20 rule or alternatively the Results Test as prescribed by the PSI legislation. The other option is to seek a tax ruling from the Australian Tax Office as to the correct classification of the work carried out. (However this is not necessarily a recommended action) 

A contractor would be considered compliant under the 80% Rule if the following criteria were met:

If 80% of the individuals income derived from his or her personal services doesn’t come from the one client, then they still need to pass one or more of the following tests in order to be compliant:

  • The unrelated clients test – if two or more clients provide greater than 80% of the income derived from delivering personal services then the companies must not be connected or related in any way.
  • The employment test –the contractor employs or contracts others/s to help complete the work that generates the personal services income.
  • The business premises test – the contractor works out of premises to conduct a business. There are certain criteria that apply to this test and a home office does not qualify.

The 80% Rule can be difficult to comply with when a contractor is engaged on a long-term assignment (such as offered by many companies) or if the contractor has multiple clients but cannot meet one of the required sub-set tests or the common law requirements. 

An individual can claim compliance under the Results Test, however, the area’s most commonly overlooked (and seldom taken into account) are the common law definitions of an employee relationship and how they affect the engagement.   Recent ATO and Fair Work Australia prosecutions have established precedents demonstrating that common law definitions of employment can have more weight in assessing compliance than the published ATO PSI self-assessment provisions would indicate.

In less than 6% of all compliance audits we are aware of, the methods and documentation used to comply under the 80% Rule or the Results Test are flawed and are not compliant.

Engaging non-compliant contractors clearly creates a significant risk to the contractor as well as the company retaining their services.

There are also other issues to consider when engaging contractors.  For example, are they paying for their own Public Liability and Professional Indemnity Insurance; is there an implied work cover liability, or will Accident and Disability suffice?  These issues extend to other areas such as liability for superannuation payments and management of OH&S obligations.

Frankly, there are no definitive answers, as each case must be considered on its merits and this is why each engagement needs to be examined in some detail.

There are Robust and Tested Compliance Solutions Available.

There are ways to take the complexity and fuzziness out of this compliance minefield and provide a very practical methodology to engage eligible contractors under the Results Test, even when a long term engagement is envisaged.

If you would like further information, or if you would like to discuss any aspect of your existing or prospective contractor engagements without any cost or obligation then contact us for an introduction to Workforce Advisors Group or phone Neil Fairley on 07 3726 1050 and mention this article.  Neil can also be contacted at neil@workforceadvisorsgroup.com.au

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