Differentiating between an employee and an independent contractor is an evolving and complex area of law. Significant penalties and charges may apply if the nature of a worker’s relationship is wrongly classified. This level of uncertainty and complexity is not ideal.
Your Obligations
Your Australian taxation and superannuation obligations depend on the classification of your worker as an “employee” or as an “independent contractor”.
For workers classified as an “employee”, PAYG withholding, Superannuation and Payroll Tax is payable. Fringe Benefits Tax may also apply.
Workers classified as an “independent contractor” are responsible for their own tax obligations, unless they have not quoted their ABN, or you have a voluntary agreement to withhold tax from their payments. Superannuation may still be payable if the contract is principally for the supply of labour. Payroll Tax may apply.
TIP – It’s against the law to wrongly treat an employee as an independent contractor.
Recent Developments
On 9 February 2022, the High Court of Australia delivered two important decisions on the classification of worker relationships. In both decisions, the High Court ruled that where the parties have comprehensively committed the terms of the relationship to a written contract, and no party is disputing the validity of that contract, the classification of a worker as an employee or independent contractor must proceed on the basis of the legal rights and responsibilities established in that written contract, rather than the subsequent conduct of the parties.
Until now, the multifactorial test was a well-established principle for characterising the totality of a legal relationship. This approach required a holistic consideration of all formal and practical aspects of a worker relationship, with a key consideration being control of the way work is performed. To assist employers, the ATO developed an online Employee/Contractor Decision Tool (see: here) to correctly classify workers.
Following these recent decisions, the ATO has confirmed that the High Court has not disturbed the established practice of examining the totality of a relationship. The most significant clarification relates to primarily examining the terms of a written contract between the parties to establish the character of the relationship, where that contract is an accurate and accepted record of the particulars negotiated.
However, if the contract was a sham, or had been varied, then the High Court would have turned to the parties’ post-contractual conduct and applied the multifactorial test. In situations where there is no written contract or agreement in place between the parties, the ATO considers it is still appropriate to apply the multifactorial test to determine the true nature of a worker relationship.
Multifactorial Test
As previously mentioned, the approach historically taken by Australian Courts for determining whether an employment relationship existed between parties required a consideration of the totality of the relationship.
Whether there was a written contract between the parties, and the terms of that written contract, although relevant, was not determinative. That is, Courts would consider the terms of a written contract, but could, and very often would, look beyond that contract, to the parties’ post-contractual conduct to determine the ‘true’ nature of the relationship. Courts applied a ‘multi factor’ test to determine whether a worker was genuinely an employee or an independent contractor. Inevitably, greater weight was given to certain factors over others.
The ATO website lists six factors, which when taken together, determines whether a worker is an employee or an independent contractor for Australian tax and superannuation purposes. These are reproduced here for ease of reference:
| Employee | Contractor |
| Ability to subcontract/delegate: the worker can’t subcontract/delegate the work – they can’t pay someone else to do the work. | Ability to subcontract/delegate: the worker can subcontract/delegate the work – they can pay someone else to do the work. |
|
Basis of payment – the worker is paid either:
|
Basis of payment: the worker is paid for a result achieved based on the quote they provided. A quote can be calculated using hourly rates or price per item to work out the total cost of the work. |
|
Equipment, tools and other assets:
|
Equipment, tools and other assets:
|
| Commercial risks: the worker takes no commercial risks. Your business is legally responsible for the work done by the worker and liable for the cost of rectifying any defect in the work. | Commercial risks: the worker takes commercial risks, with the worker being legally responsible for their work and liable for the cost of rectifying any defect in their work. |
| Control over the work: your business has the right to direct the way in which the worker does their work. | Control over the work: the worker has freedom in the way the work is done, subject to the specific terms in any contract or agreement. |
| Independence: the worker is not operating independently of your business. They work within and are considered part of your business. | Independence: the worker is operating their own business independently of your business. The worker performs services as specified in their contract or agreement and is free to accept or refuse additional work. |
Further, the ATO has compiled a list of ‘Myths and Facts’ (see: here) to assist employers in determining whether a worker is an employee or an independent contractor and also debunks various common myths.
The ATO is reviewing all its advice and guidance products following the recent High Court decisions, but has not indicated any plans to change its existing guidance.
Practical Takeaways…
Even though the Courts now emphasise primacy of contract to determine the true nature of the relationship between parties, a written contract must reflect an independent contracting relationship in order to achieve that classification.
It is insufficient for a relationship to simply be labelled as one of independent contractor/principal. The terms of the contract must reflect and emphasise the actual substance and commercial nature of the relationship. To this end, the terms of a contract should reflect or provide that an independent contractor:
- is running their own enterprise (rather than being a subordinate of the principal’s business);
- can and does work for other businesses (carefully drafting any restraint or restriction clauses);
- can control how, where and when the work will be performed (and should, to the extent reasonably practicable limit the principal’s control over such matters); and
- is able to (and does) delegate the provision of the services.
Businesses should also ensure that contracts are signed, to prevent any argument that the conduct of the parties has varied the terms of their agreement. Any variations to the contract should also be made in writing.
Final words…
In light of the recent High Court decisions, it is important for all businesses to review their contractual agreements, as well as, the true nature or substance of their worker relationships.