Late last year, the Australian Taxation Office (ATO) released Draft Ruling TR 2022/D3 Income tax: pay as you go withholding – who is an employee (Draft Ruling) and Draft Practical Compliance Guideline PCG 2022/D5 (Draft PCG).
The Draft Ruling provides updated guidance on businesses’ obligations in relation to Pay as You Go (PAYG) withholding and Superannuation Guarantee payments and the Draft PCG outlines the ATO’s proposed compliance approach for businesses that engage workers who are classified as either employees or independent contractors.
The updates seek to reflect recent developments in the law following the High Court’s decisions in CFMEU & Anor v Personnel Contracting Pty Ltd [2022] HCA 1 (Personnel Contracting) and ZG Operations Australia Pty Ltd & Anor v Jamsek & Ors [2022] HCA 2 (ZG Operations).
Key updates
The employee definition is relevant for businesses to assess their withholding and superannuation obligations.
Section 12-35 of Schedule 1 to the Taxation Administration Act 1953 (Cth) (TAA) provides that an entity must withhold an amount from salary, wages, commission, bonuses or allowances that it pays to an individual as an employee. This obligation will apply if the relevant payment is made by the engaging entity to an employee as a consequence of their employment and as an individual in their capacity as an employee. Similarly, businesses are required to pay superannuation in respect of ordinary time earnings paid to their employees.
Given that the term ‘employee’ is not defined in the TAA (and is defined in the superannuation legislation by reference to its ordinary meaning (as specifically expanded to encompass various specific engagements)), the significant consideration given to the ordinary meaning of ‘employee’ as determined through recent cases, including Personnel Contracting and ZG Operations, remains particularly relevant.
Draft Ruling
The key takeaway from the Draft Ruling is the ATO’s reiteration of the importance of the terms of the contract (and the legal rights and obligations housed within such contract), as these will be used to determine whether a worker is an employee. Specifically, the ATO stresses that the central question for this assessment is whether the worker is working in the business of the engaging entity, based on the terms of said contract.
Notwithstanding this focus, the ATO notes this evaluation should not be approached as though there is a checklist against which ticks and crosses may be placed to produce an answer (and similarly that labels used by the parties to describe their relationship are not determinative of, or necessarily relevant to, that characterisation).
‘Totality of the relationship’ between worker and engaging entity
Reflecting the High Court’s decision in Personnel Contracting, where the parties have committed the terms of their relationship to a written contract, the Draft Ruling confirms that an examination of the totality of the relationship between a worker and an engaging entity is required by reference to the legal rights and obligations which constitute the relationship. These are to be found in the terms of the contract (whether express or implied) between the parties. This reflects the High Court’s shift away from a ‘substance over form’ approach toward an assessment of the contractual relationship between the worker and the engaging entity. Six important indicia are relevant to this examination:
Control – does the engaging entity have the contractual right to exercise control about how, where and when an employee performs work?
The Court in Personnel Contracting noted that “the existence of a right of control… [assists] in an assessment of whether a relationship is properly to be regarded as a contract of service rather than a contract for services”.[1] In this particular case, the engaging entity retained control of the individual’s work, and this element of control was a key asset of the engaging entity’s business.
- Control – does the engaging entity have the contractual right to exercise control about how, where and when an employee performs work?
The Court in Personnel Contracting noted that “the existence of a right of control… [assists] in an assessment of whether a relationship is properly to be regarded as a contract of service rather than a contract for services”. In this particular case, the engaging entity retained control of the individual’s work, and this element of control was a key asset of the engaging entity’s business. - Delegation – does the worker have a power to delegate work to others?
An unlimited power to delegate is indicative of the worker being an independent contractor. However, delegation in a purely supervisory or managerial role is consistent with an employment relationship. - Results – is the substance of a contract to achieve a specific result?
How the worker is remunerated is relevant to this factor. For example, a fixed sum paid or payable on completion of the worker’s job is indicative of the worker being engaged as a contractor. On the other hand, if a worker is remunerated according to their hours worked or by commission this will be more indicative of an employment relationship. - Tools and equipment – does the worker provide their own tools and equipment and incur their own expenses?
In considering this factor, the scale of the cost of the tools and equipment is important. In ZG Operations, the Court acknowledged the conventional view that owners of expensive equipment (such as a vehicle) are independent contractors. - Risk – does the worker bear the risk of any costs arising out of injury or any defect in carrying out their work?
A worker who bears little or no risk in this regard is likely to be an employee (this could be the case where, for example, the engaging entity takes out an insurance policy that covers acts of its workers). - Goodwill – does the contract for the work prevent goodwill from accruing for the worker’s possible business?
While contractors are at liberty to generate goodwill in their business, this is not the case (and contractually prohibited) for employees.
In these circumstances, the Draft Ruling also provides that evidence of how the contract was performed cannot be considered for the purposes of assessing the legal relationship between the parties. This reflects the High Court’s curtailment of the “multifactorial test” that courts and tribunals have previously applied in determining whether a person is engaged as a contractor or employee.
Importantly, recent cases have now considered Personnel Contracting and ZG Operations, to outline the principles that apply in circumstances where a contract between the parties is partly or wholly oral, and consequently when consideration of conduct is relevant. While the Draft Ruling does not contemplate these decisions, the principles will apply to determining whether a worker is an ‘employee’ in these circumstances.
Draft PCG
The Draft PCG contains a helpful framework against which businesses can assess their worker engagements against the ATO’s risk matrix and understand the likelihood of the ATO dedicating its compliance resources to analysing the business’ characterisation of those relationships.
Moving forward
The developments in this space following the High Court decisions and the ATO’s updated guidance emphasise that it remains critical for businesses to adequately document the contractual relationship between the relevant engaging entity and a worker for both tax and employment purposes.
However (and importantly) we note that the Draft Ruling is not binding on the ATO for superannuation purposes and therefore does not clarify the ATO’s view on the extended definition of employee under the Superannuation Guarantee (Administration) Act 1992 (Cth). We expect such guidance will follow the Full Federal Court’s decision in Jamsek v ZG Operations Australia Pty Ltd NSD332, in which this specific question was remitted to the High Court for determination.
We also note that Superannuation Guarantee Rulings SGR 2005/1, 2005/2 and 2009/1 are currently under review in light of the recent decisions. Completion is expected in late 2023 and will presumably follow the Full Federal Court’s decision.
For specific advice on how to navigate the new landscape from a tax or employment law perspective, contact any of the authors below, or a member of our Tax or Employment Relations and Safety teams.
[1] Personnel Contracting [73].