In late 2023 the ATO finalised a taxation ruling and accompanying guideline, to align its guidance on who is an ‘employee’ for taxation purposes following two landmark decisions of the High Court from 2022.

While the ATO has finally caught up with case law, in the next six months the Fair Work Act 2009 (Cth) (FW Act) will change again to insert a new definition of employment, and undo the impact of Personnel Contracting and Jamsek.[1]

Once this new definition commences, employers may face circumstances where someone is assessed as an employee for employment entitlement purposes under one test (substance i.e. practical reality), but for tax, pay as you go (PAYG) withholding and superannuation purposes (under the ordinary meaning of employee) under a different test (form i.e. the totality of the contractual arrangement).

TR 2023/4 and PCG 2023/2 – Who is an employee for tax purposes?

The ATO finalised Taxation Ruling TR 2023/4 and Practical Compliance Guideline PCG 2023/2 from the drafts released over 12 months ago, to provide updated guidance on the ordinary meaning of employee for PAYG withholding purposes and outline the risk matrix for the ATO’s compliance approach for businesses that engage works as employees or independent contractors.

The term ‘employee’ is not defined in the Taxation Administration Act 1953 (Cth) (TAA), which means it takes its ordinary meaning. Businesses need to consider the meaning of employee to determine whether a worker they engage is an employee or independent contractor.

It is important to get this right, as a business’ tax and superannuation obligations can vary greatly depending on how the worker is classified. For a discussion on the various obligations that apply for businesses depending on whether a worker is classified as a contractor or as an employee see our previous article.

Aligning ATO guidance to recent decisions

TR 2023/4 and PCG 2023/2 align the ATO’s guidance on the meaning of employee for the purpose of the TAA with recent developments in the decisions of Personnel Contracting, Jamsek and JMC.[2]

Relevantly, in Personnel Contracting the High Court confirmed that the terms of the contract are key in determining whether there is an employment relationship. This reflected a shift away from the ‘substance over form’ approach towards assessing workers as employees or independent contractors.

What about superannuation?

Under the Superannuation Guarantee (Administration) Act 1992 (Cth) (SGAA) ‘employee’ also takes its ordinary meaning (as well as an expanded meaning to encompass various specific engagements).

To the extent TR 2023/4 aids in understanding the ordinary meaning of employee for the purposes of the SGAA, it is not binding on the ATO. However, a taxpayer acting in accordance with the ruling should mean the ATO exercises its discretion favourably towards the taxpayer regarding the imposition of penalties.

The ATO’s compliance approach towards businesses set out in PCG 2023/2 does apply for superannuation purposes (as well as in relation to other taxation laws, including Single Touch Payroll reporting, fringe benefits tax etc). In particular, where a business fails to seek specific advice confirming the application of the extended meaning of employee under the SGAA and communicate that advice to the worker, the business will not be able to fall within the low risk category under the ATO’s compliance approach.

Currently the guidance on who is an employee under the ordinary meaning and the extended definition in the SGAA is outlined in Superannuation Guarantee Ruling SGR 2005/1. SGR 2005/1 (and other rulings) have been and remain under review since Personnel Contracting and Jamsek.

Closing loopholes or creating more?

On 26 February 2024 the Fair Work Legislation Amendment (Closing Loopholes No. 2) Act 2023 (Cth) (Loopholes No. 2 Act) received Royal Assent.

The Loopholes No. 2 Act will insert a new section 15AA into the FW Act, to provide that whether a worker is an employee will be determined by ascertaining the ‘real substance, practical reality and true nature of the relationship’. The effect of the change is to undo the High Court’s decisions, which require assessment of the terms of the contract and intention of the parties at the time the contract is entered into.

The new definition of ‘employee’ will commence six months after 26 February 2024 or earlier by proclamation.

Once the new definition commences and until any equivalent changes are made to the TAA and SGAA (and to the ATO’s rulings), employers may face circumstances where a worker is assessed as an employee:

  • for employment rights and entitlements purposes under one test (substance); but
  • for tax, PAYG and superannuation purposes (under the ordinary meaning of employee) under a different test (form).

This will only create more uncertainty for both employers and workers.

Are you across the changes?

Correctly determining whether a worker is an employee or contractor, and adequately documenting this relationship, remains critical to ensuring that businesses and workers get their employment, tax, superannuation, ABN registration and reporting obligations right. A written contract with appropriate terms remains the best way to protect your business, although regular review of a person’s engagement by the business will be required.

For specific advice on how to navigate this increasingly challenging landscape from a tax or employment law perspective, contact our authors below, or a member of our Employment Relations or Tax teams.

[1] Decisions of the High Court of Australia in CFMEU & Anor v Personnel Contracting Pty Ltd (2022) 275 CLR 165 and ZG Operations Australia Pty Ltd & Anor v Jamsek & Ors (2022) 275 CLR 254.

[2] JMC Pty Ltd v Commissioner of Taxation (2023) 297 FCR 600.