On 12 December 2022, the Australian Taxation Office released a draft ruling and practical compliance guideline clarifying the Commissioner of Taxation’s views and approach to worker classification after the High Court decisions in Jamsek and Personnel Contracting.
The High Court’s approach in those cases involved a focus on the terms of the written contract to establish the character of the relationship between a business and its workers. You can read our previous article about those decisions here.
Previously, the nature of an employment relationship was determined by the “multi-factorial test” which involved an analysis of the totality of the relationship, including the post-contractual conduct of the parties, not just the terms of the written contract.
Businesses must take care in correctly determining the character of the relationships with their workers.
ATO draft ruling and draft practical compliance guideline
In the draft ruling, ‘Income tax: pay as you go withholding – who is an employee?' (link here), the Commissioner provided a definition of ‘employee’ for the purposes of income tax under the Taxation Administration Act 1953 (TAA).
This draft ruling also “aids in understanding the ordinary meaning of an 'employee'” under the Superannuation Guarantee (Administration) Act 1992 (SGAA) but “is not binding on the Commissioner” in that regard.
The draft ruling relevantly provides that:
- “Whether a person […] is an employee of an entity […] is a question of fact to be determined by reference to an objective assessment of the totality of the relationship between the parties”;
- “[…] the contract of employment must be […] construe[d] and characterise[d] at the time of entry into it.”;
- “Where […] a written contract [exists] and the validity of that contract has not been challenged as a sham nor have the terms of the contract otherwise been varied, waived, discharged or the subject of an estoppel or any equitable, legal or statutory right or remedy, it is the legal rights and obligations in the contract alone that are relevant in determining whether the worker is an employee of an engaging entity.”; and
- “However, evidence of how a contract was actually performed may be considered for other purposes consistent with general contract law principles, including to:
- establish formation of the contract;
- identify the contractual terms that were agreed to; for example, where the contract is wholly or partially oral;
- demonstrate that a subsequent agreement has been made varying, waiving, or discharging one or more of the terms of the original contract;
- show the contract was a sham; or
- establish evidence of an estoppel, rectification or other legal, equitable or statutory rights or remedies.”
The Commissioner also issued a draft Practical Compliance Guideline (link here) outlining the Commissioner's approach to investigating compliance for businesses that engage workers and classify them as employees or independent contractors. Businesses can use this resource to “self-assess [and] understand the likelihood of the ATO applying compliance resources to review their arrangement.”
Risks of incorrectly classifying employees/contractors
The ATO’s draft ruling provide helpful guidance in determining whether a worker is engaged as an employee or independent contractor for the purposes of income tax and superannuation.
If an employee is incorrectly classified as an independent contractor, a business may be liable for (amongst other things):
- superannuation contributions;
- Pay As You Go (PAYG) withholding;
- payments under a modern award (ie for overtime, penalty rates and allowances);
- annual and long service leave;
- financial penalties under the Fair Work Act 2009 (Cth); and
- payroll tax (including penalties and interest).
The ATO’s draft ruling reinforces the critical importance of the written contract when assessing the relationship between a business and its workers.
To provide greater certainty and minimise risk, we recommend businesses review their arrangements with their workers and consider reviewing and updating (or replacing entirely) the contracts to properly reflect the nature of the relationship.
If you require advice on how the changes may affect your business, or assistance reviewing and updating your contracts, please contact our experienced Employment and Workplace Relations team for assistance.