Are your Contractors actually Employees?
A real example and ATO audit outcome.
Most businesses reach a point at which they need an extra pair of hands. This could be on either a short term or long-term basis. Hiring someone as a ‘contractor’ sounds like a simple and cost-effective solution: payment on invoice, no calculating tax, withholding and paying superannuation, work cover, insurance, annual leave, sick leave etc … the advantages seem endless and attractive!
However, at what point is the contractor legally classified as an employee?
It’s a fine line between Contractor and Employee and this ‘fine line’ is in the cross-hairs of the authorities including the Australian Tax Office (ATO), WorkCover (Return to Work SA) and the Fair Work Ombudsman. Getting it wrong can be costly!
A real life scenario.
The employer/company in this scenario, had both had employees and contractors on their books and did their best to comply with the guidelines surrounding employee/contractor definitions – they had a history of changing long term contractors to employees when they thought appropriate. Most of the company’s work was frame construction for houses, hence contractors were brought in on a project basis for short periods of time … not a problem.
Due to their excellent work the company was awarded a large, long-term construction project for which a person was brought in, on a contract basis, for the initial term of the project. The contract was repeatedly extended and the ‘contractor’s’ role changed according to the needs of the project. During the period of the long-term project some other contractors were taken on as employees but this one person wanted to remain as a contractor.
The employer/company was audited by the ATO and the following is the actual ruling from the audit – only the names have been changed for privacy.
Names have been changed below as follows:
Employer = Employer
Worker = Contractor/Employee
AUSTRALIAN TAXATION OFFICE
REASONS FOR DECISION
Workers Identified As Employees
Whether a person is an employee of another is a question of fact to be determined by examining the terms and circumstances of the contract between them having regard to the key indicators expressed in the relevant case law. Defining the contractual relationship is often a process of examining a number of factors and evaluating those factors within the context of the relationship between the parties. No one indicator of itself is determinative of that relationship. Accordingly, the contractual relationship as a whole must be considered in order to determine the true character of the relationship between the parties.
The Employee Contractor Decision Tool provides an outcome to the analysis of the arrangement between you and your workers in accordance with both:
» Taxation Ruling TR 2005/16 Income tax: Pay As You Go – withholding from payments to employees, and
» Superannuation Guarantee Ruling SGR 2005/1 Superannuation Guaratnee: who is an employee?
These rulings discuss the various indicators the courts have considered in establishing whether a person, engaged by another individual or entity, is an employee within the common law meaning of the term.
Based on the information you have provided and the outcome of the Employee Contractor Decision Tool, we consider that you have engaged workers listed below as employees for Commonwealth taxation and superannuation purposes.
Employee Name Period
Worker 1 July 2016 to 30 September 2018
The following information was obtained during the audit.
- Employer provides the work
- He tells workers where the job is located and what needs to be done, but doesn’t specifically tell them how to do it
- Hours are not set. Generally, Employer will outline what work is required, and a deadline for completion, but when the worker actually completes the task is up to them.
- Because building projects have an ultimate deadline from Client (and other clients) there is a very clear need for tasks to be completed in a timely and sequential manner, so there is some time management/coordination undertaken by Employer.
- All workers understand tasks must be done to acceptable standard. Employer himself has some guidelines imposed by Client and these are reviewed from time to time.
- Employer regularly visits worksites to review quality and ensure appropriate standard is maintained. This is one aspect of this agreement with Client.
- Workers do not get paid breaks.
- Employer explained that particularly for the larger projects, which take several months, some workers are paid progress payments, rather than waiting for completion.
- Some of Worker’s invoice very clearly invoices for hours worked, although he also clearly outlines what work was completed and the location.
- Most other workers invoiced on completion of work, although on larger projects, many are paid regular progress payment.
- Worker was paid regularly (often weekly) – especially from February to September 2018.
- All workers (including Worker) provide their own tools and equipment, which usually includes fixing materials such as nails, screws and glue.
- All workers must have their own personal protective equipment (PPE), which they supply for themselves.
- Workers are not required to use Employers uniforms.
- Employers doesn’t pay workers for annual leave, sick leave or long service leave (LSL).
- Workers are not required to advise Employer when they are taking leave.
- However, Employer has good relationships with most of his workers and he felt they would let him know as a courtesy if they were unavailable and/or had planned some leave.
Occupation Of The Worker
- The workers perform the following duties in your business:
- Mainly carpentry – first fix and second fix, but also has knowledge across trades, including: -
- Cladding, gyprock, flushing
- General building tasks
The Work Agreement
- The worker is hired as your labourer.
- There is an agreement between your business and the workers.
- The worker does have an Australian Business Number (ABN).
- The worker is allowed to pay someone else to do the work.
Basis Of Payment
- The amount you pay the worker is based on a set amount per period.
- Many of Worker’s invoices show hours worked over a period of a week.
Equipment, Tools Of Trade, Plant Or Vehicle
Your workers required the following tools and equipment to perform their work:
- Multiple carpentry tools
- Worker in particular has “an array of tools and equipment” required to undertake a variety of tasks
You do not pay your worker an allowance or reimbursement to cover their expenses for providing the tools and equipment needed to perform the work.
Rectification Of Work
Your workers are responsible for fixing any problems, defects or damage they cause when doing the job, at their own cost.
Workers can work for other businesses as well as for your business.
We relied upon the following evidence:
Documents provided by you (your Tax Agent) at the interview on date and other documents provided before and after that interview, including:
- Various invoices
- Subcontractors reports for 2016-27 and 2017-18, and also 1 July to 30 September 2018
- 2018 financial statements
- Detailed explanation of the working arrangement with 3 other people (names removed)
- Information provided at the interview held on Date.
- Results of the Employee Contractor Decision Tool (contractor).
The analysis completed indicates these workers are employees based on the following factors:
- Worker is essentially fully controlled by you
- Worker was paid on a weekly basis based on the hours worked for an extended period
The outcome from the ATO was that they deemed the contractor to be an employee and calculated that PAYG withholding was required to be paid for nearly 2 years at 47%* of the amount paid to them, approximately $19,000 for 1 person.
*The reason for the high tax rate of 47% is that the Employer didn’t have their tax file number for their contractors just their ABN (as is standard practice with all businesses).
If you’re concerned about your particular situation with contractors, speak to us. We can help!
After writing this article I was contacted by one of my clients who has been working as a subcontractor for 5 years. There has been a falling out between them and he wanted to know if he was entitled to superannuation for the past 5 years which would be in the order of $25,000. Based on the ATO case there is strong chance that he was technically an employee for the past 5 years and therefore entitled to super.