Employees vs Contractors: Can you tell the difference?

It is important to determine the status of workers as payers have different tax obligations under the pay as you go (PAYG) system depending on whether they engage a worker as an employee or an independent contractor.

Employee or independent contractor?

There are a number of factors to consider in determining whether a worker is an employee or an independent contractor, with no one factor necessarily conclusive. A payer must examine all the facts in each case, including the terms of their contract with the worker showing the intent of both parties.

A key factor in deciding if a worker is an employee is the degree of control that can be exercised over the worker. If the payer has the right to direct how, when, where and who is to perform the work, the worker is likely to be an employee. These directions may be verbal or in writing, or simply understood between the parties.

Another key factor to consider is whether the worker is being paid for the time they work, or being paid for a result. Workers being paid by the hour are more likely to be employees. Workers being paid for a result are more likely to be independent contractors.

Employee

Generally, a worker is an employee if they:

  • are paid for time worked
  • receive paid leave (for example, sick, annual or recreation, or long service leave)
  • are not responsible for providing the materials or equipment required to do their job
  • must perform the duties of their position
  • agree to provide their personal services
  • work hours set by an agreement or award
  • are recognised as part and parcel of the payer’s business, and
  • take no commercial risks and cannot make a profit or loss from the work performed.

If a worker is an employee, the payer must withhold an amount from any salary, wages, commissions, bonuses or allowances they pay to the employee. The payer determines the amount to withhold using the tax tables published by the Tax Office and information provided by the employee on a Tax file number declaration (and Withholding declaration if applicable).

Independent contractor

An independent contractor is an entity (such as an individual, partnership, trust or company) that agrees to produce a designated result for an agreed price. In most cases an independent contractor:

  • is paid for results achieved
  • provides all or most of the necessary materials and equipment to complete the work
  • is free to delegate work to other entities
  • has freedom in the way the work is done
  • provides services to the general public and other businesses
  • is free to accept or refuse work, and
  • is in a position to make a profit or loss.

If a worker is an independent contractor, a payer is required to withhold an amount from payments to them only where the contractor:

  • has entered into a voluntary agreement with the payer to have amounts withheld
  • provides their work or services for a client of the payer under a labour hire arrangement, or
  • has not quoted their Australian business number (ABN) to the payer.

In some cases the superannuation guarantee laws may apply to payments for work or services by an independent contractor.

Case Law

A recent decision by the Administrative Appeals Tribunal (AAT) (Associated Translators and Linguists Pty Limited and Commission of Taxation [2010] AATA 260) should serve as a warning for any employer who employs independent contractors. In a case brought by the Tax Commissioner, a company that employs over 1000 contractors to provide interpretation and translation services is now potentially liable for superannuation guarantee payments to all of its contractors – now and retrospectively.

So what went wrong? The problem is that there is no conclusive definition of who or what an independent contractor is. The fact that an agreement might state that someone is a contractor is considered merely a label by the court. Where the contractor primarily supplies their personal labour, the dividing line between an employee and a contractor is even harder to distinguish as the tools of the contractor’s trade is their knowledge and expertise.

Associated Translators and Linguists Pty Limited (ATL) provide interpretation and translation services in 90 different languages across the country. ATL has two full time interpreters and translators but the bulk of the service is managed through a panel of consultants. The panel of over 1000 interpreters and translators fulfil between 1300 and 1500 client assignments per month. The panel of consultants are predominantly individuals who contract back to ATL when a job comes up in their area of expertise that cannot be fulfilled by the full time staff.

In this case, the Tax Commissioner singled out one panel member from ATL pool, Mr Sani, who started contracting to the company in 2003. The Tax Office was of the view that Mr Sani was an employee of ATL not a contractor and issued ATL a superannuation guarantee assessment for a shortfall in superannuation guarantee payments to Mr Sani. ATL objected. The ATO held firm on its view that Mr Sani was an employee and therefore the super guarantee should apply.

The Superannuation Guarantee Assessment (SGA) Act requires that superannuation guarantee payments are made by the employer for employees (using the ordinary term for employee). Then, the Act goes one step further stating that if a person works under a contract that is wholly or principally for the labour of the person, the person is an employee of the other party to the contract.

The case before the AAT first had to determine if Mr Sani was an employee under its ordinary meaning. If not then the tribunal had to decide if Mr Sani was an employee under the extended definition of employee in the SGA Act. As it turned out, the case didn’t get that far with the AAT deciding that Mr Sani was in fact an employee of ATL under its ordinary meaning.

Generally, to determine if an independent contracting relationship exists the courts have looked at factors such as:

  • Whether the work involves a particular profession or skill set
  • The level of control the contractor has over how the contract is executed
  • The ability of the contractor to delegate work to another person
  • Whether the contractor supplies his own tools or equipment
  • Whether the contractor has his own place of business
  • The contractors ability to generate goodwill or saleable assets during the course of the contract
  • How the contractor is paid (for hours worked or a result)
  • The level of risk the contractor bears, and
  • Whether the contractor is independent or in reality, simply part and parcel of the organisation they contract to

No single factor is determinative; it is the weight of evidence, on balance, across all of the factors. However, the last point, called the organisation test, was a significant factor in ATLs loss to the Tax Commissioner. But there were also a number of other factors raised by the Commissioner and considered during the tribunal:

Procedurally, panel members complete the interpretation or translating assignments in the same way as employees. They agree to attend a particular assignment at an allocated time, complete the assignment, and report back on the time taken to complete the assignment. ATL pointed out that unlike employees panel members have the right to refuse an assignment.

ATL exercised strong controls over how work was completed. Panel members cannot delegate the assignment without permission from ATL. They are also required to comply with a code of conduct that covers punctuality, dress, confidentiality etc. Panel members also need to report back to ATL within 24 hours of the completion of the assignment. ATL argued that the code of conduct was consistent with the ethics for all interpreters and translators as part of their professional membership and that the administrative requirements are for efficiency. It was argued that these same arrangements would apply to a totally independent interpreter engaged for a one-off assignment.

Complaints were not dealt with by the panel member but by ATL. The Tax Commissioner argued that complaints affected ATL goodwill not the contractors. The Commissioner also noted that the panel member did not have the capacity to develop goodwill with the client or generate business. Panel members had to refer back any assignments requested by clients.

The payments and invoices were managed by ATL. In the event of a complaint or poor conduct, panel members may be subject to some sort of warning or sanction. Where payment was withheld, it was generally because the client had withheld payment. In effect, the panel member did not bear the risk of the assignment.

Panel members carry ATL business cards, or identification cards, with their name, confirmation that they are an ATL panel member, and their NAATI accreditation number. ATL pointed out that the identification cards are simply a way of confirming to the client that the interpreter is an ATL panel member and properly accredited. The Tax Commissioner saw that the panel members were represented as being part of ATL not independent to it. Commercially, this issue would pose a problem for many businesses if they followed the Commissioner’s logic as it would mean diluting the prominence of their own brand by exposing their client base to and developing the contractor’s personal profile.

ATL also noted that panel members were free to accept and generate business in their own right including from competitors. This fact however was disregarded by the tribunal.

ATL also noted that it did not place controls over how the panel member completed the assignment. However, the tribunal saw that employees also did not face these controls and the company’s capacity to review all of the assignments was limited.

Weighing up the case, the tribunal saw that ATLs panel members were not only part and parcel of the business, they were the business. ATL has no capacity to deliver their services across the range of languages and geographic locations without them. Following this decision it would be hard to see how any business that relied predominantly on independent contractors to fulfil its services could establish the independence of its contractors under this definition.

But it was two other factors that tipped the scales in favour of the Tax Commissioner:

  1. Control – while panel members can decline an assignment, once they have accepted they are under fairly tight control by ATL. The view of the tribunal was that a contractor would generally not be expected to report back to the contracting organisation within 24 hours. ATL argued that this is merely an administrative necessity of how their services are sold.
  2. Lack of freedom – panel members did not have the capacity to delegate an assignment. They could not complete the assignment as they saw fit.

The tribunal also considered the issue of the contractors being employed to produce a result. The contractor being paid to produce a result is a key test in other areas of tax law to determine if someone is a contractor or an employee. ATL contested that panel members are paid for an assignment. Contentiously, the tribunal agreed with the Commissioner’s view that panel members are not contracted to produce a result but paid for their time because if a client cancels at the last moment, ATL still charges the client and the panel member will still be paid – therefore, the panel member is not paid to produce a result in these circumstances because there was no result.

The tribunal’s decision is interesting as cancellation fees are a standard policy of many businesses to compensate for time being wasted, opportunity cost, or the administrative cost of managing a cancellation. In this case, the fact that a panel member is paid even if the assignment is not completed is merely an extension of the penalty applied by ATL.

This case deals with independent contractors who are individuals. The use of an interposed company structure is often seen as a way of overcoming this problem (where the company represents an individual only and is the vehicle to provide their personal services) but there still may be a risk.

If you employ contractors, take a close look at the arrangements in place and whether you might have a superannuation guarantee exposure.

The above advice is intended as a guide only. Please contact Eclipse Accounting Group if you require additional information or clarification on any issues or rules.