For most businesses we encourage clients to use contractors instead of employees. Significant planning is required to ensure that you comply with ATO and Fair Work rules
Key to ensuring that you are compliant is the nature of the agreement that you have with your workers.
In December 2022 the ATO 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.
Below is an overview of the ATO's view on Employees versus Contractors.
Determine the difference
The High Court’s approach in both cases involved a focus on the terms of the written contract to establish the character of the
relationship between a business and its workers. The two rulings are significant because they emphasise the importance of written
contracts and the wording of the contracts themselves. If the terms of a written agreement are not in dispute, characterisation of the arrangement is done by referencing the rights and obligations of the parties under that contract. Therefore, the available position will be that it is not necessary to look beyond the contractual terms unless:
- The worker and the engaging entity have not committed the terms of their relationship to a
written contract. - The validity of the contract has been challenged as being a sham; or
- The terms of the contract have been varied such that the contract no longer represents what is happening in practice.
Suppose a worker has undertaken to do some work based on a comprehensive set of written terms. In that case, those terms will be the basis for determining whether or not you’re an employee or an independent contractor, not the reality of your working arrangements. The legal rights and obligations in the contract alone are relevant in determining whether the worker is an employee of an engaging entity.
The draft ruling provides guidance on the factors that will be considered when determining whether a worker is an employee or an independent contractor, with a significant focus on how the contract expresses the relationship between the engaging entity and the worker
Factors that determine classification
The ATO’s draft ruling on the difference between employees and contractors aims to clarify the circumstances in which a worker will be considered an employee or a contractor for tax purposes. The evaluative exercise should not be approached because there is some checklist against which ticks and crosses may be placed to produce the answer.
Whether or not the worker conducts their own business is not determinative. The ruling now asks if the worker is engaged by the entity (employer) based on a contract of service or a contract for service and provides several determining factors to assist in reaching a decision.
The relationship between a worker and an engaging entity will generally be either:
- A relationship of employment, often referred to as a contract of service.
- A principal and independent contractor relationship, referred to as a contract for services.
The draft ruling sets out a number of factors that will be considered when determining whether a worker is an employee or a contractor. To reach an objective determination, assessment of the following elements is needed:
- Control: The level of control the employer has over the worker, including the ability to direct the worker on how, when and where to perform their work.
- Representing/Integration: Whether a worker is presented to the public as part of the engaging entity’s business is a critical consideration in determining whose business they are serving. The extent to which the worker is integrated into the employer’s business is evaluated.
- Mode of Remuneration: How a worker is remunerated for their services and the process through which the parties determine this remuneration can help identify whether a worker is engaged to serve in an engaging entity’s business or has merely contracted with that business to produce a specified result.
- Delegation: The level of independence the worker has, including the ability to subcontract or delegate work and whether the worker is free to work for other clients.
- Provision of Tools and Equipment: The provision of assets, equipment and tools by a worker, and the incurring of expenses and other overheads, may indicate that the worker is an independent contractor. However, a worker bringing their own tools is not automatically inconsistent with an employment relationship. The nature, scale and cost of the tools and equipment must be considered.
* There are situations where, having regard to the custom and practice of the work, or the practical
circumstances and nature of the work, very little or no tools of trade or plant and equipment are
necessary to perform the work. This fact by itself will not lead to the conclusion that the worker is
engaged as an employee. - Commercial Risk: The level of financial risk the worker bears, including whether the worker is
responsible for their own equipment and expenses and whether they are paid for results rather
than time. - Goodwill: Who is benefiting from the goodwill arising from the work being completed? Where a
contract between a worker and an engaging entity prevents any goodwill from accruing for a
worker’s possible business, this may indicate that the worker is instead serving in the engaging
entity’s business. - Producing a Result/Outcome: Where the substance of a contract is to achieve a specified result. Result’ in this context is the performance of a service by one party for another where the first-mentioned party is free to employ their own means (such as third-party labour, plant and equipment) to achieve the contractually specified outcome. Satisfactory completion of the specified services is the ‘result’ for which the parties have bargained. A payment is more likely to be for a result if it bears little to no reference to the time spent working to produce the outcome.
The draft ruling provides guidance on how each of these factors should be assessed and how they should be weighed against each other to determine whether a worker is an employee or a contractor.
It is important to note that the factors outlined in the ruling are not exhaustive, and each case will be assessed on its own merits. Taxpayers still determining a worker’s classification should seek professional advice or contact the ATO for guidance.
From the ATO
Employee |
Contractor |
| Control - your business has the legal right to control how, where and when the worker does their work | Control - the worker can choose how, where and when there work is done, subject to reasonable direction by you./ |
| Integration - the worker serves in your business. They are contractually required to perform work as a representative of your business | Integration - the worker provides services to your business. The worker performs work to further their own business. They may choose to present themselves as part of your business. |
|
Mode of remuneration - the worker is paid either:
|
Mode of remuneration - the worker is contracted to achieve a specific result, and is paid when they have completed that result, often for a fixed fee. |
| Ability to subcontract or delegate - the worker must perform the work themselves and cannot pay someone else to do the work for them | Ability to subcontract or delegate - the worker is free to delegate to others who the worker will pay to complete the work on their behalf. |
| Provision of tools and equipment - your business provides all or most of the equipment, tools and other assets required to complete the work, or the worker provides all or most of the tools, but your business provides them with an allowance or reimburses them for expenses incurred. |
Provision of tools and equipment - the worker provides all or most of the equipment, tools and other assets required to complete the work, and you do not give them an allowance or reimbursement for the expenses incurred. The work involves the use of a substantial item that your worker is wholly responsible for |
| Risk - the worker bears little or no risk. Your business bears the commercial risk of any costs arising out of injury of defect in their work | Risk - the worker bears the commercial risk for any costs arising out of injury or defect in their work. |
| Generation of Goodwill - your business benefits from any goodwill arising from the work of the worker. | Generation of Goodwill - the worker's business benefits from any goodwill generated from their work, not your business. |
