Contractor or employee: The consequences of getting it wrong
The changing social and economic environment has seen an increase in the use of independent contractors, as opposed to employees, in the labour market.
What are the tax implications for an employer who employs an employee?
Broadly, if an employer employs an employee, the tax implications for the employer are:
- The employer is required to withhold PAYG from employee’s salary and wages and remit same to the ATO;
- The employer is required to pay superannuation guarantee (although certain exceptions apply) of 9% (or more if salary sacrifice agreements are entered into); and
- The employer will be required to pay Payroll tax in respect of salary and wages where the threshold (which is $623,000 for the year 1 July 2008 to 30 June 2009) is reached.
Overview of the tests applied to determine whether a person is an employee or an independent contractor
Distinguishing between an independent contractor and employee can be difficult. The distinction is usually made by reference to a ‘multi-factor’ test that examines the relationship between the worker and the organisation. However, this test can be difficult to apply. The mere fact that a person has an ABN does not preclude that person from being an employee - each contract must be examined to determine whether it is a contract ‘of service’ or a contract ‘for services’.
The following circumstances might point to the existence of an employment relationship:
- the payer usually has the right to direct the manner of performance of the work
- the commercial risk is borne by the payer;
the worker receives benefits such as annual, sick and long service leave;
- the person who pays the worker prescribes the times and locations for the performance of the work;
- the remuneration is in the form of a salary or wages;
- the person who pays the worker provides the equipment and materials for the work;
- any use of the worker's own equipment or materials is compensated for by reimbursement or by an allowance;
- the person who pays the worker has the discretion in relation to task allocation and termination of the engagement; and
- an employee has no inherent right to delegate his or her tasks to another, though there may be power to delegate some duties to other employees.
Indications of independent contractor
The following circumstances might point to a person having the status of an independent contractor:
- the contract is for a given result (the payer may only terminate the contract without penalty where the worker has not fulfilled the conditions of the contract);
- the contractor maintains a high level of discretion and flexibility as to how the work is to be performed, even if the contract contains precise terms as to the material to be used and the methods of performance;
- the worker bears the risk of the commercial loss or profit,
- the worker sets his/her own hours of work;
- the worker provides his/her own equipment and assets;
- the contract does not include leave provisions;
- payment to an independent contractor is based upon performance of the contract;
- the contractor incurs his or her own expenses;
- the contractor is likely to advertise his or her services to the public at large; and
- the worker has an unlimited power of delegation.
When distinguishing between an employee and independent contractor, regard must be had to the totality of the relationship, and take into account the overall context of the contract.
What are the tax consequences where a person is incorrectly treated as an independent contractor but is in fact an employee?
Failure to withhold and remit PAYG withholding has the most dire consequences of any of the taxes. If PAYG withholding should have been withheld (and was not) and was not remitted, then the ATO has very wide-ranging powers to ensure recovery of these funds. The Commissioner of Taxation can make a reasonable estimation of an employer’s liability and notify the employer in writing. Once notification to the employer has been provided, the Commissioner can commence recovery proceedings (including winding up the company) based on this estimate.
In addition, a general interest charge (GIC) in respect of the unremitted PAYG withholding applies.
In addition to recovery from the company, the director’s of a company may be personally liable to pay an amount equal to the company’s liability. This is irrespective of whether the failure arises as a result of a genuine mistake on the part of one or both parties.
Failure to pay the Superannuation Guarantee by the due dates will result in financial penalties as follows:
(a) the total of the employer's individual superannuation guarantee shortfalls for the quarter; and
(b) the employer's nominal interest component for the quarter; and
(c) the employer's administration component for the quarter-$20 for each employee there is a ‘shortfall’ for per quarter
Failure to pay Payroll tax means the primary tax must be paid. In addition, interest and penalties as assessed may be payable.
Some things to consider
Before engaging a person (or company as the case may be) as an independent contractor, always undertake an ABN search (or company search) of the person or company. There have been a number of cases where independent contractors (for example cleaners) have been engaged as companies but subsequent ABN searches have shown that such companies do not exist, and thus the principals are in fact employers engaging individuals as employees without intending this to be the result.
It is important to review the terms of the contract- make sure it appropriately and adequately reflects the true nature of the relationship. It is not sufficient to simply state the parties agree the relationship is one of independent contractor and principal.
Dominique Egan, Partner