3 February 2023
TR 2022/D3 pay as you go withholding - who is an employee?
Following some recent and prominent High Court decisions in this area, the ATO has released a draft ruling which explains how to determine whether a worker should be classified as an employee for PAYG withholding purposes. The ruling focuses on determining whether someone is an employee under the ordinary meaning of the term but doesn’t look at the extended definition of employee that is used in the context of the superannuation guarantee system.
The ATO emphasises that whether an individual is an employee is a question of fact to be determined based on an assessment of the entire relationship between the parties. If the worker and engaging entity have committed the terms of the relationship into a written contract then the analysis needs to be performed with reference to the legal rights and obligations in the contract. That is, the key focus is on the terms of the contract rather than the subsequent conduct of the parties.
The label used by the parties to describe the relationship is not determinative of the classification. Labels which are inconsistent with the rights and obligations under the contract should be ignored when classifying the worker.
In determining whether a worker should be classified as an employee there are a range of factors that need to be considered. The ATO indicates that the key distinction between an employee and an independent contractor is that:
- An employee serves in the business of an employer, performing their work as a representative of that business;
- An independent contractor provides services to a principal's business, but the contractor does so in furthering their own business enterprise; they carry out the work as principal of their own business, not a representative of another.
In addition to looking at whether the worker is serving in the engaging entity’s business, it is important to consider the extent to which the business can control how, where and when the workers perform their work.
Aside from these two key factors there are a number of other indicia that could be relevant in classifying the worker, including:
- The ability to delegate work;
- Whether the contract is on a results basis;
- Which party provides the tools and equipment;
- Risk; and
- Generation of goodwill.
In the draft ruling, the ATO states that where a worker engages to perform work for a business as a partner of a partnership or through a company or trust then this may indicate an intention by all parties not to create an employment relationship. However, a different conclusion may be reached if a worker uses an interposed entity but is also directly a party to the contract with the engaging entity.
PCG 2022/D5 Classifying workers as employees or independent contractors - ATO compliance approach
In addition to the updated draft tax ruling, the ATO has issued a draft PCG which explains how the ATO will allocate compliance resources in connection with the classification of a worker as an employee or independent contractor.
The PCG starts by outlining some of the consequences of a worker’s classification. This is a brief but useful checklist for both engaging entities and workers.
The draft PCG then outlines the risk framework that will be used by the ATO for worker classification issues, based on the actions taken by the parties when entering into the arrangement. It is important to recognise that the draft PCG does not extend to employment law issues, state based issues or the income tax affairs of the worker (e.g., whether they are subject to the PSI rules etc).
The PCG sets out four risk categories, which are based on a number of factors, including:
- Whether there is evidence to show that the parties have agreed on the classification;
- Whether there is evidence that the parties understand the consequences of the classification;
- Whether the performance of the arrangement has deviated significantly from the terms of the contract;
- Whether the party seeking to rely on the PCG has obtained specific advice confirming that the classification is correct; and
- Whether the party seeking to rely on the PCG is meeting various tax, superannuation and reporting obligations.
