Contractor or employee? Getting it wrong could prove costly

By Paul Trimble, Director, Westlawn Business Services
18 March 2014

Distinguishing employees from independent contractors can be a vexing issue for many businesses today.

The distinction between the two was clarified somewhat in a 2011 Federal Court ruling on a case between On Call Interpreters and Translators Agency Pty Ltd and the Commissioner of Taxation.

In that case, On Call, a translation company that offers jobs to a panel of interpreters and translators, appealed a determination by the ATO that the panel comprised casual employees rather than independent contractors. As a result of the ATO determination, the company owed several years worth of back superannuation guarantee charges. As the company had been treating them as independent contractors, they had not provided those benefits.

Federal Court judge Justice Bromberg examined the nature of the work affiliation, saying it was important to look beyond the contractual terms to determine the roles, functions and work practices that establish the “totality of the relationship”.

One of the issues reviewed was whether the interpreters and translators took risks to earn their profits and thus could be considered to be running their own businesses. Justice Bromberg determined that their economic activities did not suggest any risks were involved.

This is one of the defining factors in the ATO’s guidelines for distinguishing between employees and contractors.

Contractor or employee? The ATO guidelines

According to the ATO, employees generally bear no legal risks in earning money. It is the employer who is legally responsible for the work they perform. Contractors, however, do take on risk. They have the potential to make a profit or a loss, and it is their responsibility to remedy any defective work at their own expense.

Another issue highlighted in the On Call case was how employees and contractors are paid. On Call argued that the interpreters were paid for results, making them independent contractors. The ATO said they were paid for their time, thus meeting another of its criteria defining employees.

Under the ATO’s guidelines, employees can be paid either for time worked or for ‘piece rates’ or commission. Payments to independent contractors, on the other hand, depend on fulfilling specified contract services.

The court also addressed control over work. The company stressed that the interpreters could refuse assignments and work for competitors. It added that the only way it could sanction them was to refuse to offer them work. Justice Bromberg pointed out that these were also features of casual employment.

Under the ATO guidelines, when an employer controls and directs a person’s work the individual is an employee. With contractors, the organisation or person paying the individual can specify how services are to be performed only if that control is outlined in the contract.

Otherwise, the contractors are free to use their own discretion in how to complete a job.

Other factors the ATO uses to distinguish between employees and contract workers include:

FactorsEmployeesContractors
IndependenceEmployees perform work in accordance with an employment contract.Contractors perform work specified in a contract and provide additional services only by agreement.
DelegationEmployees perform the work personally and generally cannot subcontract to someone else.Unless otherwise specified in the contract, a contractor can subcontract or delegate the work.
EquipmentThe employer generally provides tools and equipment.Contractors generally provide their own tools and equipment.

The list is not exhaustive and the ATO says employers must consider all the terms of each contract. You can use the ATO’s Employee/contractor decision tool to help determine whether an individual is an employee or a contractor.

Be careful with your employment relationships. If they don’t meet the standards your organisation might be liable for paying:

    • Employment related costs including back wages, holiday pay and superannuation payments
    • Workers compensation premiums
    • Payroll taxes, and
    • Fines of as much as $33,000 for each violation of the Fair Work Act 2009.

Consult your advisers before signing contractor agreements. Professional guidance is important because the stakes can be high.

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Disclaimer

Westlawn Business Services Pty Ltd provides this information for general guidance only, and does not constitute the provision of legal advice, tax advice, accounting services, investment advice, or professional consulting of any kind. The information provided herein should not be used as a substitute for consultation with professional tax, accounting, legal, or other competent advisers.

Before making any decision or taking any action, you should consult a professional adviser who has been provided with all pertinent facts relevant to your particular situation.