ATO will scrutinise fine print in employee v contractor issues

The ATO has issued guidance on how it defines an “employee” and says businesses will need written agreements that reflect how tasks are performed to avoid the risk of a PAYG or superannuation audit.

The ruling and practical compliance guideline, issued on Wednesday, comes after two landmark employment law rulings by the High Court last year (FMMEU v Personnel Contracting and ZG v Jamsek).

Bennett Law employment lawyer Nicholas Parkinson said the ATO’s latest guidance confirmed it would align its approach with the High Court, departing from the old “multi-factorial” analysis of parties’ conduct when determining worker classification.

“[The decisions] have led to much greater certainty,” he said.

“Courts and tribunals will not look to the conduct or behaviour of the parties in determining whether the worker is an employee or a contractor unless, for example, there is no written agreement or there is a written agreement but the terms of the agreement do not reflect how the parties actually conduct themselves,” he said.

“The ATO’s new ruling and practical compliance guideline reflects these two High Court decisions.”

Employers are subject to a variety of tax obligations depending on whether workers were classified as employees or contractors, such as withholding salaries under the PAYG system, paying FBT on benefits and making superannuation payments.

In TR 2023/4, the ATO said whether a worker was an “employee” under the Taxation Administration Act 1953 was a question of fact and should be determined by reference to an objective assessment of the parties’ relationship, legal rights and obligations.

These legal rights and obligations should be determined by reference to an employment contract according to established contractual interpretation principles, the ATO added.

In circumstances where parties determined a written contract “comprehensively committed the terms of their relationship”, however, evidence of how they performed the contract and parties’ conduct must not be considered.

“A useful approach for establishing whether or not a worker is an employee of an engaging entity when analysing and weighing up each of the indicia of employment identified in the case law is to consider whether the worker is working in the business of the engaging entity, based on the construction of the terms of the contract,” the ATO said.

“The contract between the parties must be considered holistically to determine whether, on balance, the worker is an employee or independent contractor.”

The ATO has also set out its approach to investigations and audits under PCG 2023/2 with an updated risk assessment framework.

The framework classified arrangements with seven criteria between “very low”, “low”, “medium” and “high” risk zones, based on the actions taken by the parties when entering into them, such as their intentions, conduct and any advice they received.

The most “significant factors” under the risk framework in determining whether a worker was an employee or independent contractor would be the existence of a comprehensive written agreement and whether the conduct of the parties was consistent with, or significantly deviated from, the terms of the written agreement, according to Mr Parkinson.

He said that a comprehensive, written agreement that was signed by both parties and that reflected how the worker actually performed the work would “significantly mitigate” the risk of an ATO audit or investigation.

According to the ATO, a hypothetical courier service that hired overflow workers as contractors during busy periods without a comprehensive written contract would attract a medium-risk “amber” classification. Despite the business obtaining legal advice to verify the classification and being compliant with its tax and reporting obligations, the ATO said it would still allocate compliance resources to consider whether the overflow workers were correctly classified.

Reviews into PAYG or superannuation obligations could be triggered through its own “proactive case selection” or through complaints from workers who were employed as contractors but suspected superannuation underpayment due to being incorrectly classified, the ATO said.

It would then apply “compliance resources” to arrangements it deemed as medium or high risk to test whether businesses classified the worker correctly.

‘When we review an arrangement we will apply compliance resources initially to determine which risk zone the arrangement falls into. Once the risk zone has been determined, whether we have cause to apply compliance resources will depend on the [risk zone],” the ATO said.

“Parties can self-assess against this risk framework to understand the likelihood of the ATO applying compliance resources to review their arrangement.”