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Employee vs. Contractor: Why it’s important

In the ever-evolving landscape of employment obligations, it is crucial for small businesses to stay informed about the distinctions between employees and independent contractors. Recent developments have highlighted the need for employers to carefully review their operations to ensure compliance and avoid severe penalties, including potential jail time and reputational damage.

PAYG (Pay As You Go) Withholding rules

The PAYG Withholding rules necessitate that employers withhold amounts from payments made to employees. However, these rules do not apply to independent contractors, underscoring the importance of correctly classifying workers. The ATO can impose significant penalties where PAYG W is not withheld, and the worker is considered to be an employee.

Superannuation Guarantee (SG) regime

The SG regime further complicates the employee versus contractor debate. Under certain conditions, individuals working under contracts ‘wholly or principally for their labor are considered employees for SG purposes, even if they are not common law employees. This has significant implications for superannuation contributions and penalties can apply where SG is not paid.

High Court decisions: A (brief) shift in focus

Recent High Court decisions have shifted the focus from what is often labeled the Multi-Factorial Test (MFT) – which considers various aspects of the working relationship when determining whether a worker is an employee or a contractor – to the actual written contract between the parties. The Court emphasised that the rights and obligations outlined in a contract are paramount in determining the nature of the employment relationship.

This was a welcome ‘win’ for businesses in that it provided more certainty as to the status of the worker. Using the MFT to determine the status of a worker could be difficult at the best of times and could vary significantly depending on each individual’s arrangement, including any evolution in the arrangement over time. The risk to businesses of misinterpreting the status could be so costly as to risk the future of a business when applied to multiple workers over multiple years.

Governments Response

In response to these High Court decisions, the government introduced the Fair Work Act Legislation Amendment (Closing Loopholes) Act 2023 which received Royal Assent late last year. They also introduced the Fair Work Act Legislation Amendment (Closing Loopholes No.2) Bill 2023 which received Royal Assent in February this year.

The Bills, among other things, define an employee by reference to the real substance, practical reality, and true nature of the relationship between the parties, rather than the contract alone. This effectively returns us to the MFT approach. 

Implications for Small Businesses

The changes to the Fair Work Act only apply to matters relevant to that Act. This means the ‘new’ definition of employee will not apply to PAYG W, SG, Payroll Tax, or many other employee provisions.

In fact, the ATO last year released guidance (PCG 2023/2) that effectively accepted the High Court decisions in relation to PAYG W, SG, ABNs and related reporting obligations where the worker and the business have, among other things, committed the terms of their relationship to a written contract (providing of course the contract is not a sham). The extended definition of a worker for SG purposes is unchanged and the ATO’s guidance in relation to that can be found in their ruling SGR 2005/1.

However, businesses would presumably need to reach the higher Fair Work bar to ensure they do not find themselves in a position where they become liable for unpaid long service leave, annual leave or the many other provisions covered by the Fair Work Act. Meeting the PAYG W and SG obligations would be little consolation in that case.

These significant changes highlight the critical importance of correctly classifying workers and doing it regularly. A worker that was a contractor last year may now be considered an employee if the nature of the relationship has at all changed.

We suggest you undertake these steps now, and then again each year in relation to your contractors:

  1. Review Contracts: Examine your agreements with workers to ensure they accurately reflect the relationship. If you do not have contracts in place speak to a suitably qualified lawyer.
  2. Understand the Law: Stay informed about the latest legal rulings and how they may impact your business.
  3. Consult Professionals: Seek legal advice when drafting or reviewing contracts to ensure compliance with current laws.

We are here to assist you in navigating these complex matters and to support your business in maintaining compliance. Please contact our office if you wish to discuss your situation.

Disclaimer

The content provided in this article is for informational purposes only and does not constitute legal or financial advice. While we strive to ensure accuracy, we recommend that readers consult with an appropriate specialist for professional guidance specific to their individual circumstances. The information presented here may not cover all aspects of the employment regulations or tax implications. It is essential to conduct further research and consider seeking personalised advice before making any decisions related to your workers. Grenfell Murray Pty Ltd disclaims any liability arising from reliance on the information contained in this article. Readers should exercise due diligence and verify details independently.

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