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The ATO’s updated guidance on employee / contractor distinction

Feb 19, 2024 | Business

TR 2023/4 Pay as You Go Withholding – who is an employee?

The ATO has now finalised its ruling TR 2023/4 that 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 principles in the final ruling remain substantially the same as the original draft. The ATO continues to emphasize 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.

In line with more recent High Court decisions in this area, 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 that written contract.

The key focus is on the terms of the contract, rather than the labels used by the parties to describe the relationship.

Where a contract is not comprehensively committed in writing, the ATO now makes it more clear in the final ruling that the subsequent conduct of the parties can be relevant to work out the contractual terms that have been agreed to by the parties.

In determining whether a worker should be classified as an employee, there are still 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 part 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 as part of another.

In addition to whether the worker is serving as part of the engaging entity’s business, it is also important to consider the extent to which the business has a contractual right to control how, where and when the workers perform their work. Aside from these two key factors there are a number of other indicators 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.

Consistent with the draft ruling, the ATO considers 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 2023/2 Classifying workers as employees or independent contractors – ATO compliance approach

Together with the tax ruling, the ATO has also now finalised PCG 2023/2 which explains how the ATO will allocate compliance resources when it comes to classifying a worker as an employee or independent contractor.

The PCG 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 and their subsequent conduct. It is important to recognise that the 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 whether certain conditions are met.

While the final PCG remains the same as the draft in many respects, there are some notable updates. This includes:

  • Changes to the conditions that determine whether an arrangement falls within a medium-risk zone.
  • A new condition that has been added for an arrangement to be considered a very-low or low-risk which requires the parties to enter into a comprehensive written agreement that governs their entire relationship.
  • One of the original conditions for an arrangement to be considered very-low or low risk is that the business has obtained specific advice confirming that the classification is correct. This condition remains, but will only be satisfied if the ATO consider the advice provided is at least reasonably arguable.

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