Overview

The relatively brief, legally binding portion of the ruling (paragraphs [6] – [14]), confirms the ATO’s interpretation of the definition of employee and independent contractor. Importantly, the ruling explains when an individual is an 'employee' of an entity for pay as you go (PAYG) purposes with respect to s 12-35 of Schedule 1 of the Taxation Administration Act 1953 (Cth) (TAA); which imposes an obligation on a paying entity to withhold amounts from salary, wages, commission, bonuses or allowances it pays to an employee. However, while the ATO notes that the ruling may assist in understanding the ordinary meaning of an employee in regard to s 12(1) of the Superannuation Guarantee (Administration) Act 1992 (Cth) (SGAA), the ruling is not binding on the Commissioner in this respect.

The ruling

Some notable points of the ruling:

• Whether a worker is an employee of an entity … is a question of fact to be determined by reference to an objective assessment of the totality of the relationship between the parties: [7].
• Where the worker and the engaging entity have comprehensively committed the terms of their relationship to a written contract … it is the legal rights and obligations in the contract alone that are relevant in determining whether the worker is an employee of an engaging entity: [9].
• Evidence of how the contract was performed, including subsequent conduct and work practices, cannot be considered for the purpose of determining the nature of the legal relationship between the parties: [9].
• Conversely, evidence of how a contract was actually performed may be considered to establish the contractual terms or to challenge the validity of a written contract consistent with general contract law principles: [10].
• The terms of the contract between the parties must be considered holistically: [11].
• The 'label' which parties choose to describe their relationship, whether within a written contract or otherwise, is not determinative of, or even relevant to, that characterisation: [13].

The ruling broadly reflects the High Court’s decisions in Construction, Forestry, Maritime, Mining and Energy Union v Personnel Contracting Pty Ltd [2022] HCA 1 (Personnel Contracting) and ZG Operations Australia Pty Ltd v Jamsek [2022] HCA 2 (Jamsek). In part 2 of our series of articles, we provided a more in-depth analysis of these High Court decisions.

Consistent with these decisions, a clear emphasis is placed on the legal rights and obligations of each party as determined with reference to the terms of the comprehensive written agreement.

Explanation of the ruling
The lengthy non-binding explanation of the ruling describes in greater detail the factors that should be considered when deciding if an individual is an employee for PAYG purposes. Below we set out a brief summary of some of the key factors.

The totality of the relationship (and steps to determining a worker relationship)

The appendix provides further detail on this concept:

[22] The totality of the relationship between a worker and an engaging entity comprises the legal rights and obligations they have in respect of each other - that is, the contractual relationship between the parties.

To determine the nature of the contractual relationship between a worker and an engaging entity, it is the terms of the contract alone, whether express or implied, which are to be taken into account.

A two-step process is then provided for determining whether an employment relationship exists. Firstly, identify the contract between the parties. Secondly, identify the terms of the contract. It is these terms alone that are relevant to a determination of the nature of the relationship.

However, evidence surrounding the formation of the contract may be considered to assist with the identification of the purpose of a contract, establish evidence of equitable rights (e.g., estoppel and rectification) or show the contract was a sham.

Core distinction and employment test

In paragraph [39] the core distinction between employees and independent contractors is summarised as follows:

• An employee serves in the business of an employer, performing their work as a 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 part of another.

The relevant test is stated as ‘Is the worker an employee of the engaging entity?’ Again, this is with regard to the terms of the contract and the contractual relationship between the parties.

Indicia of employment

Paragraphs [45] – [75] then set out the factors or indicia of employment as identified in the relevant case law to assist in ascertaining whether a worker is an employee or independent contractor. Importantly, these factors must be weighed in relation to the totality of the relationship between the parties. Below we set out a summary of some of these factors.

Presenting as an emanation of the business

A distinction is noted between workers who voluntarily wear uniforms or other logos that bear their employer’s insignia and those who are contractually obliged to do so. The latter of which will tend towards a finding of employment.

Control and right to control

The focus of this factor is not on the actual exercise of control but on the contractual right of the employer to exercise control. Such a contractual right will tend towards a finding of employment.

The ability to delegate, subcontract or assign work

An unfettered right to delegate, subcontract or assign work to others will be a very strong indicator against the worker being an employee (i.e. being an independent contractor).

Results contracts

A contract to achieve a specified result is a strong indication that the contract is one for services and consistent with an independent contractor relationship. Nevertheless, there are non-hourly remuneration models that are still consistent with employment.

Provisions of tools and equipment

Workers providing their own equipment, assets and tools, incurring expenses and other overheads may be an indicator of an independent contractor relationship, but regard must be had to the nature, scale and cost of the tools and equipment.

Risk

A clause requiring a worker to take out public liability/indemnity insurance will likely be a neutral factor unless the totality of the relationship suggests that a worker is an independent contractor, in which case such a clause will support that finding.

Generation of goodwill

While not all businesses generate goodwill, it would be common for an independent contractor to generate goodwill for their own business.

Despite the distinct ambiguity of many of the above indicia of employment, it is relatively clear that such indicia are only suggestive of the type of relationship involved. The ruling stresses on multiple occasions that regard must always be had to the totality of the relationship relevantly determined by the terms of the contract. Similarly, certain labels and clauses in a contract may be consistent with a contractor or employee relationship (e.g., a clause requiring a worker to provide invoices suggests a contractor relationship) while again not being determinative by themselves.

Practical Compliance Guideline

Released in conjunction with the Ruling, the PCG specifically highlights when the ATO will investigate a worker’s classification (e.g., employee or independent contractor) in an arrangement between an engaging entity and a worker. The PCG details how the ATO will allocate its compliance resources based on seven risk factors using the – now relatively standard – ATO system of no, low, medium, and high risk.

Importance of obtaining specific legal and tax advice

In addition to the ordinary meaning of employee under common law, an independent contractor may still meet the extended definition of an employee under s 12 of the SGAA. Notably, criterions 6 and 7 deal with obtaining specific advice confirming the classification of employees under s 12 of Schedule 1 of the TAA and the expanded definition of an employee under s 12 of the SGAA respectively. This advice must be from an appropriately qualified professional (e.g., solicitor, tax professional or specific advice from the ATO).

Criterion 6: The party relying on these guidelines obtained specific advice confirming the classification was correct.

Criterion 7: An engaging business relying on this Guideline also obtained specific advice confirming the application of the extended meaning of employee under the SGAA and communicated this outcome to the worker.

The definition for the high-risk zone for each criterion also states:

Any arrangements that do not fall within the 3 other risk zones.

The implication is clear. A failure to obtain specific advice in relation to worker classification will automatically place an entity in the high-risk category. Notably, an engaging entity minimises risk by obtaining legal and tax advice.

The PCG notes that the Commissioner will be satisfied with regard to criteria 6 and 7 if the advice is at least reasonably arguable. A reasonably arguable position (RAP) must be cogent, well-grounded and considerable in its persuasiveness.

DBA Lawyers, among other things, review any employee/contractor agreements and prepare written tax opinions and where the facts and law support the position, can prepare a RAP. Moreover, legal and tax advice from a law firm like DBA Lawyers is covered by legal professional privilege.

Conclusions

The ruling and the PCG reflect the ATO’s revised position in view of the High Court’s decisions in Personnel Contracting and Jamsek. These ATO materials summarise the various factors in determining a worker’s classification as an employee or contractor. In accordance with the High Court decisions, the primary focus is on the totality of the relationship as evidenced by the terms of a comprehensive written contract.

The PCG highlights the need for, in addition to a comprehensive written agreement, a RAP by an engaging business to minimise risk. The PCG notes that professional advice is required from a lawyer or tax professional.