Contractor vs Employee
Many contractors are now employees – under the new rules
You call yourself an independent contractor. Your business operates out of a company. However, the new rules mean that you are still an employee. The Contractor vs Employee question is now murky.
What is an ‘employee?’ What is an ‘independent contractor?’
The desire for flexibility in the workforce muddies the waters. The government classifying an independent contractor as an employee is detrimental to you. This is because employer obligations are lower for an independent contractor.
Am I an employee?
Australian has long had the traditional master–servant and control test. This use to prove that you are an employee.
But now the courts consider a multi-factorial approach. This is to determine whether you are an employee or an independent contractor. Consider the on call interpreters in Hollis v Vabu Pty Ltd [2001] HCA 44.
Am I a contractor?
An independent contractor runs their their own business. You may hire the labour of a contractor. But you have little direction or control of how that service is supplied.
The electrician comes to your home. You tell him what you want done. But you do not tell him what to wear or how to do his job.
Consider ATO ruling TR 2005/16. It is on ‘Income tax: Pay As You Go – withholding from payments to employees’:
The relationship between an employer and employee is a contractual one. It is often referred to as a contract of service. Such a relationship is typically contrasted with the principal/independent contractor relationship that is referred to as a contract for services. An independent contractor typically contracts to achieve a result whereas an employee contracts to provide their labour (typically to enable the employer to achieve a result).
A small business is more likely to suffer as an employee than a contractor
Take John. He is a partner in a large Accounting house. He assists a single client for 12 weeks. John, or rather his Accounting house, is an independent contractor. The client is the Principal.
But what about where John is a sole proprietor. He does the same work for the client for 12 weeks. It is now likely that John is the client’s employee. What a mess.
“Contract of Service” vs “Contract for Service”
- An employee relationship is a “contract of service.” An employee provides services exclusively at the employer’s discretion.
- A contractor relationship, on the other hand, is a “contract for services.” Contractors work to produce a service or product for the benefit of the Principal.
That seems simple. But the government refuses to define either “independent contractor” or “employee.” The result? Whether a person is an employee is a question of fact. Therefore, Courts look at previous cases to work out whether you are a contractor or an employee.
Traditionally, the High Court used the “control test.” Greater control by the boss implies an employee relationship. In contrast, an employer exercising little control suggests a contractor relationship. However, the test has changed.
The control test is now only one factor. Courts look to four other key factors of the relationship between the boss and the worker. This puts the 1949 case of Humberstone v Northern Timber Mills back in vogue.
In this case, they were:
- Payment-payment on a regular basis, as opposed to payment for a particular service, indicates that it is an employee relationship.
- Delegation-independent contractors can delegate work to others. However, an employee does the job personally.
- Commercial risks-contractors carry their own insurance. They bear the cost of defects in their work. An employee on the other hand usually bears no risk for errors.
- Responsibility for equipment–independent contractors pay for their equipment. In contrast, employees are supplied with equipment. Or they are reimbursed for expenses.
Does this new approach help?
The new approach blurs the distinction between independent contractor and employee.
Ask yourself: Are you operating your own business? Or are you working for an employer?
Contractor vs Employee? Found to be an independent contractor
A truck falls, a man dies – Humberstone v Northern Timber Mills [1949] HCA 49 389.
Mr Humberstone’s truck fell on him, killing him instantly. Mr Humberstone was an independent contractor, working for Northern Timber Mills. His wife thought otherwise. She believed her husband was an employee. If true, this entitled her to workers compensation.
The battle pursued right up to the High Court.
Mr Humberstone used his own vehicle. He worked the same hours each day. Payment was made weekly based on weight per mileage, as opposed to time spent. On the side of his truck, Mr Humberstone painted: “Humberstone Carriers”. Northern Timber Mills had no control over the way in which Humberstone carried out his work.
The High Court rejected Mrs Humberstone’s claim. Mr Humberstone was an independent contractor. Mrs Humberstone couldn’t get her hands on Northern Timber Mills’ workers compensation.
Contractor vs Employee? Found to be an employee
Illiterate migrant tricked into signing an independent contractor’s agreement – Fair Work Ombudsman v Quest South Perth Holdings Pty Ltd & Ors [2015] HCA 45.
Ms Roden, an illiterate migrant, worked happily as a housekeeper for the company, Quest. One day, Quest prepared a contract for Ms Roden to “get around employment laws”. Ms Roden was an employee, but the contract expressly stated that Ms Roden was an independent contractor. The High Court held that Quest’s actions were a sham that contravened the Fair Work Act:
The High Court stated, “Parties cannot create something which has every feature of a rooster, but call it a duck.” Just because a contract states an individual is an independent contractor, does not mean that they are an independent contractor.
Contractor vs Employee? Five independent insurance agents now employees – and get $500,000 to boot
In ACE Insurance v Trifunovski [2013] FCAFC 3, five insurance agents sold insurance for Combined Insurance Company of Australia. There were poorly drafted independent contractors agreement explicitly stating that the agents were ‘independent contractors’. Two of those contracts were with the agent’s company – rather than with the agents individually.
The insurance agents were only allowed to work in set geographical locations. They had to report to the Regional Manager. The Regional Manager was an employee of the insurance company. The agents received no income or retainer. They were rewarded exclusively on commission. (This breaches employment law – if they are employees – because while employees can get commission they must, at least, get the minimum wage or Award rate.)
The court noted:
- Combined Insurance had an ongoing and intensive training programme that the agents had to partake in
- their duties were ‘carried out through the personal effort of the individual agent and only by them’
- the agents were not allowed to employ anyone else to sell Combined Insurance’s insurance on their behalf
- the agents were unable to delegate their work
- the insurance company was significantly involved in the agents’ day-to-day operations – the old ‘control’ test is still there, but less important
- the agents had ‘no real independence of action or true independence of organisation’
- the poorly drafted contractor agreement was a sham hiding an employment relationship
The Court, however, failed to note the agents:
- operated with their own office, car and other work expenses
- kept their own hours of work
- carried the profit and loss of their ‘business’ being the sale of insurance
Nevertheless, the Court held the agents were employees of the Combined Insurance Company of Australia. Therefore, the company became responsible for the retrospective payment of:
- annual leave
- sick leave
- long service leave
The Courts didn’t seem to know about compulsory superannuation, otherwise, the 5 wise insurance agents would have got superannuation, as well, compliments of their ’employer’.
Legal Consolidated Barristers & Solicitors’ Independent Contractors Agreement is superior in that our contracts include:
- the ‘work’ referred allows the contractor to sub-contract, subject to approval
- the principal only has control of the work done, the time limits and cost involved – but not how the work is carried out
- the contractor provides their own plant or equipment
- the contractor is paid on results and not merely for the time spent working
The High Court moves to back to ‘agreement’
Workpac v Rossato & Ors [2021] HCA 23
Consider Workpac v Rossato & Ors [2021] HCA 23. In this case the High Court carefully considered the employment contract between Workpac and Mr Rossato. The result? Mr Rossato is a casual employee.
He, therefore, does not get leave entitlements.
The High Court in Workpac v Rossato states:
57. A court can determine the character of a legal relationship between the parties only by reference to the legal rights and obligations which constitute that relationship. The search for the existence or otherwise of a “firm advance commitment” must be for enforceable terms, and not unenforceable expectations or understandings that might be said to reflect the manner in which the parties performed their agreement. To the extent that Bromberg J expressed support for the notion that the characterisation exercise should have regard to the entirety of the employment relationship, his Honour erred.
62. To insist upon binding contractual promises as reliable indicators of the true character of the employment relationship is to recognise that it is the function of the courts to enforce legal obligations, not to act as an industrial arbiter whose function is to synthesise a new concord out of industrial differences. …
…
101. … the present case is concerned with the character of an employment relationship, a question the resolution of which has no significance for the rights of persons who are not privy to the relationship. The analysis in Hollis v Vabu affords no assistance, even by analogy, in the resolution of a question as to the character of an employment relationship, where there is no reason to doubt that the terms of that relationship are committed comprehensively to the written agreements by which the parties have agreed to be bound.
The decision in Workpac v Rossato places greater emphasis back on the Employment Contract. It did not follow the multi-factorial test applied in Hollis v Vabu.
Similarly, the Independent Contractor’s agreement may now start to provide a stronger indication of whether is a person is an employee or contractor.
Principals may still have to withhold Pay As You Go (PAYG) for their contractors
Employers hold back Pay As You Go (PAYG). This is for their employees. The rational is that the employee cannot budget. The employee spends all the money he gets. When he gets his tax bill, he has no money to pay the tax!
So the ATO requires the employer to hold back PAYG. And send that money to the ATO. But contractors are not employees. Nevertheless, some principals are still required to hold back PAYG for payments to contractors.
The PAYG withholding rules are in the Tax Administration Act 1953 (Cth) Sch 1 Pt 2-5 (s 10-1 to 20-80). Section 12-35 states:
An entity must withhold an amount from salary, wages, commission, bonuses or allowances it pays to an individual as an employee (whether of that or another entity).
TR 2005/16 states that the term ‘employee’ has an ordinary meaning. However, for independent contractors, PAYG withholding does not occur. This shows the distinction between independent contractors and employees. There are tests to decide who is an employee and who is a ‘true’ independent contractor. The ATO in TR 2005/16 states:
Whatever the facts of each particular case may be, there is no single feature which is determinative of the contractual relationship; the totality of the relationship between the parties must be considered to determine whether, on balance, the worker is an employee or independent contractor.
The ATO is quick to argue that everyone is an employee, rather than an independent contractor. This is if the contractor is:
- paid for their personal labour
- perform the work personally
- are paid by reference to hours worked
A Legal Consolidated Independent Contractors agreement helps. But the question is often decided on the multi-factorial approach. This is as set out in Hollis v Vabu and On Call.
Superannuation guarantee: ‘contract plumber’ also an ’employee’
– Virdis Family Trust t/a Rickard Heating v Fed Commission of Tax [2022] AATA 3
The court held that a plumber is an ’employee’. This is under the extended meaning of that term in s 12(3) Superannuation Guarantee (Administration) Act 1992 (SGAA). This is for a person working under a contract wholly or principally for labour.
Employers have to pay super for their employees. But what does ‘Employers’ and ‘Employees’ mean? Can a ‘contractor’ and be an ’employee’ as well? This is for the compulsory super.
The question about whether a Superannuation Guarantee Charge should be imposed requires a determination about whether the business is for Mr Pirie, an ‘employer’. And whether Mr Pirie is an ‘employee’ of the business. This is having regard to the definitions of those words in s.12(1) and (3) SGAA.
Sub-sections 12(1) and (3) SGAA states:
- (1) Subject to this section, in this Act, employee and employer have their ordinary meaning. However, for the purposes of this Act, subsections (2) to (11):
(a) expand the meaning of those terms; and
(b) make particular provision to avoid doubt as to the status of certain persons. . . .
- (3) If a person works under a contract that is wholly or principally for the labour of the person, the person is an employee of the other party to the contract.
In Virdis Family Trust t/a Rickard Heating v Fed Commission of Tax [2022] AATA 3 the taxpayer business sells and installs cooling and heating systems. The business hires Mr Pirie. This is under a letter of engagement. It was not legally prepared. It states Mr Pirie is a “Sub-contract plumber”.
- This is for which he is paid an hourly rate for work allocated each day.
- There is no capacity to delegate the work.
- Materials are paid by the taxpayer.
- But Mr Pirie pays the expenses for his own van, tools and mobile telephone.
The non-legally prepared agreement describes Mr Pirie as a sub-contractor.
- But the court rules that he is an employee.
- This is under the extended meaning of that term in s 12(3) SGAA.
- And the taxpayer is liable to pay superannuation on Mr Pirie’s behalf.
The court states that the contract is the paradigm kind of agreement that is caught by s 12(3) for contracts principally for labour.
Accordingly, the court upholds the Superannuation Guarantee Charge (SGC) assessments. These were issued to the taxpayer for failing to make super contributions on behalf of Mr Pirie.
Interestingly, the fact that Mr Pirie agreed to pay his own superannuation is irrelevant to the liability of the taxpayer to pay the SGC.
See: The Trustee For Virdis Family Trust t/a Rickard Heating Pty Ltd and FCT [2022] AATA 3, AAT, Reitano M, 5 January 2022
A cornerstone of the Superannuation Guarantee Scheme, is that employers, who do not make superannuation contributions for the benefit of an employee, to a superannuation funds are liable to pay the Superannuation Guarantee Charge. This includes the amount of the contributions that should have been made.
What Virdis cases teaches us – ’employer’ has a wide definition for complusory superannuation
You can be a contractor, and your ’employer/principal’ may still be liable to pay your superannuation. You cannot contract out of this. See the Superannuation Guarantee (Administration) Act 1992 (Cth).
The definition of ‘employer’ and ‘employee’ in s.12 is wider than its ‘ordinary meaning’. It is wider than the most businesses think. That puts the problem back on to accountants and financial planners to educate their business clients.
Section 12 acknowledges the widening of the definition. This is by using the words:
- ‘for the purposes of this Act’
- ‘expands the meaning of those terms’
- ‘make[s] particular provision to avoid doubt as to the status of certain persons’.
The clear intent is to widen the class of people who are treated as employees. This is for the making superannuation contributions to these ‘contractors’.
The Superannuation Guarantee Scheme has no regard for private arrangements that may have made to pay amounts of one kind or another as a substitute for superannuation contributions, nor for arrangements that are made to avoid obligations created by the Act: if superannuation contributions are not made to employees as defined by the Act, the Superannuation Guarantee Charge applies regardless.
It is not for parties to a private contract to determine when superannuation payments apply. The fact that Mr Pirie agreed to pay his own superannuation contributions or agreed that the business should not pay them is irrelevant to the liability of to pay the Superannuation Guarantee Charge.
At the very least the Contractor/Principal relationship should be legally prepared. This is by building an Independent Contractors Agreement on Legal Consolidated’s website.
Principal may have to pay superannuation for their contractors
Sometimes the Principal must hold back PAYG for their contractors. Similarly, at times the Principal has to pay superannuation to the Contractor. This is just like an Employer paying the compulsory super for their employees.
When does the Principal have to pay the minimum level of SG contributions to a complying superannuation fund? This is on behalf of their Contractor.
Under Section 12 Superannuation Guarantee (Administration) Act 1992 (Cth) states that ‘employee’ and ‘employer’ have their ordinary meanings. But section 12 extends their meanings. Section 12(3) of that act state that in augmentation of the common law employee:
if a person works under a contract that is wholly or principally for the labour of the person, the person is an employee of the other party to the contract.
For the ATO your contractor must be paid the compulsory super as stated in SGR 2005/1 ‘Superannuation guarantee: who is an employee?’. The ATO is on a winning streak at the moment with the multi-factorial approach:
For the purposes of subsection 12(3), where the terms of the contract in light of the subsequent conduct of the parties indicate that:
- the individual is remunerated (either wholly or principally) for their personal labour and skills;
- the individual must perform the contractual work personally (there is no right of delegation); and
- the individual is not paid to achieve a result,
the contract is considered to be wholly or principally for the labour of the individual engaged and he or she will be an employee under that subsection.
Dental Corporation v Moffet [2020] FCAFC 118
Section 12(3) is considered in the case of Dental Corporation v Moffet The dentist claims the compulsory super. This is from his Principal being Dental Corporation.
But the court refused to consider whether the dentist is a contractor or employee. This is for the purposes of the compulsory superannuation:
In our opinion, what s 12(3) requires is that: (a) there should be a ‘contract’; (b) which is wholly or principally ‘for’ the labour of a person; and (c) that the person must ‘work’ under that contract. There is no doubt that Dr Moffet provided his work under the Services Agreement so the requirements of (a) and (c) are met. [at 82]
For that reason, the question of whether the Services Agreement, from Dental Corporation’s perspective, was wholly or substantially ‘for’ Dr Moffet’s labour should be answered in the affirmative. It was substantially for that purpose. [at 104]
Finally, we would have rejected Dental Corporation’s submission in this Court that the employment-like setting test should be answered by reference to the same kinds of indicia, especially control which govern the general issue of whether one person is employed by another. This would collapse s 12(3) (on the assumption that On Call is correct) into the ordinary test of employment. It is clear that is precisely what s 12(3) does not mean. [in 108]
Unlike the PAYG rules section 12(3) looks at the purpose of the contract between the principal and contractor. It does not do so =on the ordinary meaning of employee and employer.
Construction, Forestry, Maritime, Mining and Energy Union v Personnel Contracting Pty Ltd [2022] HCA 1
In the past, most ‘employee versus contractor’ cases have not been tax or superannuation cases. Instead they are normally fighting over the Fair Work Act 2009 and personal injury law. As to the later, this is where injured workers or third parties seek to hold businesses vicariously liable for the actions of one of their workers. This is on the basis they are an employee of that business.
For example:
- My favourite case is is the bicycle courier in Hollis v Vabu Pty Ltd [2001] HCA 44.
- Also consider Stevens v Brodribb Sawmilling Pty Ltd [1986] HCA 1. The Court finds that the two workers are both independent contractors. And, therefore, Brodribb Sawmilling Pty Ltd is not vicariously liable for the injuries sustained to one of the workers by the other worker. The High Court states:
… the common law has been sufficiently flexible to adapt to changing social conditions by shifting the emphasis in the control test from the actual exercise of control to the right to exercise it …
ZG Operations Australia Pty Ltd v Jamsek [2022] HCA 2.
In these cases the High Court tells us to look at the rights and duties. This is to decide if a person is an employee or independent contractor.
Are you and employee or independent contractor? Look to the legal rights and obligations agreed under the contract. If you do not have a legally prepared written contract, your position is weakened.
This approach is similar to the High Court’s WorkPac Pty Ltd v Rossato [2021] HCA 23. That is a case on casual employment.
These two cases move away from the “multi-factorial” test. This test was adopted in Australian courts over the past 28 years.
It is new approach. Legal Consolidated believes it provides increased certainty for businesses.
New approach to employee vs contractor in ZG Operations
- Before, under the “multi-factorial” approach the terms of the contract were relevant. But not conclusive. It was a dogs breakfast of issues and how the relationship changes over time. Very messy. Very expensive to work out.
- If you have a Legal Consolidated Independent Contractors Agreement or Employment Contract it sets out all of the terms of the parties’ relationship. Then the High Court states that you escape the “multi-factorial” approach. Instead, the Court looks at the rights and obligations in the contract itself. This saves having to try and unravel how the working relationship pans out.
- The decisions gives much needed certainty. This is to companies who have properly recorded their relationships with employees and independent contractors. This is in well-drafted written contracts that correctly set out the nature of the relationship.
New rules for contractor vs employee
1. The terms of the contract are central. This is in deciding the nature of the relationship between a principal/employer and contractor/employee. The subsequent conduct of the parties is irrelevant.
However, simply asserting in a contract that a worker is a contractor may help, but does not make it so, of itself. An assessment of the relationship is undertaken. This is based on the terms of the contract.
A major question is who controls the work? How is it carried out? To what level does the worker is said to operate an independent enterprise.
2. The Legal Consolidated Independent Contract reflects that the contractor:
- has control over the relevant work
- how it is to be performed
- demonstrates that the contractor is running their own business rather than that of their principal.
There may be commercial limits on how much freedom a Principal is prepared to provide a Contractor.
3. Legal Consolidated’s Independent Contractor’s Agreement contains clauses that help show that the agreement is contained wholly in the written contract. Our clauses clearly state that the contract reflects the entire agreement of the parties. We, of course, allow variations to the contract by an exchange of emails. This includes a waiver of the rights under the contract. This ensures that the ICA does not fall fowl of the new rules.
4. Most contractors operate through a company or a company as trustee of a Family Trust. This advantage has less value. (But obviously for asset protection operating through a corporate trustee of a Family Trust is preferred.)
What you need to do: Contractor vs Employee
Employers need to exercise caution when classifying relationships with their employees. Failure results in the employer’s liability for:
- Superannuation charges
- Workers compensation
- Payroll tax
- Back pay
- Unfair dismissal
It is not always clear if there is an employment relationship. Businesses must correctly classify their workers as employees or contractors. Make sure you are correct in the classification process. Any error is costly. To ensure the highest possible chance in being an independent contractor, you need to build an independent contractor’s agreement.
On the Legal Consolidated Barristers and Solicitors website you can build:
- Independent contractor agreements
- Employment contracts
You must have one or the other, not both.
The definition of ‘employee’ has many meanings
The impost of each type of the 5 employment taxes is dependent on the definition of ‘employee’.
However, the meaning of employee is defined differently for each purpose. Plus, the existence of multiple different administrators at the federal and state levels results in additional complexity even if the definitions are the same.
This is a mess.
And it is the employer who suffers. Regulators also change their mind.
The difference in the definition of ‘employee’ for these tax, as well as confusion in the determining of who is an employee, often leads to errors in compliance. This is with the requirements of the various taxes and charges levied on employers.
Our accountants and advisers tell us that this shows itself in 3 failures:
- to meet payroll tax, PAYG withholding and superannuation obligations for contractors who
fall within the extended definitions of ‘employee’ for those purposes - to identify that someone describing themselves as a contractor is, in fact, an employee
- to keep pace with changes in the labour market to encompass the emerging work relationships resulting from the sharing or gig economy.
Each of the above problems exposes employers to tax compliance costs.
The Contractor vs Employee 5-way test:
Test yourself: are an independent contractor or an employee?
| Contractor vs Employee? | Employee | Contractor |
| Are you paid based on a set amount per period (this includes award rates, annual salary, and hourly rates)? | Yes | No |
| Are you paid based on a quoted price for an agreed outcome? | No | Yes |
| Are you responsible for equipment, tools, plant, or motor vehicles? | No | Yes |
| Are you paid an allowance to cover expenses for providing tools for work? | Yes | No |
| Are you allowed to pay other people to do work for you? | No | Yes |
