The contractor vs employee debate: a tax perspective

Key points:

• Recent decisions by the High Court of Australia confirm that written contracts are the starting point when deciding if someone is an employee or a contractor. While the substance of the work should align with the contract, the terms of the contract take precedence over the conduct of the parties in determining this.
• Getting worker classification wrong can lead to unpaid tax, superannuation, payroll tax or workers’ compensation, and the Australian Taxation Office and State and Territory regulators may apply heavy penalties.
• Worker obligations are not the same everywhere. Payroll tax and workers’ compensation rules can vary, so it is important to check what applies in your state. 

When engaging workers, businesses are responsible for ensuring that they comply with the relevant laws and obligations, including employment taxes. Failure to do so can result in significant financial and legal consequences, such as fines, lawsuits, and reputational impact to the business.

With an increased level of activity by State and Federal revenue authorities, coupled with recent changes in the Courts’ views, the spotlight has never been brighter on worker classification and associated obligations. We are aware that revenue authorities have data sharing arrangements and are able to analyse vast amounts of data from varying sources to identify potential risks. In such an environment, it is crucial that businesses understand the risks as non-compliance can create uncommercial outcomes and, if not detected in time, can be costly to rectify.

Employee or contractor?

Two recent High Court¹ decisions held that the terms of a contract should take precedent over the subsequent conduct of the parties when distinguishing whether a worker should be considered an employee or an independent contractor. These decisions confirm that in the first instance, the nature of the relationship is determined by the legal rights set out in a written contract between the parties. If there is a valid written contract between the parties which is not considered a sham or otherwise legally ineffective, the courts have stated that there is no need to look beyond the contract in order to determine the nature of the relationship.

From this, the Australian Taxation Office (“ATO”) released Taxation Ruling 2023/4 and Practice Compliance Guideline 2023/2 to provide guidance on the potential tax obligations for businesses engaging contractors. A non-exhaustive list of indicia include:

What are the tax considerations?

Broadly, if the worker is considered an employee, the employer is responsible for meeting PAYG-Withholding (“PAYG-W”), Superannuation Guarantee (“SG”), Fringe Benefits Tax (“FBT”), Payroll Tax and Workers’ Compensation Insurance. If a worker is engaged via a company, trust or partnership (provided it is not a sham arrangement), they cannot be considered an employee, for the purposes of PAYG withholding, Superannuation Guarantee and FBT.

However, such workers can still be considered as deemed employees for the purposes of SG, Payroll Tax and Workers’ Compensation.

A high-level summary of the obligations, depending on the worker’s classification, is below:

PAYG-W

PAYG-W obligations should only arise on payments to contractors if they do not provide a valid ABN or there is a voluntary agreement between the contractor and the principal engaging them.

Importantly, if a business fails to comply with any PAYG-W and reporting requirements, the payments made to a contractor could be treated as non-deductible for income tax purposes. Director penalties may be imposed in certain circumstances.

Superannuation guarantee

Whilst SG obligations should not arise where the contractor engages through a company, trust or partnership (in most cases), they may apply where a contractor (individual or sole trader) is engaged wholly or principally for their own labour and:

is remunerated for their personal skills

must perform the work personally and have no right to delegate

is paid by reference to time (e.g. hourly, daily rate) rather than for a specified result

There are specific SG rules that apply to contracted performers and entertainers which should be considered separately to the above.

Where SG obligations are not met, the payer is liable for the Superannuation Guarantee Charge (“SGC”) to correct non-compliance and must self-report to the ATO. SGC is currently not deductible and further penalties of up to 200% of the SGC amount and Director penalties can be imposed in certain circumstances.

With the anticipated introduction of Payday Super from 1 July 2026, employers should regularly review their obligations for future changes in the application of the SGC regime.

Payroll tax

The relevant contract provisions are mostly harmonised in all Australian States and Territories except for Western Australia. The exemptions set out below are applicable in all States and Territories except for Western Australia.

Payments to a contractor are subject to Payroll Tax, unless at least one of the following exemptions applies:

There are also specific exemptions available for owner-drivers, insurance agents, door-to-door salespeople, and medical professionals, depending on the State or Territory.

Workers’ compensation

Contractor provisions in relation to Workers’ Compensation vary across the States and Territories. In many States and Territories, the contractor provisions rely on common law principles.
However, payments to a contractor in Victoria should be rateable wages for Workers’ Compensation purposes where the following criteria are met:

• The contract is mainly for labour (i.e. greater than 50% for the contract value is for labour);
• At least 80% of the work is performed by the same individual; and
• At least 80% of the contractor’s gross income (from the provision of similar services) is earned from the employer in question.

¹ Construction, Forestry, Maritime, Mining and Energy Union v Personnel Contracting Pty Ltd [2022] HCA 1; ZG Operations Australia Pty Ltd v Jamsek & Ors [2022] HCA 2.