Contracting has long been seen as a viable alternative to the traditional employment relationship. Contractors can be engaged directly, through an interposed entity (e.g. a company or trust) or through a labour hire agency.
Set up properly, the use of contractors offers labour flexibility and savings in administration and cash flow. Set up improperly, a business can find itself exposed to shortfalls of income tax, superannuation, pay-roll tax and workcover.
A question we are often asked (and which business owners often get wrong) is what makes an individual an ‘employee’ or a ‘contractor’?
Below is a brief summary of the rules surrounding these classifications. Whilst you may be a contractor for income tax for example, you may still be an employee for payroll tax.
Whether an individual is an employee or a contractor requires a consideration of:
- The degree of control exercised by the principal over how the individual performs the service;
- Does the individual have the right to delegate performance of the services?
- Does the individual provide their own tools of trade?
- Does the individual bear the risk of rectifying defects in the work?
- How is the individual paid? For example, are they paid to achieve a result or paid on a time basis?
- Is the individual engaged directly or via an interposed entity?
If an individual is a contractor, the business owner is relieved from withholding tax on payments made to them if they provide an ABN. If an individual operates as a contractor through an interposed company or trust, no withholding applies but the contractor needs to consider the Personal Services Income rules.
Employers are required to make superannuation contributions on behalf of employees or contractors engaged principally for their labour.
SGR 2005/1 provides that a business is not liable for superannuation contributions if they engage the contractor via a company because the superannuation obligations lie with the interposed company rather than the business.
However, SGR 2005/1 is not legally binding. In recent years, there have been a string of Federal Court decisions holding that whilst incorporation is a relevant factor, it is not decisive. If the dealings are in substance between the principal and the key person, superannuation obligations may still apply even if an interposed company is used.
Pay-Roll Tax & Workcover
Pay-roll tax and Workcover are State taxes. It is therefore important to check the rules in the relevant States.
In Victoria, payments to contractors for the performance of work are generally subject to State taxes, even if the contractor is engaged via a company, unless a specific exemption applies.
Common exemptions for contractors include:
- Contracts for 90 days or less
- Contracts where the provision of labour is ancillary to the supply of materials or equipment. For example, a company contracts to purchase a new air-conditioning unit and as part of the agreement, the contractor who supplied the unit also installs it.
- Contracts where the supply of services are of a type not typically required as part of the taxpayer’s business and the contractor provides those services to a range of clients. For example, an aged care provider hires painters to paint its aged care homes once every five years.
- Contracts for services of a type ordinarily required by the taxpayer for less than 180 days in a financial year. For example, a farm engages a number of contractors to help with harvesting in the peak season but has no need for the contractors outside of the peak season.
- Contracts where the Commissioner of State Revenue is satisfied that the contractor ordinarily renders services of the type under the contract to the public generally. This exclusion is widely relied upon by business owners but before it applies, the Commissioner needs to be satisfied that the contractor is conducting a genuine independent business which stands in the market place and renders like services to a range of clients. Unless the contractor provides those services to at least two principals and the services are provided to the taxpayer for less than an average of 10 days a month, a ruling must be obtained from the Commissioner before this exemption applies.
If you engage contractors as part of your business, we recommend that you review their classification and treatment for income tax, superannuation, pay-roll tax and workcover purposes. Determining whether an individual is an employee or a contractor is inherently difficult and requires various factors to be weighed up.
Mutual Trust Pty Ltd ACN 004 285 330 (AFSL 234590). Liability limited by a scheme approved under Professional Standards Legislation. For participating members (other than for the acts or omissions of Australian Financial Services Licensees). This information is general in nature and subject to change. It does not constitute tax, legal or financialadvice. We recommend you seek advice specific to your circumstances before taking any action. Copyright © 2014 Mutual Trust Pty Ltd.