Contractors v Employees: The differences and why it matters - Part 2

Article by Andrew Tobin, Partner

4. 'Employer' obligations and liabilities in relation to contractors

   4.1 PAYG withholding tax Under the PAYG withholding system, a person who makes certain kinds of payments must withhold amounts from those payments and pay the withheld amounts to the Australian Taxation Office (ATO). Employers must withhold PAYG tax from any salary, wage, commission, allowance or bonus paid to an employee.

   Generally, there is no PAYG obligation attached to payments made to contractors, but there can be exceptions.

   The limited circumstances in which a principal is required to withhold PAYG tax from payments made to a contractor are where the contractor:

   enters into a voluntary agreement with the employer to withhold PAYG tax; provides their work or services for a client of the principal under a labour hire arrangement; or has not quoted their Australian Business Number (ABN) to the employer. Failure to withhold and remit amounts required to be withheld under the PAYG system may result in unexpected tax liabilities, plus associated penal liability. For advisers seeking to help parties structure their affairs, the potential impact of tax laws needs to be considered carefully to ensure that relevant obligations are met.

   4.2 Statutory superannuation Under the Superannuation Guarantee Scheme (SGS), employers are generally required to make compulsory superannuation contributions for their employees at (currently) the minimum rate of nine percent of ordinary time earnings. In this context, the meaning of 'employee' and 'employer' is determined by the common law, with the result that, in many situations, the obligation imposed upon employers to make superannuation contributions for workers does not apply to contracting arrangements.

   However, the SGS legislation deems a person to be an employee if a person works under a contract that is wholly or principally for the labour of the person.22 A contract for a person's labour is one where the work must be done by the person engaged to do it, as distinguished from an engagement where, for example, the contractor is free to engage other workers to do the work.

   Where the deeming provisions applies, and whether or not the contractor has an ABN and for other purposes can be treated as a contractor, the principal will be liable to make superannuation contributions for the contractor under the SGS.

   There are adverse consequences for a principal/employer who fails to make superannuation contributions as required. Employers may incur a non-deductible superannuation guarantee charge and additional costs and penalties for late payment.

   4.3 Workers' compensation The liability to include a worker under statutory workers' compensation insurance arrangements is another area in which those engaging workers as contractors commonly misunderstand their obligations.

   The aim of the Workers' Compensation and Rehabilitation Act 2003 (Qld) (WCRA), is to require employers to maintain insurance that covers against legal liability for compensation or damages arising out of injury sustained by their workers during the course of employment. The employer is required to take out insurance under the legislation for each 'worker' employed by the employer.

   The definition of 'worker' adopted by the legislation includes not only workers engaged under a contract of service (employees in the usual sense), but also (and among others):

   a person who works under a contract, or at piece work rates, for labour only or substantially for labour only; or a person who works for another person under a contract unless the person performing the work: is paid to achieve a specific result or outcome; has to supply the plant and equipment or tools of trade needed to perform the work; and is, or would be, liable for the cost of rectifying any defect in the work performed.23 In every case it will be necessary to consider whether the terms and nature of a particular contract are such so as to exclude the arrangement from liability to insure under the workers compensation legislation. If a worker suffers an injury where a policy of insurance should have been but was not taken out, WorkCover can recover the premium that should have been paid from the employer, plus a penalty of up to 100 percent, and the entire cost of the claim (ie any damages paid to the worker), plus a penalty of up to 50 percent.24

   The risk of injury to a contractor, even where there is no liability to insure, should at least be considered by the parties, particularly an employer, when putting together a contracting arrangement. It will often be appropriate and prudent for the parties to make alternative insurance arrangements. In the absence of insurance cover there will always be a risk, in the event of injury to a worker, that a claim will be made against the employer seeking to establish liability for the injury. The fact that liability might not be established will be of little comfort to an employer who nevertheless has to incur time, trouble and expense in defending such a claim.

   The other thing to bear in mind in relation to workers' compensation issues is that workers' compensation legislation is State-based legislation subject to different rules in different States. If a prospective contract will or might involve work outside Queensland, the insurance requirements in each relevant jurisdiction will need to be considered and appropriately managed.

   4.4 Payroll tax Payroll tax is a State/Territory based tax imposed on employers in respect of 'wages'. As such, payroll tax rules also vary between the States and Territories and the requirements of all jurisdictions relevant to any particular contracting engagement will have to be considered.

   In Queensland the payroll tax rate is 4.75 percent once total wage payments exceed the tax exemption threshold of $1,000,000 in a financial year. Different rates and thresholds apply in other jurisdictions.

   Before 1 July 2008, the Queensland payroll tax legislation did not impose payroll tax on remuneration paid to contractors - rather, it attached to 'wages' paid to 'employees' proper in respect of services performed within Queensland. Because of this, payroll tax was not, at least in Queensland, previously an issue impacting upon genuine contracting engagements.

   However, this changed under the payroll tax harmonisation process undertaken by the Queensland Government – to bring the Queensland payroll tax rules into line with those applicable in other States – which took effect from 1 July 2008.

   So far as contracting engagements in Queensland are now concerned, the current rules deem parties to a 'relevant contract' to be an employer and employee, and payments made under such a contract to be 'wages'.

   Practically speaking, the effect of the contractor provisions now in the legislation will be to rope service fees paid to contractors working in Queensland into the payroll tax system in a wide range of situations (subject to a number of exemptions), when prior to 1 July 2008 most payments to contractors would not have been caught.

   Potential exemptions include, among others:

   '90-day exemption': A contract may be exempt from payroll tax if a person provides the principal with the same or similar services provided by the principal's business, for a total of not more than 90 days in a financial year. On the 91st day, the entire period becomes liable for payroll tax. '180-day exemption': This exemption may be applicable where the contract relates to the provision...