Who is an employee and why does it matter?

Contracting is becoming more popular as an alternative to the traditional employment relationship. As contracting and employee mobility become more popular, the difference between an employee and a contractor becomes less clear. However, there are dangers in engaging a worker as a “contractor” without having a proper understanding of the various employer obligations.

Where a worker is deemed an “employee” the employer is required to:

  • Withhold and remit PAYG withholding from the employee’s wages.
  • Pay superannuation guarantee on behalf of the employee.
  • Report and pay fringe benefits tax (FBT) if fringe benefits are provided.

Where a worker is deemed a “contractor”:

  • The contractor will generally look after their own tax obligations
  • The principal may still have to pay superannuation for individual contractors if the contract is principally for their labour.
  • There are no FBT obligations.

PAYG withholding

There is no definition of an “employee” in any tax legislation. The relevant test for determining whether an individual is an employee for PAYG withholding is the common law test.

Courts have traditionally assessed the relationship against a range of indicia (known as the ‘multi-factor’ test), all of which, when combined, determine whether a relationship is one of independent contract or employment.

The attached table outlines the indicia that the courts have considered.

The outcome of this test is subjective in nature and is not determined mathematically by reference to the total number of factors pointing to the existence of one type of relationship versus the other. It is equally important to note that no one factor will be conclusive. In addition, the position for an individual is not affected by whether or not the individual has supplied an ABN.

Generally, PAYG does not need to be remitted where payments are made to a contracting entity that is a partnership, trust or company, provided that entity quotes an ABN and the arrangement is not a sham or a mere re-direction of an employee’s wages. The question as to whether an individual engaged through a contracting entity can be characterised as an employee was determined in the Full Federal Court in Ace Insurance Limited v Trifunovski [2013] FCAFC 3.

The Full Court upheld the decision that the sales agents were in fact employees of Ace Insurance Limited despite providing services to Ace Insurance Limited through companies incorporated by each of them. The judges considered the indicia relevant in determining whether a person is an independent contractor or employee.

Even when an individual is deemed a contractor under common law, we suggest that the employer (and the contractor) also consider whether the individual may be deemed an “employee” for superannuation guarantee and payroll tax purposes under the extended definition.

If you would like further clarification about these terms, or believe this information could be relevant to your employment situation, contact your financial adviser.