Human Resources

Are your Contractors really contractors, or are you engaging employees?

In Australia most organisations or businesses at some time will consider the use of a variety of engagement methods to comprise their workforce, either as permanent or casual employees, with a direct engagement. Other options include the utilisation of a contractor where there is a temporary need of additional capacity or skills or due to budget or cash flow restrictions. Typically there are three main forms of engagement.

  • Employment - (full time, part time and casual)
  • Contract Labour (Pty. Ltd. and ABN)
  • Labour Hire Recruitment (contract labour).

Workforce engagement in the Australian Business Landscape has become a hot topic recently. As technology advances the Australian Tax Office (A.T.O.) increasingly has the ability to profile and data match business sectors. In particular demographic profiles that  traditionally have not experienced normal levels of interrogation are actually being identified as high priority by the A.T.O. for closer scrutiny.

One of these areas is the engagement of contractors, and whether they are compliantly engaged. There is evidence to suggest that a significant amount of current independent contract engagement is not compliant. As an example when I initially meet with business owners and senior managers they are quite confident that there are no compliance issues. In some instances their accountant has recommended that the owner ensure that whoever they engage has an Australian Business Number (ABN) and invoice the business the hours worked. Unfortunately this is incorrect advice. On its own an ABN is simply for the purposes of collecting and remitting goods and services tax. Contractors, even those working through a company structure or family trust can fall foul of the ATO rules.

In fact using the example above as a simple case study could be deemed a "sham contract". A "sham contract" or arrangement can be best described as a misrepresentation of an employment relationship as one of Independent Contracting. The penalties can include $33,000 for a business and $6,600 for an individual for each and every breach. A compelling argument to get it right! And the above penalties do not even cover the rectification costs such as unpaid superannuation, sick leave and annual leave or other legislative requirements!

So it begs the question - are your contractors really contractors, or are you engaging employees? In order to answer this question we need to understand why businesses engage contractors. While there are a variety of reasons the most common include:

  • the requirement for a simple arms length engagement structure
  • flexibility with the engagement such as mutual "no cause" termination provisions and in some cases the reduction of associated financial requirements such as redundancy payments
  • the engagement falls outside industrial law
  • there is evidence that contractors require less supervision and time off

So what do you have to do to ensure you engage contractors in a compliant way that are not in reality employees? As discussed earlier it is not as easy as go and get an ABN. There is quite a prescriptive legislation that must be followed to ensure you are not in breach of the relevant legislation.

To be able to work as or to become a contractor the individual must passwhat is known as either the 80/20 rule or the results test of the Personal Services Income (PSI) legislation. He or she must also be recognised as a contractor under common law. It is not a simple piece of tax legislation, combined with common law and case law requirements it necessary to a have a thorough understanding of its application. Ignorance when misapplied is not accepted by the ATO. Given the potential financial penalties I recommend you access experts within this field.

PSI was introduced in Australia in 2000 to prevent individuals from reducing their tax by diverting their personal services income to an associated company, partnership, trust or individual, or by claiming inappropriate business deductions. In reality the PSI framework has been designed to eliminate situations of disguised employment.  

On the other hand the PSI legislation does provide certain exemptions. It is not possible to address these exemptions within this editorial as due to the complexity of the requirements. However it is possible to reduce legislative requirements and costs while ensuring complete compliance.

As previously discussed the ATO are currently very active in this area (Independent Contractor Engagement and the relative PSI rules) which is evidenced by the recent spate of rulings and the associated penalties. If you are interested you might want to "Google" BRMJCQ Pty Limited and Commissioner of Taxation [2010].

Unfortunately it is a regular occurrence that breaches of the PSI are found and the relevant parties penalised.

It is not possible to cover all the intricacies of Independent Contractor Engagement within this overview, it is intended to provide you with a working knowledge of the pitfalls and the consequences of the Independent Contractors act in particular the PSI legislation. While it is not a very entertaining subject it is important that you include it in your arsenal of tools and knowledge. I hope from our discussion you are now aware that it is a complex area but if handled correctly a real option for alternative worker engagement.

Brett Griffith is the Principal of Fulcrum Business Support and is a Business Partner with the Workforce Advisors Group. If you have any queries or questions regarding alternative workerengagement the contact details are provided below.

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