Employers may be surprised to discover that their workers who describe themselves as "contractors" may be viewed by the courts and revenue authorities as actually being employees of an employer. Similarly, thousands of contractors may be surprised to discover that the way they describe themselves is completely at odds with how the courts see them.
According to the 2011 Global Entrepreneurship Monitor Report, 10.5 per cent of Australia's Adult population are setting up or own a new business. Many of these businesses contract out the personal services of their principals. However, when the courts are asked to rule they are increasingly describing these workers, not as independent contractors, but as employees. This legal update considers the significant legal and financial implications of these rulings and suggests practical ways for purchasers of services to manage this risk.
In our recent WorkplacePulse survey, we discovered that only 35% of independent contractors were considered to have the characteristics of "entrepreneurs" – as identified by the organisation engaging them. This would suggest that the engagement of 65% of independent contractors is a major source of legal risk.
What is an independent contractor?
A "mixed indicia" test is applied by courts and revenue authorities to determine which workers are employees and which are independent contractors. Indicia pointing towards a contractor relationship include that the "contractor":
- controls the manner in which the work is performed and sets the hours of work
- is engaged for a defined result or task which ends on completion of the task, and the "contractor" is paid for result achieved
- can delegate performance of the work to a third party
- charges GST for the work
- is an incorporated business which supplies the workers
- is not limited to working exclusively for the service purchaser.
In making judgments, the courts and revenue authorities happily pierce corporate veils. The simple fact that the contractor is a private company of which the worker is an employee is not necessarily decisive as to the worker's status.
The surprising view expressed in Court decisions is that the only workers who are genuinely contractors or self-employed for the purposes of tax and workplace laws, rather than employees, are "entrepreneurs" who generate saleable goodwill in their activities. This point is illustrated by two important decision of the Federal Court.
In Trifunovski v ACE Insurance (2011), the Federal Court found the distinction between an employee and an independent contractor to be rooted fundamentally in the difference between a person who serves his employer in the employer's business, and a person who carries on a trade or business of his/her own. ACE Insurance was fined $10,000 and ordered to pay the agents it had engaged as independent contractors, but whom the Court found to be employees, $500,000 in accrued leave entitlements.
In Commissioner of Taxation v On Call Interpreters and Translators Agency (2011), in determining whether On Call's service providers were independent contractors or rather employees of On Call, the Federal Court asked:
- Is the person performing the work of an entrepreneur who owns and operates a business?
- In performing the work, is that person working in and for that person's business as a representative of that business and not of the business receiving the work?
Results of WorkplacePulse survey
There is a clear difference between compliance – appropriately engaged independent contractors (on the critical criteria of pay for outcome rather than hours worked, requirement to rectify their own errors, ability to delegate tasks, actual examples of task delegation, high degree of discretion how tasks are performed, and performing work for other businesses) – and non-compliance, with organisations taking a risky approach in engaging workers as contractors while many important indicia point to an employment relationship on the other.
The WorkplacePulse surveyed large employers regarding their arrangements with contractors and employees. The survey sample was organisations with a mean of 1,300 workers of which an average of 8% were engaged as independent contractors and 92% as employees (based on numbers of workers and numbers of hours worked). These organisations typically used independent contractors to provide a means of numerical (number of workers) and financial (dollar cost) flexibility.
The terms of arrangements that organisations had with independent contractors involved:
- more incorporated as compared to natural person independent contractors, typically with more than one employee providing services;
- 25% receiving 9% Superannuation Guarantee Contributions paid by the organisation;
- 30% having worker's compensation insurance premium entitlements paid by the organisation based on fees to the independent contractors;
- 28% having payroll tax paid by the organisation based on fees to the independent contractors.
- 9% of organisations had been audited by a revenue authority where the question of whether workers are genuinely independent contractors had arisen.
Characterisation as an employee rather than independent contractor entitles the worker to receive employment entitlements and obliges the user of the labour to pay statutory on-costs to relevant authorities. Employment entitlements include:
- annual leave
- personal / sick leave
- minimum pay for each hour worked
- overtime and penalty rates
- the right to valid reason and fair procedure before dismissal.
Users of labour may have engaged workers believed to be contractors for many years, without accrual or payment of employment entitlements, and without payment of statutory on-costs such as payroll tax. Therefore very large obligations may arise quite suddenly if the workers are reclassified as employees – subject to a statute of limitations period of six years accruals of entitlements. In the On Call decision described above, the resulting financial implications were sufficient to place the business into voluntary administration for a period of time.
What should organisations do to manage these risks
Given the potential costs to your organisation, you should have adequate processes and procedures to:
- identify if contractors / consultants are properly engaged as such rather than as employees;
- reasonably assess whether any employment entitlements obligations arise;
- have written contractor agreements that clearly identify the party / legal entity engaged under the contract, and the rights and obligations of the respective parties;
Where workers are genuinely engaged as contractors, your agreements and practices should be drawn to maximise prospects of satisfying the "entrepreneurs only" test, particularly regarding:
- rectification and insurance
- payment for result
- insurance / WorkSafe determination
- engagement via an interposed entity (corporate contractor or a labour hire agency) where practicable.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.