Hidden Liabilities In Contractor Arrangements

For many businesses, engaging workers as subcontractors is part of the operating model.

The worker has an ABN; they submit an invoice; there is a contractor agreement in place. The business does not withhold PAYG, pay superannuation, include those payments in its payroll tax calculations, or provide for annual leave and the like.

On its face, the arrangement looks straightforward. But what happens when the ATO or a state revenue authority takes a different view?

We have seen businesses, particularly those operating in labour hire and labour-intensive industries, accumulate significant liabilities after arrangements they believed were genuine subcontractor relationships were reviewed and found to give rise to employee/ATO obligations. 

The resulting exposure can extend across PAYG withholding, superannuation guarantee and payroll tax, often retrospectively and across several years. Further liability can arise in relation to annual leave and the like. That can turn a healthy balance sheet into a very different financial position.

Personnel contracting, the label doesn’t determine the relationship 

The High Court's decision in CFMMEU v Personnel Contracting Pty Ltd [2022] HCA 1 remains an important authority in this area.

Personnel Contracting operated a labour hire business. Mr McCourt, a Contractor, entered into an agreement with the company that expressly described him as a ”self-employed contractor” with Personnel Contracting, who then supplied his labour to a construction client.

Despite the terminology used in the agreement, the High Court ultimately found Mr McCourt to be an employee of Personnel Contracting. The case reinforced an important principle, that calling someone a contractor doesn’t necessarily make them one.

Interestingly, both the Federal Court and Full Federal Court had left Mr McCourt’s classification as an independent contractor undisturbed before the High Court overturned that outcome. The decision makes clear that an ABN or a contract describing a worker as a contractor will not, of itself, determine the true nature of the relationship. 

Where parties have entered into a comprehensive written agreement, the contractual rights and obligations created by that agreement are central to determining the nature of the relationship for common law tax purposes. The ATO incorporates the principles arising from the Personnel Contracting matter into Taxation Ruling TR2023/4. 

Relevant considerations include the degree of control available to the engaging entity, whether the individual is working in the business of the engaging entity or operating an independent enterprise of their own, the ability to delegate work, the basis on which payment is made, commercial risk, equipment and the capacity to generate goodwill. An ABR and an invoice are therefore only part of the picture. 

PAYG Withholding can be part of the exposure 

If a business has treated an individual as a contractor when the person was actually an employee, PAYG withholding obligations may also have been missed.

The ATO requires businesses to withhold tax from wage payments to employees and payments made to workers under labour hire arrangements. That is particularly important in the labour hire industry. A common misconception is that PAYG withholding does not apply simply because the worker is described as an independent contractor. Under the PAYG withholding legislation, payment made by a labour hire company to workers under a labour hire arrangement can be subject to PAYG withholding, whether those individuals are employees or independent contractors.

The ATO’s ruling on labour hire arrangements specifically recognises that a labour hire company may fulfil its obligations to a client using employees or independent contractors, with PAYG withholding provisions potentially applying in either case.

So, the question is not simply ‘Is this person a contractor?’. It may also be, ‘What type of arrangement are these payments being made under?’. 

Superannuation creates another test 

Superannuation adds another layer, even where an individual is genuinely an independent contractor under the ordinary common law test, they may still be treated as an employee for superannuation guarantee purposes.

The ATO states that an independent contractor can be an employee for superannuation purposes where they are paid mainly for their labour, are paid for their personal labour and skills, and are required to perform the work personally rather than delegate it.

Importantly, having an ABN does not prevent this extended definition from applying. This means a business may be correct in saying ’this person is an independent contractor’, but still be wrong in concluding ’therefore, we are not required to pay super’. That distinction can produce significant historical liabilities where a contractor model has operated for several years.

Payroll has its own rules 

And then there is payroll tax. Payroll tax is administered separately by each state and territory, and its treatment of contractors cannot simply be assumed to follow the ATO’s conclusion.

In most jurisdictions, contractor provisions can bring payments made under certain contracting arrangements into the payroll tax net, even where the worker is otherwise an independent contractor. Labour hire and employment agency arrangements can also be subject to specific deeming provisions.

Western Australia is not harmonised with the other jurisdictions in its treatment of contractors, although it similarly has provisions dealing with employment agency arrangements. RevenueWA expressly notes that under an employment agency arrangement, the agent is deemed to be the employer and is liable for payroll tax on payments made to workers.

The details vary across the country, which makes jurisdiction-specific advice particularly important for businesses operating in multiple states.

What matters from a risk perspective is that an ATO conclusion about employment status does not necessarily determine the payroll tax outcome, and vice versa.

One relationship, several different questions 

This is perhaps the most important point for advisors. There is no longer a single “employee vs contractor test” that answers every question.

A business may need to consider separately: 

• whether the individual is an employee at common law for tax purposes; 

• whether PAYG withholding applies to the payments; 

• whether the individual falls within the extended employee definition for superannuation; 

• whether state or territory payroll tax legislation captures the payments; and 

• whether the individual is an employee for Fair Work Act purposes. 

The Fair Work position has itself changed. From 26 August 2024, constitutionally covered businesses generally apply a "whole of relationship" test which considers the real substance, practical reality and true nature of the relationship, including both the contractual terms and how those arrangements operate in practice. 

Importantly, Fair Work expressly notes that this definition does not alter the meaning of employee under separate tax, superannuation or workers compensation legislation. The same worker can therefore require consideration under several different legislative regimes. 

Where the risk becomes significant 

There are some common characteristics that should prompt closer review of a contractor model. 

Risk of the historical contractor relationship being considered an employer/employee relationship may turn on an assessment of whether the relevant personnel: 

• predominantly provide their own labour; 

• are paid hourly, daily or weekly rather than to achieve a defined result; 

• work predominantly or exclusively for one organisation; 

• are required to personally undertake the work; 

• have limited ability to delegate or subcontract; 

• perform substantially the same work as employees of the business; 

• are subject to significant control or direction; 

• bear little commercial risk; or 

• have remained continuously engaged for an extended period. 

The insolvency consequences and way forward

Prior to the High Court’s 2022 decision in Personnel Contracting, some directors may have treated payments to contractors as ordinary operating expenses without recognising the potential for associated PAYG withholding, superannuation or payroll tax liabilities.

Following Personnel Contracting, however, the existence of an ABN, the issuing of invoices, or simply describing a worker as a “contractor” in an agreement is not, of itself, determinative of the relationship. An ATO or State Revenue Authority review can result in a very different characterisation and potentially significant historical liabilities. 

This is particularly important for businesses that rely heavily on contractor workforces, including those operating in labour hire, construction, transport, cleaning, security and other labour-intensive industries. Reviewing contractor arrangements before they come under regulatory scrutiny provides directors and their advisers with an opportunity to properly assess the potential exposure and consider the company’s position in a more timely and controlled manner. 

Whether the issue is identified through an internal review or following an ATO or State Revenue Authority audit, the resulting exposure to unpaid PAYG withholding, superannuation and payroll tax can be substantial. Where those liabilities cannot be met from existing resources, the issue can quickly become one of solvency rather than simply tax compliance. In those circumstances, a formal restructuring process may provide the most effective means of addressing the historical liabilities while preserving an otherwise viable business.