A common misconception for higher education institutions is that tax is not an issue because they are charitable not-for-profits and therefore tax exempt. However, employment taxes still need to be on every institution's radar. PAYG tax withholding, fringe benefits tax, payroll tax and superannuation are relevant to all employers, even charitable ones, and the penalties for breaches can be severe.
There are two common situations where higher education institutions need to take particular care. This will ensure they are meeting their employment tax obligations and not exposing themselves to unnecessary risk, particularly when engaging contractors/consultants and paying out leaving employees.
Issue 1: Tax and contractor arrangements
Employment-related taxes apply even when an individual is engaged as an independent contractor. Payroll tax, for example, automatically applies to contractor arrangements unless the conditions in one of the exemptions are met. This means that whenever a contractor arrangement is entered into, each exemption must be reviewed to confirm whether or not one will apply to avoid a payroll tax liability. The superannuation guarantee scheme also casts a wide net. Individuals who are engaged under a contract that is wholly or principally for their labour will be deemed employees for SG purposes and super contributions will be required.
However, even where the parties have assumed that an individual is an independent contractor, they may discover that an employer/employee relationship has inadvertently been created via the terms of the engagement. If this happens, the range of employment taxes that apply can become much broader.
In recent years, the 'employee v independent contractor' landscape has shifted due to a number of key tax and employment law cases. As a result, we have seen the ATO and State revenue offices become more active in reviewing contractor arrangements. In many cases, they have even re-characterised the relationship as one of employer/employee and the deemed employer has become liable to taxes and withholding obligations (and penalties) they had assumed did not apply.
Deciding whether someone is an employee or an independent contractor will always be a 'facts and circumstances' test, but the following checklist can help to differentiate an individual who is engaged as an independent contractor from an individual who is an employee:
- the individual is engaged through their personal services entity (eg their company);
- the individual is able to provide their services to more than one client;
- the individual is free to engage others to help perform their services (and is responsible for the costs associated with engaging others, eg superannuation, worker's compensation);
- the individual has control over the manner in which they provide their services (eg how, where and when it is provided);
- the individual advertises their services;
- the individual does not hold themselves out as an employee or representative of the contracting entity; and
- the individual has their own business identity and operates from their own business premises.
However, the following features will not be determinative:
- the individual has an Australian Business Number – it is now not enough to simply assume that an individual is a contractor because they have an ABN;
- the agreement states that the individual is being engaged as a contractor;
- the individual issues a tax invoice for the work they do; and
- the individual is engaged as a contractor by other clients.
Recent cases, and the response from the ATO and revenue offices, mean that every contractor engagement now needs to be reviewed much more closely to determine whether, on balance, an independent contractor or employee relationship exists. This process can be aided by having practical and clearly communicated guidelines which staff can use to classify the arrangement and identify what tax obligations apply. If simple steps are taken at the outset, it can help to protect against future unforeseen tax consequences if the regulators scrutinise the arrangements in the future.
Issue 2: Leaving employees – getting the tax obligations right
Whenever payments are made to leaving employees it is imperative to properly categorise the payments for tax purposes and to correctly withhold and report tax to the ATO. Penalties will apply if an employer fails to withhold when they should have or if they fail to withhold at the correct rate. In addition, because employers are required to report termination payments to the ATO, failing to properly withhold could mean that they make false statement to the ATO, which will expose them to even further penalties. It is therefore important to divide every termination payment into its various parts and then apply the special tax withholding rules to each of those parts.
One type of termination payment is an 'employment termination payment' (ETP). These are lump sum payments that are made to an individual when their employment is terminated and include 'golden handshakes', severance pay and payments in lieu of notice. The tax regime that applies to ETPs was changed quite significantly in 2012 and employers paying ETPs now need to take additional steps to ensure they meet their tax obligations.
The changes mean that the concessional tax treatment for certain ETPs is limited where the employee's taxable income (including the ETP) exceeds $180,000 for the year, with employers having to withhold from any part of the ETP that exceeds the applicable 'cap' at the top marginal rate. This means that employers have to make inquiries about how much taxable income has been received by the employee prior to the ETP being paid, to then work out what cap applies and how much tax they need to withhold.
There are a range of payments that are excluded from these rules, such as ETPs for unfair dismissal, genuine redundancy payments, and certain payments for personal injury. It is also worth remembering that payments for unused annual and long service leave are subject to their own tax withholding rates, which are dependent on the employee's service period.