The incorrect characterisation of workers as contractors rather than as employees can lead to a range of regulatory risks.
Our tax and employment law teams have prepared a simple case study, based on actual events, to demonstrate some of the problems.
The start of a new financial year is an ideal opportunity to:
- review the contractual arrangements in place with workers; and
- specifically, consider whether the current characterisation of your workers as either ‘employees’ or ‘contractors’ is consistent with tax and employment law, at both the State/Territory and Federal level.
Times have been tough in recent years, but David’s business, operated by Success Co Pty Ltd (Company), is going reasonably well. David is looking ahead with optimism for the new financial year.
In the ensuing months, David looks back at this time as the calm before the storm. What went wrong? On reflection, David has identified the following chain of events as contributing to the Company’s current financial woes.
A disgruntled worker contacts the Australian Tax Office (ATO) claiming that they were an employee of the Company and employer superannuation contributions should have been made for them.
The ATO investigates the worker’s complaint and the investigation ultimately escalates to an ATO audit over multiple income years.
The Commissioner of Taxation (Cth) (Commissioner) issues default assessments to the Company on the basis that he considers that the Company is liable to pay superannuation guarantee charge. The Commissioner determines that the majority of the Company’s workers are in fact employees within the meaning of sections 12(1) and 12(3) of the Superannuation Guarantee (Assessment Act) 1992 (Cth).
David is aware that as a director of the Company, he may now be personally liable for a company’s unpaid superannuation guarantee charge.
The Company considered the majority of its workers to be contractors and not employees. Therefore, the payments it made to its ‘contractors’ were not salary and wages and accordingly, the Company did not withhold amounts from the payments under the PAYG withholding regime.
David thought that no withholding was required from payments to each of the contractors as in each case, the contractor quoted an Australian Business Number (ABN) on tax invoices provided to the Company.
David received some preliminary tax and legal advice to the effect that the Commissioner may prosecute the Company for failing to withhold an amount from payments of salary and wages to employees. Alternatively, the Commissioner may impose an administrative penalty equal to the amount that the Company should have withheld from each payment. David is hoping that the Commissioner will adopt the latter approach and also exercise his discretion to remit at least part of the administrative penalty, although he is not optimistic.
Fringe benefits tax
The Company receives a request from the ATO for information and documentation in relation to any benefits the Company may have provided to its workers over a number of income years, including the nature of the benefit and the value.
The ATO correspondence refers to a potential liability for fringe benefits tax and the current FBT rate of 46.5 percent. David immediately thinks of the cars provided to a significant number of workers in recent years and the payments commonly made to reimburse workers’ expenses.
As a small business with few employees, the Company considers it is not subject to payroll tax. The taxable wages paid by the Company to its employees are well below the threshold. This is on the basis that payments made to contractors, representing the lion’s share of the Company’ workforce (and cost for the Company), are not required to be taken into account.
The Company has now received correspondence from the Office of State Revenue (Qld). The letter refers to the concept of a “relevant contract” and flags a liability for payroll tax (calculated at 4.75 percent on taxable wages) and corresponding penalties and interest.
The players in our case study have not had to contend, yet, with the Fair Work Ombudsman (FWO). The FWO continues to be very active in the investigation and prosecution of sham contracting arrangements contrary to the Fair Work Act (Act). Under the Act, employers cannot:
- misrepresent an employment relationship, or a proposed employment relationship, to be an independent contracting arrangement;
- dismiss, or threaten to dismiss, an employee in order to re-engage that employee as an independent contractor to perform substantially the same work; or
- knowingly make a false statement with the intention of persuading a person to enter into an independent contracting arrangement.
Employers and the individuals running them found to be in contravention of the prohibitions against sham contracting can be prosecuted for unpaid wages and other employment entitlements that should have been paid or provided, along with civil penalties up to $51,000 for companies and $10,200 for individuals.
In April this year a Sydney retailer, EA Fuller & Sons Pty Ltd, was ordered by the Federal Circuit Court to pay a penalty of $139,040 as the result of a sham contracting arrangement and consequent failure to pay award entitlements. A director of the employer (Mr EA Fuller himself) was found to have been involved in those contraventions and was ordered personally to pay a penalty of $27,808.
Today, 1 July 2013, the FWO has announced the outcomes of a prosecution of a Brisbane real estate agency, found to have improperly classified a real estate agent as a contractor. The agency, Burpengary-based Property Lovers, was fined $19,800 for failing to pay the agent more than $12,000 in wages and entitlements that should have been paid to him over a five month period. Two of its directors were personally fined $3,960 each for their involvement in the employer’s contraventions.