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Decoding the ATO employee definition of PAYG withholding

In the realm of Australian taxation, the classification of workers as either employees or contractors holds significant implications for both the engaging entity and the individual providing services. The Australian Tax Office (ATO) has recently finalized Taxation Ruling TR 2023/4, which outlines the criteria for identifying an employee under s12-35 of Sch 1 of the Taxation Administration Act 1953. 

Simultaneously, the ATO has issued Practical Compliance Guideline – PCG 2023/2 – Worker Classification as Employees or Independent Contractors – ATO Compliance Approach (PCG 2023/2). This guideline outlines the Commissioner of Taxation’s compliance approach for business on how compliance resources are allocated and considering the associated risks with the classification.  Similar to TR 2023/4, this signifies the conclusion of the earlier draft version that was released.

Understanding these criteria is crucial for the business to ensure compliance with the PAYG withholding rules for employees. This article aims to decode the ATO’s employee definition for the PAYG withholding and highlighting the factors used to determine the nature of the working relationship following the TR2023/4.

Section 12-35 stipulates that entities must withhold a certain amount from payments such as salary, wages, commission, bonuses, or allowances made to an individual acting as an employee, regardless of whether the paying entity is the employer. To fall under this section, the payment must be linked to the individual’s employment and be made in their capacity as an employee. It excludes the payment for work and services that are subject to withholding under other provisions, such as director’s payment, labour hire payments and alienated personal services income. 

The term ’employee’ is not explicitly defined in the Tax Administration Act (TAA), the ATO considers various factors to determine whether a worker is an employee or a contractor. These factors collectively assess the totality of the relationship between the worker and the engaging entity. Key aspects include the degree of control exercised over the worker, the method of remuneration, the provision of tools and equipment, and the intention of the parties involved.

The more control an engaging entity has, the more likely the worker is considered an employee for PAYG withholding purposes, as it indicates a subservient and dependent relationship with the engaging entity. 

The totality of the relationship between a worker and an engaging entity is assessed from the contractual relationship between the parties. The first step involves identifying the contract between the parties, which can be entirely in writing, wholly oral, or a combination of both. The second step is to identify the terms of the contract, which comprise the legal rights and obligations. 

When a contract is claimed to be wholly written, it’s essential to ensure that it comprehensively covers all agreed-upon terms, including potential oral and implied terms. This may involve examining the factual arrangement to understand the contractual terms. In the case of Hollis, the High Court determined that the contractual relationship with bicycle couriers was partly oral, considering aspects like remuneration not recorded in the written agreement.

If a contract is not entirely in writing, evidence of contract performance, subsequent conduct, and work practices is considered to identify the agreed-upon terms. Once the terms are established, they alone are relevant to determining the nature of the relationship between the parties. The former ‘multifactorial test’ is no longer necessary. 

Please note that additional evidence surrounding contract formation or performance may be considered under general contract law principles to identify the contract’s object, demonstrate agreements varying terms, reveal shams, or establish legal, equitable, or statutory rights or remedies.

The core distinction between an employee and an independent contractor lies in their role within the engaging entity’s business. An employee serves as an integral part of the employer’s business, performing work within that framework, while an independent contractor provides services to a principal’s business while advancing their enterprise.

Employers generally possess the authority to dictate how, where, and when their employees carry out their work. The significance of this control lies not only in its actual exercise but also in the contractual right of the employer to exert such control.

Kiefel CJ, Keane, and Edelman JJ in Personnel Contracting emphasized that the existence of a right of control helps in distinguishing between a contract of service and a contract for services. This is particularly common for businesses operating in the supply of labour or any similar industries, where the business retains the right to control the work of a person. The right to control will be strongly indicative of an employment relationship for PAYG Withholding purposes, such as in the case of Mc Court v Construct. 

Additionally, a right to terminate a worker’s contract or a requirement where a worker indemnifies an engaging entity for damages from failing to adhere to the engaging entity’s instructions may also confer a capacity to control. 

If the existence of a right that allows a person to delegate, subcontract or assign their work to another has the following components: 

  • Not limited in scope (not limited to certain task). 
  • Not a sham; and
  • Legally capable of exercise. 

It is a strong indicator that the person is working as a contractor instead of an employee. 

When a contract is primarily focused on payment to a person achieving a specified result, it strongly suggests a contract for services rather than employment, though not conclusively. 

However, ‘piece-rate’ or ‘output-based’ payment models can still indicate an employment relationship if they simply indicate a natural means to remunerate the particular kind of task the worker is performing, such as fruit pickers paid daily per bin of fruit packed.  

If a worker supplies the assets, tools, and equipment, including any expenses and overheads, it may suggest that the worker operates as an independent contractor. Nonetheless, a worker using their own tools does not automatically indicate that the worker is a contractor. It is essential to assess the nature, extent, and cost of the tools and equipment used to determine whether the worker is considered an employee for PAYG withholding purposes.

In summary, the Taxation Ruling TR 2023/4 provides clearer guidance on the definition of employee for PAYG Withholding purposes. The ruling explains the term ’employee’ through the totality of the relationship between the person and an engaging entity. It also explored various factors, including the degree of control, method of remuneration, provision of tools, and contractual intentions.  

Now that the tax ruling and PCG are finalised, the business needs to revisit the working arrangements with each individual to determine whether the individual is an employee or an independent contractor for the PAYG Withholding. Eventually, the business can manage its compliance risk effectively.   

For any enquiries related to this update, contact us today.

Beatrix Willy

Beatrix is a committed and experienced tax professional with over 7 years of experience and knowledge across corporate tax compliance, Goods and Services Tax (GST) reporting, personal tax compliance, tax equalization, shadow payroll set-up/ reporting and employee share scheme reporting.

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