On December 6, 2023, the Australian Taxation Office (ATO) finalized its guidance on the classification of workers for tax and superannuation purposes with Taxation Ruling TR 2023/4 – Income tax: pay as you go withholding – who is an employee? This ruling provides clarity on the ordinary meaning of “employee” for pay-as-you-go withholding (PAYG) and the Superannuation Guarantee (SG). The final version incorporates feedback and reflects the Full Federal Court’s decision in JMC Pty Ltd v Commissioner of Taxation [2023] FCAFC 76 (JMC), which was not available during the draft’s release.
In tandem, the ATO also issued Practical Compliance Guideline PCG 2023/2 – Classifying workers as employees or independent contractors. This guideline details the Commissioner of Taxation’s compliance approach, emphasizing various process and governance risk factors. Both TR 2023/4 and PCG 2023/2 have been developed to support accurate classification of workers, moving from draft status to their finalized forms.
Key updates in TR 2023/4 highlight the significance of the written contract, evaluating it within a broader context of external events and conditions to determine if it accurately reflects the rights and obligations of all parties involved. This approach prevents undue reliance on contract labels or disproportionate assessments misaligned with actual performance. The ruling introduces a requirement to evaluate external circumstances known to parties at the time of contracting, ensuring comprehensive representation of the contractual relationship.
Although the Fair Work Legislation Amendment (Closing Loopholes) Act 2023 received royal assent on December 14, 2023, it did not include a proposed statutory definition of “employee” for Fair Work purposes. This part of the proposal will be considered in 2024, aiming to introduce a “totality of the relationship” test. This measure, counteractive to 2022 High Court decisions, intends to assess not just contractual terms but also practical performance. However, this Fair Work Act addition will not directly impact tax or superannuation, which will continue using common law principles focused on contractual terms.
Key Differences Between TR 2023/4 and its draft: The finalized TR 2023/4 reflects feedback and principles from the JMC case, emphasizing multiple aspects:
- Contract Identification: The ruling underscores identifying the contract as the “first step,” whether it’s wholly written, oral, or implied through conduct. It supports considering external factors known during contract negotiation to identify its true purpose and terms.
- Totality of the Relationship: The ruling clarifies that an analysis of the “totality of the relationship” should focus on legal, contractual rights, aligned with guidance from notable High Court decisions. This responds to feedback suggesting the draft overlooked key High Court principles.
- Control: The revised ruling elaborates on the “right to control” as a primary indication of employment status, important for understanding modern flexible work arrangements. The ruling suggests that control is more about the employer’s right to exercise it rather than its actual enforcement.
- Hourly Rate Remuneration: While hourly rates often align with employment, the decision in JMC suggests they are not strong indicators on their own, particularly in JMC’s unique factual context. The ruling cautions against disregarding hourly remuneration in classifying employment.
- Subcontracting/Delegation: The ruling incorporates insights from the JMC case, indicating that even restricted delegation (e.g., with principal’s approval) opposes an employment relationship. It stresses that limitations must be assessed in context with the rest of the contractual terms.
- Sham Contracts: The final ruling revises “sham” contract guidance, aligning more closely with contract law than the Fair Work Act’s “sham arrangement” provisions.
PCG 2023/2 outlines a risk-based approach to worker classification, emphasizing comprehensive contracts for lower compliance risk zones. Key changes include:
- Very Low and Low Risk: A comprehensive written agreement is now required, with “very low” risk profiles needing evidence of worker classification under SGAA Section 12.
- Medium Risk: It removed the need for formal advice confirming classifications but added criteria on not deviating from agreed contractual rights and obligations.
Implications for Employers: The trend towards non-traditional worker engagement persists, necessitating robust governance frameworks to address varying assessments under Fair Work and tax principles. With potential legislative changes and the finalized ATR rulings, employers are advised to review governance structures, ensuring comprehensive contract documentation and readiness for ATO scrutiny beyond written contracts.
The importance of understanding the distinction between legal interpretations for tax, superannuation, and employment purposes cannot be underestimated. Organizations are urged to ensure clarity in contractual terms and maintain processes that evaluate the performance against said contracts. Automation and strategic communication pathways can help embed compliance and mitigate risks.
In conclusion, employers stand to benefit from proactively adjusting their contractor management processes in view of the new guidelines. Ensuring that contract terms reflect actual working conditions, reviewing governance frameworks, and preparing for external verification are prudent steps forward. As the ATO solidifies its stance on these classifications, businesses must pivot to remain compliant, reducing potential exposure to legal challenges and compliance actions.
