In The Tax Institute’s TaxVine email [No.3, 10.2.23], their Tax Counsel, Julie Abdalla, FTI, examines the draft ATO guidance on the characterisation of workers as employees or contractors, following the High Court decisions in 2022.



Relevance of the ‘employee or contractor’ distinction

The ‘employee or contractor’ distinction pervades both federal and state laws including PAYG withholding, superannuation guarantee (SG), Single Touch Payroll reporting, GST, payroll tax and workers’ compensation [not to mention Fair Work type law, as well]. Contemporary changes to the working environment and ways of working have seen an increase in arrangements challenging the traditional employee-contractor distinction. The different legal and administrative frameworks at the federal and state levels, each with differing definitions of the relevant terms, compounds this complexity. This lack of harmony unsurprisingly leaves taxpayers concerned about exposure to potential penalties and interest for failing to comply with their tax obligations due to lack of awareness or understanding of the nuances as between the various regimes. While it is clear that more must be done to address this complexity and resulting uncertainty, the High Court decisions provide guidance on how employers can determine if an individual is an ‘employee’ within the ordinary common law meaning of the term.

The new employee-contractor landscape

Prior to the High Court decisions in Construction, Forestry, Maritime, Mining and Energy Union v Personnel Contracting Pty Ltd [2022] HCA 1 (CFMEU case) and ZG Operations Australia Pty Ltd v Jamsek [2022] HCA 2 (Jamsek case), the courts applied various methods to determine whether an individual was an employee or a contractor. However, since these cases, the contractual terms of a complete and valid written contract have taken a clearly paramount role in making this determination.

Implications of the High Court cases

In CFMEU, the High Court ruled that a the relevant written labour hire agreement, in fact created an ’employer – employee’ relationship, despite the fact that, this agreement purported to characterise the worker, as an independent contractor’. This was determined by considering the totality of the relationship, arising from the legal rights and responsibilities contained in the contract. This was something of a watershed, as Courts had previously followed a ‘multifactorial’ approach, under which, conduct, subsequent to the parties entering into the contract, was relevant to determining whether it created a master-servant, or independent contractor relationship. The High Court affirmed this approach in Jamsek, and the approach from both of these cases was applied in JMC Pty Ltd v Commissioner of Taxation [2022] FCA 750 (JMC). The High Court decisions, and that of Federal Court in JMC, emphasise that in the absence of a sham, or some other variation or displacement by conduct, the terms of the contract should be accepted over the traditional multifactorial test.

Extended definition of ‘employee’ for superannuation guarantee

While the High Court in Jamsek declined to rule on the extended definition of employee for the purposes of section 12(3) of the Superannuation Guarantee (Administration) Act 1992, JMC provides some guidance on this issue.

From JMC, the following elements must be satisfied for a person to be characterised as an employee under the extended definition:

  • there must be a contract;
  • the contract must be wholly or principally for the labour of the person; and
  • the person must work under that contract.

The second element is likely the most contentious and is to be approached from the perspective of the putative employer by reference to the terms of the contract. It will not be satisfied, if the contract is for the provision of a result and the worker is paid for that result.

In JMC, the worker hired to lecture and mark exams was held to be an employee because, among other things, he was paid per hour rather than for completing tasks. The worker also lacked an unfettered discretion to delegate because all delegations had to first be approved by the employer. Further detail on this case can be found in our article.

What does this mean in practice?

The decisions in the High Court and the Federal Court demonstrate that where a written contract is complete, and its validity is unchallenged, determining whether a worker is an ’employee’ or a ‘contractor’ turns on the interpretation of that contract. Therefore, businesses and practitioners should verify that their contracts (particular if they intend to establish an ‘independent contractor’ relationship), that details relevant factors such as: delegation, mode of remuneration, provision of equipment, control and independence. However, where a contract is not comprehensively committed to writing, then other non-written understandings will be relevant. The High Court’s approach of being able to determine whether the contract establishes an ’employee’ or ‘independent contractor’ remains in place, even if evidence of those other understandings can be found in conduct after the contract commences. The basic ‘common law’ tests of ‘control’ and degree of ‘integration’ remain undisturbed, even if the way that is assessed has changed (that is – to be found in the terms of the contract, as from the beginning).

ATO Guidance

Historically, the ATO considered the totality of the relationship in determining whether the individual was an employee or a contractor. This approach is reflected in Taxation Ruling TR 2005/16 Income tax: Pay As You Go – withholding from payments to employees (TR 2005/16). No one factor was considered decisive and various factors were balanced including the degree of control over the worker, ability to delegate and risk allocation. The contractual terms were also considered, although only as one factor of many.

Following CFMEU and Jamsek, the ATO withdrew TR 2005/16 and released the following draft guidance:

  • draft Taxation Ruling TR 2022/D3 Income tax: pay as you go withholding – who is an employee? (draft Ruling); and
  • draft Practical Compliance Guideline PCG 2022/D5 Classifying workers as employees or independent contractors – ATO compliance approach (draft PCG).

Paragraph 7 of the draft Ruling currently states that whether a worker is an employee of an entity under the term’s ordinary meaning is a question of fact to be determined by reference to an objective assessment of the totality of the relationship between the parties, having regard only to the legal rights and obligations which constitute that relationship. The Tax Institute considers that it is important that the wording in the draft Ruling clearly reflects the High Court’s interpretation, that the examination of the totality of the relationship is limited to the contract governing the relationship.

Of importance for practitioners is the draft PCG that provides the ATO’s compliance approach to businesses that engage workers. The draft PCG contains four risk zones that indicate how the ATO will apply its compliance resources where there is an unpaid superannuation query or proactive case selection. For employers and practitioners, this should improve transparency of the factors of importance to the ATO when examining the characterisation of workers for employer obligations.

The Tax Institute is supportive of ATO guidance that is easy to understand, consistent with case law and does not impose disproportionate or additional obligations on taxpayers above those required at law. In particular, the categorisation of arrangements into the various risk zones in the draft PCG needs to be simple and clear. If it is not, the draft PCG risks increasing complexity and confusion for how employers should characterise their workers.

Consultation on the draft Ruling and draft PCG closes on 17 February 2023.

The ATO’s guidance on the extended definition of ‘employee’ for SG is also currently being reviewed, to reflect the decision in CFMEU, although existing guidance in Superannuation Guarantee Ruling SGR 2005/1 Superannuation guarantee: who is an employee? aligns with the approach taken in JMC.

Employees, contractors and beyond

When considering the bigger picture and numerous parts of the tax and superannuation systems where this question arises, the current settings are rife with complexity. The recent court decisions and ATO guidance assist taxpayers and practitioners to navigate the rules as they are currently interpreted to apply. However, they do not go so far as to keep up with the evolving work landscape. Rather than addressing interpretation and application on a regime or provision basis, The Tax Institute is of the view that we should be taking a step back and considering the merits of a broader definition of worker that could potentially be applied harmoniously. This would reduce the administrative burden on taxpayers by eliminating the need to classify workers for payroll tax SG and other purposes. It also could improve the tax system’s efficiency by more readily capturing unconventional types of working arrangements such as those arising from the sharing economy. More detail about potential options for reform in this regard are considered in our Case for Change discussion paper. This is a matter for Parliament to consider across the federal level, and perhaps in future, to consider in collaboration with the States.

Closing comments

The dichotomy between employees and contractors continues to be relevant in many Australian taxation and superannuation laws. The current approach set by the High Court in CFMEU and Jamsek focuses on the relationship between the parties as indicated in the terms of the contract rather than through their historical conduct, and the ATO has updated its guidance to reflect this. The Federal Court has suggested an approach for the extended definition of ‘employee’ for SG that looks at the terms of the contract. The Tax Institute considers more holistic reform is necessary to reduce the administrative burden and compliance costs associated with this issue.


[TaxVine 3 – 10.2.23]



[Tax Month – February 2023, last month] 21.4.23