In a previous post, Overview of Legal Entities, I mentioned that the Pty Ltd company is increasingly common in certain industries, sometimes as an attempt to convert employees to contractors and avoid employee costs. However, many government departments are aware of this, and so each has their own test to determine who is actually an employee. In this post, I go over some important points and provide links to some helpful online tests.
Why Convert Employees to Contractors?
First, a quick look at the motivation for employers to convert their staff to contractors. The most obvious motivation is to save on payroll costs. Payroll costs can be over 50% of the before-tax hourly rate paid to staff.
The second motivation is to lower payroll processing costs, i.e. the cost of the staff, software and office equipment in the payroll department. In larger manufacturing companies, there may be hundreds of staff entitled to overtime loading and various allowances. In those cases, it can take multiple full-time payroll specialists (or expensive software) to calculate each pay run, meaning that the cost of the payroll department can be well over half a million dollars per year.
If you treat a worker as a contractor, but they are deemed an employee, there are consequences.
You will be liable for all employee costs that have not been paid, some of which will have late penalties and/or charge interest for late payment.
There may also be other penalties to discourage incorrectly converting workers to contractors, depending on the government department.
Most government departments have similar, though not identical, rules. Your staff member may not be considered a contractor if one or more of the following apply:
- you are their only client,
- you specify exactly what they do and when they do it,
- you provide a uniform,
- you provide the equipment for their work,
- they can not delegate or sub-contract the work to other parties,
- you pay them for hours worked, rather than achieving a result,
- you withhold taxes from their payments,
- they are not liable for correcting defects,
- they are not free to accept or refuse additional work, and/or
- they do not appear to be running a separate business.
Every situation is treated as unique, so it is difficult to advise on the most important principle(s) in the above list. If a contractor arrangement is questioned, the practical details of the relationship will be deemed more important than the terms of the contract.
Online Tests and Further Information
Each government department has it’s own rules, but thankfully many of them also offer a questionnaire-style online test. Below is a list of links to relevant government department websites, with notes:
- Business.gov.au has an excellent section on independent contractors.
- Fair Work Ombudsman for minimum entitlements for employees, independent contractor protections, and a discussion of sham contracting (fact sheet).
- ATO for withholding tax, compulsory superannuation and fringe benefits tax (test).
- WorkCover NSW for workers compensation insurance and safety issues (assistance line). Similar bodies exist in other states.
- NSW Office of State Revenue (or similar body in your state) for payroll tax. Note that payments to contractors may still be liable for payroll tax unless they pass specified criteria.
In general, the legislation appears to target employers that are trying to avoid their responsibilities. Speak to your professional advisor about your particular situation.