Business owners have legal obligations to recognise certain worker entitlements but the nature of those entitlements differ depending on the capacity in which labour is engaged by the business. One of the most significant distinctions is that between an employee and a contractor. Complex working relationships can make the distinction challenging and business owners often make mistakes in giving weight to the wrong factors in determining the nature of the engagement.
Knowing the law in this area has become even more important following 2 key High Court decisions in 2022 that have changed the previously long-standing tests.
Failing to provide the correct entitlements can expose businesses to employment claims resulting in substantial compensation payouts and penalties for breaches of the law.
The article will identify 3 key areas where the distinction between employee and contractor is particularly important and will outline the relevant tests that business owners need to know.
Ordinarily, employees are entitled to superannuation payments from their employer whereas contractors are not. However, section 12(3) of the Superannuation Guarantee (Administration) Act 1992 (Cth) contemplates that contractors may be entitled to superannuation payments when they are engaged in a relationship or pattern of work which is more akin to that of an employee. The section sets out the following test:
‘If a person works under a contract that is wholly or principally for the labour of the person, the person is an employee of the other party to the contract’
The ATO provides guidance in determining when a contract is ‘wholly or principally for labour’ by reference to 3 factors:
1. The contractor is paid wholly or principally for their personal labour and skills
This is usually determined by reference to the proportion of the contract’s monetary value attributable to labour. Where more than half of the dollar value of the contract is for labour, the principal is deemed to have engaged the contractor ‘wholly or principally for their personal labour or skills’. On the other hand, for example, if the contractor invoices a business for labour and parts, where parts constitute a larger proportion of the invoice, the contractor is not paid ‘principally for personal labour and skills’ and thus would not be an employee for superannuation purposes.
2. The contract is performed personally by the contracted individual
This means that the contracted work is not further delegated by the contractor. By extension this means that the contract must be directly between the individual responsible for completing the works and the engaging business. Merely possessing an ABN does not automatically render an individual a contractor. However, if the contract is between the engaging business and another company, trust or partnership, then any individual from that company, trust or partnership who performs the works is not considered an employee of the engaging business for superannuation purposes.
3. The contractor is paid for hours worked, rather than upon achieving a desired result or outcome
This mirrors the type of engagement that would typically be expected with an employee of a business, where payment is routine and is calculated based on hours worked, irrespective of performance or the completion of specific tasks or projects. For example, where a contractor is engaged to paint a building and payment is a fixed amount conditional upon completion of works, the contractor is not considered an employee of the engaging business. On the other hand, contractors that are engaged on an ongoing basis are more likely to be deemed employees for superannuation purposes.
Employee Entitlements and Tax Obligations
Employees receive leave entitlements (i.e. annual leave, sick leave, carers leave etc) from the engaging business under the Fair Work Act 2009 (Cth) whereas contractors do not receive any leave benefits. Similarly, employees have tax deducted or withheld from salary and wages under PAYG arrangements whereas contractors are responsible for paying their own income tax and GST. Consequently, incorrectly classifying an employee as a contractor can result in a business defaulting on its leave entitlement and tax obligations.
Historically, courts assessed the conduct of parties before and after entering a contract to determine whether the engagement was one between principal and employee or principal and contractor. However, the High Court handed down two key decisions in 2022 that have changed the test.
Case 1: Construction, Forestry, Maritime, Mining and Energy Union v Personnel Contracting Pty Ltd  HCA 1
Personnel Contracting Pty Ltd (trading as ‘Construct’), a labour-hire company, engaged in the business of supplying labour to building clients. In 2016, Construct hired Mr McCourt who signed an Administrative Services Agreement (‘ASA’) which described him as a ‘self-employed contractor’. Mr McCourt was assigned to a construction project run by Hanssen Pty Ltd (‘Hanssen’), one of Construct’s main clients. Throughout the course of his employment, he was primarily supervised and directed by Hanssen while Construct only made occasional site visits. Several years later, Mr McCourt and Construction, Forestry, Maritime, Mining and Energy Union commenced proceedings against Construct seeking orders for compensation and penalties on the basis that Construct had not paid Mr McCourt his entitlements as an employee.
The trial judge applied a ‘multifactorial approach’ to answer the question whether Mr McCourt was an employee or independent contractor. Amongst other minor points, the judge found that the fact that Hanssen, as opposed to Construct, had control over the performance of work by Mr McCourt and that Mr McCourt had not been integrated into the business of Construct as determinative of his status as an independent contractor. In the trial judge’s opinion, these factors outweighed the evidence which supported the conclusion that Mr McCourt was an employee, including that he was an unskilled labourer, and thus did not operate his own business like an independent contractor, and that he only provided limited tools and equipment of his own. The Full Federal Court similarly applied a ‘multifactorial approach’ and although they were inclined to make a finding that Mr McCourt was an employee, they upheld the finding of the trial judge due to persuasive authority that supported the trial judge’s reasoning.
On appeal, the High Court was critical of the ‘multifactorial approach’ and stated that an overreliance on circumstantial indicia had undermined the entire purpose of having written contracts between parties which expressly contained terms that were intended to govern their relationship. Accordingly, the High Court restated the test to be applied in determining whether a person is an employee or a contractor, in the following authoritative statement:
Where the parties have comprehensively committed the terms of their relationship to a written contract the validity of which is not in dispute, the characterisation of their relationship as one of employment or otherwise proceeds by reference to the rights and obligations of the parties under that contract. Where no party seeks to challenge the efficacy of the contract as the charter of the parties’ rights and duties, on the basis that it is either a sham or otherwise ineffective under the general law or statute, there is no occasion to seek to determine the character of the parties’ relationship by a wide‑ranging review of the entire history of the parties’ dealings. Such a review is neither necessary nor appropriate because the task of the court is to enforce the parties’ rights and obligations, not to form a view as to what a fair adjustment of the parties’ rights might require.
Applying the test, the High Court determined that several key provisions of the ASA indicated that Mr McCourt was an employee of Construct. These provisions expressly gave Construct the authority to:
- fix Mr McCourt’s renumeration for work;
- act as Mr McCourt’s paymaster;
- terminate Mr McCourt’s engagement should he fail in any respect to obey the directions of Construct or Hanssen; and
- control the work Mr McCourt was to do and how the work was to be carried out.
Based on those provisions, the High Court ruled that Mr McCourt’s relationship with Construct was to be characterised as a contract of service rather than a contract for service and as such Mr McCourt was Construct’s employee.
Case 2: ZG Operations & Anor v Jamsek & Ors  HCA 2
Between 1977 and 1985, Mr Jamsek and Mr Whitby (the ‘respondents’) were employed as truck drivers in the business of ZG Operations & Anor (‘ZG’) which had undergone several changes of ownership. In 1986, ZG insisted that it would no longer employ the respondents and would continue to use their services only if they purchased the trucks and entered into contracts to carry goods for ZG. Each of the respondents agreed to the new arrangement, entered into partnerships with their respective wives (the ‘partnerships’) in order to purchase trucks from the company and executed a written agreement with the company for the provision of delivery services (the ‘1986 contract’). Between 1998 and 2001, further contracts were executed between the partnerships and ZG which were largely similar to the 1986 contract except for increases in the hourly rate of pay. Several years later, the respondents commenced proceedings against ZG claiming that they were employees of ZG who were entitled to superannuation payments, amongst other entitlements, for the entire duration of their engagement. Neither party to the contract contended that the contract was sham or had been varied or otherwise displaced by conduct of the parties.
The primary judge concluded that the respondents were independent contractors of ZG. The Full Court of the Federal Court of Australia allowed the respondent’s appeal, holding that the respondents were employees of ZG. ZG appealed to the High Court.
The appeal was heard concurrently with the appeal in Construction, Forestry, Maritime, Mining and Energy Union v Personnel Contracting Pty Ltd and thus the High Court applied the same principles as were expressed in that case. Primarily, applying well-established principles of contract interpretation which allow regard to be had to the circumstances surrounding the making of a contract, the High Court observed that the whole genesis of the 1986 contract was ZG’s refusal to continue to employ the respondents as drivers. Against that background, the High Court found that it would be difficult to conclude that that the respondents, having seemingly accepted that refusal, remained employees of ZG after entering the 1986 contract. Nevertheless, the High Court returned to the express provisions of the 1986 contract and the various subsequent contracts to note the following clauses:
- the partnerships had to supply their own vehicle to undertake carriage of goods, pay interest on the funds borrowed to finance the purchase of vehicle, pay all legal costs, such as tax and duty, in relation to the vehicle and keep the vehicle mechanically sound, road worthy and clean;
- the respondents were told what to deliver but had to organise collection from the warehouse, truck loading and delivery routes on their own;
- the respondents did not have to wear a uniform and only occasionally did ZG ask the respondents to install tarpaulins bearing ZG’s logo on the trucks;
- the partnerships were to invoice ZG, originally on a ‘per carton’ basis but subsequently on an hourly basis, for the work carried out;
- the partnerships were to obtain and maintain a public liability insurance policy for an amount of $2,000,000 or greater in respect of any liability incurred by the partnership in performing work for ZG;
- the partnerships were to obtain and maintain a comprehensive motor insurance policy over the vehicle for an amount of $5,000,000 or greater for third party property damage in respect of one accident; and
- the partnerships were able to work for other parties, providing that such work was not detrimental to either ZG or ZG’s customers.
The contracts also stated that the partnerships ‘agreed to not engage or use the services of a driver for the vehicle without prior and continuing approval by ZG’. On the High Courts’ interpretation, the fact that the clause contemplated the services of driver being fulfilled by a person outside of the partnership indicated that the contractual obligations were not personal to the respondents as they would be if the respondents were employees of ZG. Further, although the High Court conceded that the clause stipulating work hours as ‘a standard nine hour working day with a usual starting time of 6 am’ favoured the finding of an employment engagement, the clause had to be read in context of other clauses which indicated that ‘ZG would wherever possible, offer extra work to the [partnerships] at a mutually agreed rate for each job’. This indicated a level of ‘flexibility built into the contract for the remuneration to increase as extra work was undertaken’ which was more akin to the way that independent contractors are usually renumerated.
Assessing the contractual provisions in totality, the High Court found that the respondents had entered into contracts for services rather than contracts of service with ZG and as such the respondents were independent contractors.
Common Relationship Indicia
The High Court cases reinstate the importance of giving priority to the express terms of the contractual agreement in characterising the relationship between two parties. Having determined the express terms of an agreement, it is important to be able to correctly assess whether a particular term indicates the relationship of employer/employee or principal/contractor.
From a legal perspective, parties should have consideration to matters relating to:
- amount of control over work
- financial responsibility and risk
- tools and equipment
- ability to delegate work
- hours of work
- expectation of work continuing
Parties should also seek accounting advice as there are different impacts on taxation under the arrangements, including the 80/20 income rule.
What this means for your business
Businesses and contracting parties must ensure that their arrangements are correctly classified as to employees or contractors. The distinction is of significance, particularly given the important legal obligations that it imposes on businesses with regards to superannuation, employee entitlements and tax. Observing these obligations are critical and protects businesses from potential compensation claims and penalties.
Importantly, when making the assessment of whether a person is an employee or independent contractor, primacy must be given to the express terms of the written contract between the parties. General relationship indicia may be used subsequently to determine whether the contractual rights and obligations indicate a relationship of employer/employee or principal/ contractor.
Moving forward, businesses will need to ensure that they draft clear and unambiguous written agreements when engaging new people for work. Contracts expressing a clear intention as to the mode of engagement will be critical in reducing future disputes and claims being made against the business.
At Bryks Lawyers, we are experienced in dealing with contractor agreements and their related implications and consequences. Contact us today to see how we can assist you!