Determining your tax liabilities regarding the workers you engage with depends on whether they are an employee or a contractor. This distinction is important for both Pay-As-You-Go (PAYG) Withholding Tax and payroll tax. We discuss these considerations below.
PAYG Withholding Tax
PAYG is the tax your business pays on staff wages. An independent contractor must take responsibility for their income tax liabilities, which means they will need an Australian Business Number (ABN). Without an ABN, the contractor runs the risk of the hiring business withholding tax at the maximum amount. A contractor should also consider whether they need to register for Goods and Services Tax (GST).
A contractor may enter into a voluntary agreement with a hiring business for them to withhold amounts from payments made to them. This, however, is purely optional and should be included in any contractor agreement.
Payroll tax usually only applies where the business’ total wage bill is above the payroll tax wage threshold. This threshold will vary depending on your state. When payroll tax time rolls around, you want to be sure that your business is correctly paying tax and this differs if a worker is an employee or a contractor.
An independent contractor is generally an individual or a company that enters into a contract for services with a business to produce a particular outcome or result for a pre-determined fee.
Generally speaking, a contractor is paid for the work outcomes they achieve. They can delegate their work, approach work flexibly, can work for third parties, and provide most or all of their own tools, equipment and resources.
A common misconception is that you do not have to pay tax on payments made to contractors and the distinction between PAYG and payroll tax can become confusing. You may need to pay tax on payments made to contractors if the contractor is under what is considered a ‘relevant contract’.
Under the Payroll Tax legislation of each state, a ‘relevant contract’ is a contract under which your business (the hiring business) supplies services, is supplied with services, or re-supplies goods. Re-supply in this context refers to your business supplying goods to another person, whose services are to alter those goods in some way before returning them to the hiring business.
Relevant contracts are taxable unless an ‘exemption’ applies. If no exemption applies, tax payments, including superannuation, must be paid by the hiring business.
There are nine exempt contracts under the relevant Payroll Tax legislation, and a contract will only need to meet one of the exemptions to avoid payroll tax liability. These exemptions are:
- Contracts where the supply of labour is ancillary to the supply or use of goods the contractor owns. For example, a contractor hired to use a lawn tractor to mow lawns. Here, the object of the contract is primarily the use of the contractor’s goods.
- Contracts for services a business does not typically require and a contractor provides. For example, a business may hire a consultant to review their IT systems and recommend changes. This is likely not a recurring need of the business.
- Contracts for services normally required for less than 180 days in the financial year. For example, a business may hire a consultant required to conduct reviews of employee productivity. He or she regularly provides business development recommendations for no more than 180 days and is paid a fixed amount.
- Contracts for services provided for 90 days or less in the financial year, whether in one block or aggregated. For example, a business may engage an advertising consultant for 90 days or less.
- Contracts where the contractor engages two or more persons to fulfil the contract. For example, this could apply to a consultancy business which is a corporation, which engages several consultants to complete the work.
- Contracts where the contractor provides services as an owner-driver. This applies where the primary purpose of the contract is to convey goods and the goods are delivered or transported in the contractor’s own vehicle (provided the worker is not considered an employee).
- Contracts for services relating to selling insurance. Provided the worker is not an employee and the insurance agent is with an agency business, any commission paid to the contractor will be exempt.
- Contracts for door-to-door sales that are for domestic purposes only. Payments made under the contract will be exempt if the following criteria are met: (i) the worker is not an employee; (ii) the selling agent has an agreement to sell directly to the public; and (iii) the sale is made to the consumer at their place of residence or employment.
- Contracts that do not fall under any of the above exemptions, but are approved as exempt by the relevant Commissioner. The Commissioner needs to be satisfied that the contractor has provided their services of a particular type to the general public within the financial year, and assess the extent of this before granting the exemption.
What About Labour Hire?
Where there is a contract between an employment agency/labour-hire firm that engages the services of a worker for one of their clients and the agreement doesn’t result in an employment contract between the client and the worker, any payments made by the agency for the worker’s services are considered wages. The agency, in this case, is a deemed an employer and is liable for tax purposes.
For example, your business may engage an agency that specialises in finding contractor consultants across a number of industries, and provide consultants to your business at your request. In this instance, assuming you do not engage the worker under an employment contract, the agency bears the tax liability for the consultant.
If you are hiring a consultant for your business, be sure to consider the basis on which you engage them as this significantly affects the tax your business is liable to pay. The distinction between an employee and a contractor is not always clear, and if in doubt, you should contact an employment lawyer. It’s also prudent to seek tax liability advice for your business from an accountant or financial adviser. Questions? Get in touch on 1300 544 755.