Correctly distinguishing between employees and contractors is critical for businesses, with significant consequences for incorrectly applying the law. The case law has developed rapidly in this space in the last couple of years. Those cases provide some helpful lessons for businesses seeking to reduce their risks when contracting with sole traders.
We previously wrote about the employee/contractor distinction after the High Court delivered judgment in two cases: CFMMEU v Personnel Contracting Pty Ltd  HCA 1 and ZG Operations Australia Pty Ltd v Jamsek  HCA 2.
More recently, the Full Court of the Federal Court applied the principles in CFMMEU and Jamsek to JMC Pty Ltd v Commissioner of Taxation  FCAFC 76.
What happened in JMC’s case?
JMC Pty Limited carries on a business providing accredited higher education programs to students. JMC contracted with Mr Harrison to deliver teaching services to its students.
Mr Harrison’s contract required him to deliver ‘teaching services’, which included delivering a course of lectures and marking papers. Mr Harrison was paid a separate hourly rate for lecturing and marking papers.
In the contract, the parties agreed that Mr Harrison was a contractor. The contract also provided that Mr Harrison:
- was provided with the necessary equipment to teach lessons
- was required to provide lessons at the standard required in accordance with relevant legislation and at times set by JMC
- had a right to subcontract marking papers and delivering lectures to others, after obtaining JMC’s consent
- was required to comply with JMC policies
- was required to provide JMC with valid tax invoices that comply with GST legislation
- was responsible for his own workers’ compensation policy.
The Commissioner assessed JMC on the basis that Mr Harrison was an employee, either under the common law or under the extension in section 12(3) of the Superannuation Guarantee (Administration) Act 1992.
Was Mr Harrison found to be an employee?
At first instance, Wigney J held that Mr Harrison was an employee of JMC. Applying the principles laid out by the High Court in Personnel Contracting and Jamsek, his Honour found that:
- JMC had the right to effectively control how Mr Harrison provided teaching services by setting the time for lessons to be conducted and by requiring the lessons to be taught at a required standard
- Mr Harrison was effectively integrated into JMC’s business
- Mr Harrison’s right to subcontract the teaching services was not to be given significant weight, because he was required to obtain JMC’s approval first.
However, JMC was successful in its appeal. The Full Court held Mr Harrison was not an employee, and also that he was not paid under a contract wholly or principally for his labour (which would make him a deemed employee under section 12(3) of the Superannuation Guarantee (Administration) Act 1992.
In its analysis of JMC’s contract with Mr Harrison, the Full Court emphasised the following points:
- If a person has a contractual right to delegate to someone else to perform the work, that is inherently inconsistent with an employment relationship.
- If that right to delegate is unqualified (e.g. there is no requirement to obtain the consent of the other party), that may be conclusive evidence against there being an employment relationship.
- If that right to delegate is qualified, it still counts against an employment relationship.
- Whether the right to delegate is actually exercised is not the point – it is whether the person has the right to delegate that is relevant.
The Full Court concluded that the primary judge was not correct in finding that Mr Harrison had ‘only an illusory or chimerical right to subcontract or assign’. There was no suggestion of any sham in the agreement. And the evidence was that Mr Harrison had exercised his right to delegate work on a couple of occasions.
What are the lessons for businesses contracting with sole traders?
There are two key lessons from the cases for businesses seeking to reduce their risks.
- The first is that the parties’ rights and obligations must be contained in a written agreement.
- The second is that, if there is a right to delegate, this must be specifically dealt with in that written agreement.
The ATO’s PCG 2022/D5 outlines the ATO’s proposed compliance approach to contractor arrangements. At a high level, to fall within the very low and low risk zones, the parties must have a written agreement and specific advice confirming the correct classification both under the common law definition of employee and the extended definition under section 12 of the Superannuation Guarantee (Administration) Act 1992.
Please contact a member of our team if you would like any assistance with reviewing or preparing service agreements, or with advice on the correct classification of contractors.
Want to learn more?
The first webinar of our annual tax masterclass series will cover recent changes to the law and how you and your clients can ensure you are classifying your contractor relationships correctly.
Please click here if you would like to register.