27 June 2005

Employees no longer: on the federal government’s proposals for contractors

Giuseppe Carabetta, The University of Sydney
Cynthia Coleman, The University of Sydney

In the lead up to the 2004 Federal election, the Prime Minister announced that a re-elected Coalition government would introduce a new ‘Independent Contractors Act’ to enshrine and protect the status of independent contractors. The Act would be designed, he said, to enhance workers’ ‘freedom to contact’ and encourage independent contracting as a legitimate working arrangement (Howard 2004).

Australian law has traditionally maintained a distinction between independent contractors and workers in employment. The latter concept assumes the existence of an employer-employee relationship, or ‘contract of service’. The former concerns relations involving contracts ‘for services’. Historically, independent contractors have been viewed as being in business on their own account, while employees have been viewed as working for someone else in a subordinate or dependent capacity. This distinction—derived from the common law—is significant because the Australian industrial relations system generally draws a line between employees, who are protected by legislation, and contractors, who aren’t. Thus, industrial awards and workplace agreements made under Federal and State industrial laws, for example, typically apply only to employees; and it’s generally only employees who are entitled to such legislative rights as annual leave, parental leave, unfair dismissal and workers compensation.

The employee/ independent contractor distinction potentially excludes a wide range of workers from their entitlements.

However, the employee/independent contractor distinction potentially excludes a wide range of workers from these entitlements—when the very object of the legislation in question is to protect these workers. These concerns have been exacerbated by an upsurge in the number of ‘self-employed’ contractors (Stewart 2002). A significant portion of these workers are self-employed ‘dependent contractors’. These are workers who are technically (that is, at common law) contractors, but who provide services to one or mainly one organisation and have much in common with employees (Vanden Heuvel & Wooden 1995, pp. 267–68). State (Labor) governments have responded to this problem mainly through legislative provisions which ‘deem’ certain contractors to be employees, or through ‘unfair contracts’ provisions.

In its recent Discussion Paper Proposals for Legislative Reforms in Independent Contracting and Labour Hire Arrangements, the government argues that there is no such thing as a ‘dependent contractor’, since the term is not recognised by the common law (Australian Government 2005, p. 11). Mirroring the views of the Independent Contractors of Australia (ICA), it argues that workplace relations regulation is appropriate for employment relationships, while commercial law is appropriate for contractor arrangements (ICA 2002, pp. 12, 20, 21). The government argues that since the common law excludes independent contractors, it meets this objective. It points out that its 2004 election policies had raised concerns about State provisions seeking to treat contractors as employees, particularly those ‘dragging’ contractors into the workplace relations system. It argues that although it has taken a broader approach under the Income Tax Assessment Act 1997 (Cth), taxation policy objectives are driven by different objectives to workplace laws.

EMPLOYEES AND CONTRACTORS: RE-DRAWING THE LINE

The scope of the proposed reforms is unclear at this stage, with a House of Representatives Committee currently conducting an enquiry into independent contracting and labour hire. The government is, however, committed to removing laws restricting the use of contractor arrangements.

One option mentioned in the Discussion Paper includes amending the federal industrial statute (Workplace Relations Act 1996) to provide that awards and enterprise agreements cannot contain clauses restricting the use of contractors. The government sees these provisions as ‘an inappropriate incursion by unions on employers’ ability to run their businesses according to their own preference’ (Australian Government 2005, p. 10). Other key proposals reflect the government’s policy that contractors should be regulated by commercial, and not employment, law. These include:

Overriding State deeming provisions (for example, s 275 of Qld IR Act 1999 allowing the IRC to declare a class of contractors to be employees based on various criteria including relative bargaining power or economic dependency);
Overriding State unfair contracts provisions (for example, s 106 of the NSW IR Act 1996 allowing the IRC to review contracts which are ‘unfair’, including ‘unfair, harsh or unconscionable’ contracts); and
Removing (potentially) State laws other than general workplace relations laws which cover contractors (for example, workers compensation, anti-discrimination and occupational health and safety provisions).

The government is committed to removing laws restricting the use of contractor arrangements.

The Discussion Paper highlights as a ‘threshold issue’ whether the proposed Independent Contractors Act should seek to override only those laws falling in categories (a) and (b), or whether it should also override laws in category (c) (2005, p. 15).

THE PROBLEM OF DISGUISED EMPLOYMENT ARRANGEMENTS

A key object of the State-based provisions (unfair contracts provisions also exist in a more restricted form under the current Federal Act) is to deter employers from setting up counterfeit ‘contractor’ arrangements to avoid their obligations. Another is to draw a more realistic boundary between workers who are subordinate and dependent, and those who are genuinely in business. Similar attempts to clarify this distinction have also been made in other common law countries.

The Federal government argues that the common law provides greater flexibility than the State deeming legislation, and effectively addresses sham arrangements. A common law based approach will look at the substance of the arrangement (Australian Government 2005, p. 12). The ICA and the employer groups hold a similar view (ICA 2002, para. 8; ACCI 2005, p. 24). However, the common law allows what may in substance be an employer-employee relationship to be ‘disguised’, no matter how much the worker might appear to be an employee (see Stewart 2002, pp. 242–259). This can occur, for example, when the hirer uses what are called Odco arrangements, a form of labour hire contracting. These arrangements, used originally in the building industry involve a ‘triangular’ relationship where the workers are neither employees of the labour hire firm nor of the firm’s clients. Aside from being a potential avoidance device, when contrasted with other labour-hire arrangements which do create an employment relationship, these arrangements can give rise to uncertain legal relationships (Pittard & Naughton 2003, p. 101).

A more direct avoidance technique (one that has even been recognised judicially on occasion) stems from the way in the common law distinguishes between employees and contractors. In determining whether a worker is, on balance, an employee or a contractor, the courts weigh up various factors. Among the factors suggesting independent contractor status are (for example) whether the worker is free to work for others, and whether the worker is able to delegate their work. In applying this approach, the courts tend, however, not to look beyond the formal terms in the contract, to determine whether the worker is really in a position economically to be able to delegate their work. The courts will look beyond the ‘label’ the parties attach to their relationship, but even then they generally won’t go behind the formal contract terms (Stewart 2002, pp. 246–47). The result is that employees can be transformed into dependent contractors ‘by the magic of contractual language’ (Finkelstein J in Konrad v Victoria Police (1999) 91 FCR 95 p. 126, quoting Canadian academic H. W. Arthurs).

State law aims to deter employers from setting up counterfeit ‘contractor’ arrangements to avoid their obligations.

Furthermore, where the courts are called upon to examine the relationship, this involves the parties (usually the workers) bringing legal proceedings, which can be expensive and time consuming. The government seems to acknowledge this. It says that, ‘[i]n order to deter unscrupulous hirers’, the Federal Act could be amended to provide a civil penalty for employers who set up shams (2005, p. 22). It argues, however, that the provision would have to be carefully framed to ensure that Odco arrangements were not proscribed. The onus would still be on employees to prove that shams exist; and, if there is no such thing as a dependent contractor, the definition of ‘sham’ is obviously going to be a narrow one.

Finally, the government says that, in place of the States’ deeming and unfair contracts provisions, it might retain its current unfair contracts provisions in the Workplace Relations Act (ss 127A–127C) (it has previously been opposed to these provisions). However, the first step would be for the parties to decide on their working arrangements (2005, p. 20). Further, the current federal provisions apply only where the contract involves a contractor who is a natural person rather than a corporation and, as others have argued the provisions are ineffectual in comparison to the State unfair contracts provisions. This is significant when it is considered that the State provisions themselves have been criticised as being inadequate (see, again, Stewart 2002 where it is argued that a preferred approach would be to address the common law definition itself).

TAXATION REFORM

Both employers and employees save money if workers are independent contractors. Independent contractors are responsible for all their own work related expenses, including taxation, and employers are spared the heavy statutory on costs relating to employees—this includes the various employment–related costs (annual leave, sick leave, and so on), Payroll Tax, Fringe Benefits Tax and Superannuation Entitlements as well as the compliance costs associated with withholding tax instalments from employees and remitting them to the ATO. Independent contractors who are running a business have access to a wider range of deductions than are available to employees. The Review of Business Tax (The Ralph Report) noted that a large amount of revenue was being lost because independent contractors would often split income by setting up family companies. Following the recommendations of the Report, Divisions 84–87 of the ITAA 1997 were introduced to apply from July 2000.

The Divisions are a specific anti-avoidance regime intended to neutralise the tax benefits obtained when employees hold themselves out to be independent contractors. Division 87 does not apply where taxpayers are running a personal services business. It contains four tests derived from the long-established common law distinction between contractors and employees and adds additional tests which increase the number of workers who are eligible to be taxed as employees rather than as contractors.

Both employers and employees save money if workers are independent contractors.

In its Discussion Paper, the government proposes using these tests as the definition of independent contractor under the Workplace Relations Act, either wholly or in addition to the common law (pp. 13–14). The Division 87 tests are:

the results test—the contractor works for a result, supplies their own equipment and carries the risk of failure;
the 80 per cent income test—a taxpayer receives 80 per cent of their income from one client or an associate of that client;
the employment test—20 per cent by market value of the work is performed during the year by a party unrelated to the taxpayer; and
the business premises test—the taxpayer has exclusive use of separate business premises and these are separate from premises used for private purposes.

A taxpayer who meets the results test is taxed as an independent contractor and is outside the scope of the Division. Where taxpayers fail either the results test or the 80 per cent income test, they must apply to the ATO for a personal services business determination in order to be taxed as contractors and not employees, regardless of whether they pass the employment or the business premises test.

The ATO can still use Part IVA of the ITAAct 1936 (the general anti-avoidance provision) in addition to Division 87. Understanding and applying Division 87 was so difficult for taxpayers that the ATO received endless applications from taxpayers requesting a personal services business determination to establish that they were independent contractors. As a result, the original Division was amended to enable taxpayers to ‘self-assess’—in tax jargon this is called ‘tick the box’.

The government acknowledges that tax policy and workplace relations objectives are driven by different needs, and the proposal of adopting the tax tests either exclusively or in addition to the common law definitions would not solve the current problems but would cause additional ones. This is evident from the fact that the legislation had to be amended to make it easier for taxpayers to decide whether they were ‘caught’ by the Division. In addition, it was relatively easy for taxpayers to manipulate their individual circumstances so that they appeared to pass the tests and therefore escape Division 87. This is similar to the avoidance strategies under the common law approach.

CONCLUSION

A key principle underlying the government’s proposals is that ‘regulating independent or dependent contractors as employees is a regulation of entrepreneurship’ (ACCI 2005, p. 6). No distinction is drawn between true independent contractors—that is, those who are genuinely entrepreneurial—and dependent contractors. The current State laws, however, don’t seek to regulate entrepreneurialism. They don’t seek to regulate the freedom to go into business. Their aim is to protect those who in substance aren’t running a business on their own account (see, for example, ALHMWU v Bark Australia [2001] QIR Comm 22).

The government acknowledges that tax and workplace relations policy objectives are driven by different needs.

While the growth in contract labour in Australia has been due in part to the ‘changing world of work’, what also can’t be discounted as a contributing factor is the rise in disguised dependent employment. Although the State provisions are only a partial solution to this problem, they do at least lessen the incentives for employers to disguise their employees as contractors. If these provisions were to be removed without incorporating any additional protection—either through the tax tests or, better still, by tackling the issue at a more general level—this will only exacerbate the problem.

It is true that the government’s latest ‘package’ of IR reforms (the proposals for minimum wages, workplace agreements, awards and unfair dismissal) will decrease the scope of protective legislation in Australia. It is one thing, however, to shift the emphasis of the existing model and reduce the protections offered to employees under the IR system. It is quite another to allow employers and their employees to be able to ‘contract out’ of that system.

REFERENCES

Australian Government 2005, Department of Employment and Workplace Relations Discussion Paper: Proposals for Legislative Reforms in Independent Contracting and Labour Hire Arrangements, Canberra [Online], Available: http://www.dewrsb.gov.au/ministersAndMediaCentre/andrews/ [2005, May 16].

Australian Chamber of Commerce and Industry (ACCI) 2005, Submission to House of Representatives Standing Committee on Employment, Workplace Relations and Workforce Participation, Inquiry into Independent Contractors and Labour Hire Arrangements [Online], Available: http://www.mcdonald-assocs.com/irreforms/govsubs.htm [2005, May 16].

Howard, J. 2004, A Stronger Economy A Stronger Australia: The Howard Government Election 2004 Policy: Protecting and Supporting Independent Contractors, 26 September [Online], Available: http://www.liberal.org.au/documents/ [2005, Jun 24].

Independent Contractors of Australia 2002, Discussion Paper: Protecting Independent Contractors [Online], Available: http://tpareview.treasury.gov.au/content/subs/019_Submission_ICA.pdf [2005, May 15].

Pittard M. J. & Naughton R. B. 2003, Australian Labour Law: Cases and Materials, Lexis Nexis Butterworths, Sydney.

Stewart, A. 2002, ‘Redefining employment? Meeting the challenge of contract and agency labour’, Australian Journal of Labour Law vol. 15, no. 3, pp. 235–276.

Vanden Heuvel, A. & Wooden, M. 1995, ‘Self-employed contractors in Australia: how many and who are they?’, Journal of Industrial Relations, vol. 37, no. 2, pp. 263–280.

GOVERNMENT REPORT

Review of Business Taxation, Commonwealth, A Tax System Redesigned (1999) AGPS, Canberra.

LEGAL AUTHORITIES

ALHMWU v Bark Australia [2001] QIR Comm 22 (28 Feb 2001).

Income Tax Assessment Act 1936 (Cth) (ITA Act 1936).

Income Tax Assessment Act 1997 (Cth) (ITA Act 1997).

Industrial Relations Act 1996 (NSW) (NSW IR Act 1996).

Industrial Relations Act 1999 (Qld) (Qld IR Act 1999).

Konrad v Victoria Police (1999) 91 FCR 95.

Workplace Relations Act 1996 (Cth).

Giuseppe Carabetta is a Lecturer in Business Law in the Faculty of Economics and Business at the University of Sydney. He is a leading researcher in the field of police employment. His research in employment law has been published in the Melbourne University Law Review and the Australian Journal of Labour Law.

Cynthia Coleman is an Associate Professor in Taxation Law in the Faculty of Economics and Business at the University of Sydney. She is the editor of Australian Tax Forum. Her research in the area of tax administration (taxpayer behaviour, the cash economy and compliance costs) is used by revenue authorities in Australia and overseas.