21 Apr 2011

Independent contractor vs employee: do you know the difference?

A recent Federal Court case has again shown how difficult it is to prove if someone providing services is an independent contractor or an employee – and how expensive getting this wrong can be.

Justice Bromberg's decision in On Call Interpreters and Translators Agency Pty Ltd v Commissioner of Taxation (No 3) [2011] FCA 366 is a useful restatement of the main principles, but it also shows the problems a company can have in establishing the nature of its relationship with service providers that it considers to be independent contractors.

The translators, the tax man, and the superannuation guarantee charge

On Call provides interpretation and translation services. Essentially, it takes a request from a client and then matches the job to an interpreter or translator on its panel. That person is free to reject the job (and often will) and to undertake work provided by rival companies, but cannot negotiate the rate at which he or she is paid for work that comes via On Call.

On Call urges the interpreters and translators on its panel to be prompt and professional, wear name badges provided by On Call, and not to swap jobs between themselves without notifying On Call. It also offers training from time to time. If it was not happy with a person's services, it wouldn't offer him or her work again.

It had taken the precaution in 1989 of asking the Australian Tax Office whether it considered these interpreters to be employees or independent contractors. Based on the facts provided to it, the ATO said they were independent contractors.

It doesn't think so now. It has levied a superannuation guarantee charge upon On Call for failure to pay prescribed superannuation contributions for the benefit of their employees. On Call responded with the simple question: "what employees?". Answering this meant going to the common-law test.

How a court works this out

Since both independent contractors and employees trade their labour for money, how is an employee, a person providing personal services for hire, to be distinguished from an independent contractor, and in particular an independent contractor who provides personal services for hire?

A court will look beyond contractual descriptions to the real substance of the relationship, the parties' role and function, and the nature of the interactions which constitute their relations, using a range of factors, none of which will be determinative. It also uses what Justice Bromberg called "the ‘smell test’, or a level of intuition."

He then restated the test. Viewed as a practical matter:

  • is the person performing the work an entrepreneur who owns and operates a business; and,
  • in performing the work, is that person working in and for that person’s business as a representative of that business and not of the business receiving the work?

Although the interpreters generally considered themselves as independent contractors, they did not generally use business names (although they had an ABN), poach clients, have goodwill attached to a business, advertise their services, sub-contract, or hold their own insurance. All but two were therefore held not to own and operate their own businesses, so the second question did not arise.

Problems in trying to prove this: the number of employees

In this case On Call had to show that each of over 2,000 people on its books during the relevant period providing services was an independent contractor, not an employee. It had contracts which described the other party as an independent contractor, but very few of the service providers had signed one, and a court won't be satisfied just by a description in a contract anyway.

It would obviously be impractical to call all 2,500 people on its books, so it relied upon a representative sample of seven people on its books.

There was a basic problem with this strategy: whether a person who provides personal services owns and operates a business "is a complex question in relation to which a wide range of indicators are relevant. Those indicators call for evidence personal to the individual. Generalisations and extrapolations from the circumstances attending one individual to those attending the next are likely to be speculative and unhelpful."

Even if the sample could have proven anything, it had to be representative, which this one did not seem to be. Even if it had been, on the facts only two of the seven were running their own businesses.

Casting doubt on control

Another problem highlighted by this case is the difficulty of distinguishing between independent contractors and casual employees.

On Call pointed to the interpreters' ability to pick and choose assignments or work for other rival agencies, and its inability to sanction them beyond not offering further work, as evidence that they were independent contractors. As Justice Bromberg pointed out, these are also features of casual employment.

Does it matter if someone's paid for their time or their results?

Both On Call and the Commissioner of Taxation focused on the time/results distinction, ie. that employees are paid for their time, and independent contractors for their results. On Call argued that the interpreters were paid for their results; the Commissioner said they were paid for their time.

Either way, said Justice Bromberg, "great care needs to be taken with the application of this indicator… there are many examples of employees being paid on a “piece rate” … and of independent contractors (for instance, solicitors) charging on a time-basis." As a result, it's unlikely that this distinction will be of much use in future disputes over the employee/contractor distinction, except in obvious cases.

What you should do now

As Justice Bromberg pointed out, this is a perennial problem, mostly because there is no simple and clear definition which explains the distinction between an employee and an independent contractor.

It is particularly troubling, he said, "when important legislation such as the Fair Work Act (and its predecessors dating back to 1904) have steadfastly avoided defining what is an employee, yet demand (on pain of civil penalty) that there be no misrepresentation as to the nature of the work relationship".

And as this case shows, if you don't get it right there are practical (and expensive) consequences. Not only are there penalties under the Fair Work Act for misrepresenting the employment relationship as independent contracting, or the superannuation guarantee charge and penalties for unpaid superannuation as in this case, but employers could be ordered to make back payment of wages set by awards or enterprise bargaining agreements.

So, if there is no simple answer, what should companies do?

First, don't think that the terminology in a contract will determine the issue, because courts won't. A contract which clearly sets out respective rights and duties between the parties will, however, be an important part of the factual matrix which a court will use to make its decision.

Secondly, you might be (as On Call was) running on the assumption that your service providers are independent contractors. If those individuals do not run their own business, then they're not. Considering the costs of getting this wrong, or proving otherwise, it is worth reviewing these relationships and being sure that you are not inadvertently treating an employee as a contractor.

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Clayton Utz communications are intended to provide commentary and general information. They should not be relied upon as legal advice. Formal legal advice should be sought in particular transactions or on matters of interest arising from this communication. Persons listed may not be admitted in all States and Territories.