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This Ruling discusses certain aspects of the meaning of the term 'employee' as it is used in Division 2 of Part VI of the Income Tax Assessment Act 1936 (the Act). That Division, headed 'Collection by Instalments of Tax on Persons other than Companies', provides the legislative framework for what is commonly referred to as the Pay As You Earn (PAYE) system. Subsection 221C(1A) of the Act requires employers to deduct instalments of tax from payments of salary or wages to employees . The definitions in subsection 221A(1), of the terms in bold , extend the scope of the PAYE system to cover certain payments to persons other than employees within the ordinary meaning of that expression.

Subsection 221C(1A) of the Act requires employers to make tax instalment deductions from the salary or wages paid to their employees. Section 221A provides definitions which, in effect, identify the categories of payments that are subject to these deductions. In summary, those categories are: (1) salary, wages, commission, bonuses or allowances paid to a person as an 'employee' within the ordinary meaning of that expression; (2) payments made under certain contracts that are wholly or principally for the labour of the person paid; (3) salary, wages, commission, bonuses or allowances paid to: • a person who holds or performs the duties of an appointment, office or position under the Constitution or under a law of the Commonwealth, a State or a Territory; • a person who is otherwise in the service of the Commonwealth, a State or a Territory; or • a member of an Australian Parliament; (4) directors' fees; (5) payments of superannuation, pension, retiring allowance or annuities or supplements to a pension or annuity; (6) commission to insurance or time-payment canvassers or collectors; (7) regular payments by way of compensation or for sickness or accident pay in respect of incapacity for work; and (8) payments under a range of specified Government schemes, programs, pensions or benefits. Excluded from the scope of PAYE are payments of exempt income, living-away-from-home allowances, payments to members of certain local governing bodies and prescribed payments under the Prescribed Payments System (PPS) in Division 3A of Part VI of the Act. A flow chart to assist in determining whether PAYE applies is at Attachment A.

Categories (1) and (2), highlighted in bold in paragraph 2, are the most general and the most contentious. The Commissioner's views in respect of each are detailed below under the headings, ' Who is an employee within the ordinary meaning of that expression? ' (paragraphs 4 to 28) and ' Payments made under a contract wholly or principally for labour ' (paragraphs 29 to 45).

The relationship between an employer and an employee is a contractual one. It is often referred to as a contract of service (or, in the past, as a master/servant relationship). Such a relationship is typically contrasted with the independent contractor/principal relationship which, at law, is referred to as a contract for services . An independent contractor typically contracts to achieve a result whereas an employee contracts to provide his or her labour (typically to enable the employer to achieve a result). An independent contractor works in his or her own business (or on his or her own account); an employee works in the service of the employer, i.e., in the employer's business.

While at either end of the of service/for services spectrum it may be easy to discern a classic employee and a classic independent contractor, at the centre there is no sharp division between the two relationships. The emergence of performance-based contracts, flexible working hours and work from home typify a trend which is blurring the traditional distinctions between employee and independent contractor.

The issue is contentious because of the different consequences attaching to each relationship, particularly from the payer's perspective. The obligation to make PAYE deductions is one consequence of having an employee. Other consequences may include vicarious liability, workers compensation, industrial award rates and conditions, superannuation and payroll tax.

The common law meaning of the term 'employee' was most recently stated by the High Court in Stevens v. Brodribb Sawmilling Company Pty Ltd. [F1] It is clear from that case that there is no single objective test which will give the answer: '... it is the totality of the relationship between the parties which must be considered ...'; [F2] '... the question is one of degree for which there is no exclusive measure ...'. [F3]

While various features have been identified by the courts as indicators of the true nature of the relationship, those features are only ever a guide to answering that question. It is necessary in each case to examine all the terms of the contract and to determine whether, on balance, the person is acting as an employee of another or is acting on his or her own behalf.

Where there is a written contract, the express and implied terms of the contract provide evidence of the intention of the parties at the time of its formation. Those terms are identified and construed according to the circumstances surrounding the making of the contract. Conduct after formation of the contract is only relevant where it can be shown to amount to a modification of the original contract. [F4]

A clause in a contract that purports to characterise the relationship between the parties as that of principal and independent contractor and not that of employer and employee must be considered with all the other terms of the contract. Such a clause cannot receive effect according to its terms if it contradicts the effect of the agreement as a whole; the parties to an agreement cannot alter the true substance of the relationship by simply giving it a different label. As Gray J stated in Re Porter: re Transport Workers Union of Australia : [F5] 'Although the parties are free, as a matter of law, to choose the nature of the contract which they will make between themselves, their own characterisation of that contract will not be conclusive. A court will always look at all of the terms of the contract, to determine its true essence, and will not be bound by the express choice of the parties as to the label to be attached to it. As Mr Black put it in the present case, the parties cannot create something which has every feature of a rooster, but call it a duck and insist that everybody else recognise it as a duck.' However, the parties may use such a clause to overcome any ambiguity as to the true nature of the relationship. [F6]

For example, an employer may seek to change the status of an employee to that of independent contractor by both parties signing a contract of engagement that includes a clause to the effect that the worker is an independent contractor rather than an employee. That clause is ineffective if it is inconsistent with the apparent true nature of the relationship inferred from the contract as a whole. If the terms of the subsisting relationship (such as leave entitlements and other employee benefits) are not changed it is likely that the worker's status would remain that of employee.

The circumstances surrounding the formation of the contract may assist in determining the true character of the contract. [F7] Thus, if a contract comes into existence because the contractor advertises his or her services to the public in the ordinary course of carrying on a business or as a result of a successful tender application, the existence of a principal/independent contractor relationship is inferred. Conversely, if the contract is formed in response to a job vacancy advertisement or through the services of a placement agency, the existence of an employer/employee relationship is inferred. [F8]

Bearing the above in mind, the features discussed below have traditionally been regarded by the courts as key indicators of whether a contract is one of service or for services .

The classic 'test' for determining whether the relationship of master and servant existed was the exercise of control over the manner in which work was performed. While this may have been appropriate in a traditional nineteenth century master/servant relationship, it is not necessarily a relevant concept in the engagement of labour in the late twentieth century. With increasing usage of skilled labour and consequential reduction in supervisory functions, the focus of the control test has changed from the actual exercise of control to the right of control. Moreover, while control is important, it is not the sole indicator of whether or not a relationship is one of employment. [F9]

The shift in emphasis from exercise to right of control is generally attributed to the earlier High Court decision in Zuijs v. Wirth Brothers Pty Ltd [F10] in which the High Court articulated the significance of control in an employment relationship. The Court said: [F11] 'What matters is lawful authority to command so far as there is scope for it. And there must always be some room for it, if only in incidental or collateral matters.'

This concept of a lawful authority to command vested in the payer is a necessary feature of an employment relationship. Consistent with the notion of an employee working in the employer's business, it is to be expected that the employer possesses (within applicable industrial relations law) an overriding discretionary power over its employees. Conversely, the incidence of a reserve power of control vested in the payer cannot transform what is in essence a contract for services into a contract of service. [F12]

This change in emphasis is particularly important for skilled workers who may exercise significant discretion in how their tasks are performed.

Where the substance of a contract is to achieve a specified result there is a strong indication that the contract is one for services. In World Book (Australia) Pty Ltd v. FC of T. [F13] Sheller JA said: 'Undertaking the production of a given result has been considered to be a mark, if not the mark, of an independent contractor.' [F14]

An unlimited power to delegate work is an important indication that the worker is an independent contractor. [F15] Delegation is generally implied in a contract for services where the emphasis is on result rather than person. The notion of a payer not requiring a contractor to perform personally any work under a contract is anathema to the employment concept of a person working in the service of another. However, delegation clauses are considered in the context of the contract as a whole to determine if they are consistent with the apparent essence of the contract or if they are merely self-serving statements.

Where the worker bears little or no risk of the costs arising out of injury or defect in carrying out his or her work, he or she is more likely to be an employee.

The higher the degree to which a worker is exposed to the risk of commercial loss (and the chance of commercial profit) the more he or she is likely to be seen as independent. Typically, a worker who derives piece rate payments and sustains large outgoings would be so exposed.

The higher the proportion of the gross income which the worker is required to expend in deriving that income, and the more substantial the assets which the worker brings to his or her tasks, the more likely it is that the contract is for services. [F16]

The terms of the contract, when considered as a whole, indicate the presence or absence of the above features and therefore the true character of the contract. For example, the following circumstances point to an employment relationship: • provision of benefits such as annual, sick, and long service leave; • provision of other benefits prescribed under an award for employees; • payer prescribed times and location for the performance of work; • remuneration in the form of a salary or wage; • worker uses assets and materials provided by the payer or is reimbursed, or paid a compensatory allowance, for expenses incurred in respect of use of own assets and materials; and • payer discretion (within the constraints of industrial relations laws) in respect of task allocation and termination of engagement.

However, the list is not exhaustive and it must be emphasised that there is not a standard set of conditions applicable to an employee and another (different) set applicable to an independent contractor. Most conditions, when viewed individually, will be equivocal as indicators of the true character of the contract. For example: • worker discretion in matters such as time and place of work may be consistent with a modern employment relationship; • payer prescription as to time and place of work may be consistent with an independent contractor relationship; • a performance based mode of payment may be consistent with an employment relationship; and • a time based mode of payment may be consistent with an independent contractor relationship (but this may be construed as a contract wholly or principally for labour - see paragraphs 29 to 45 below).

Therefore, the significance, if any, of these matters depends on the facts of each case. What matters is how the conditions combine to colour the character of the contract. Attachment B sets out a summary of the key indicators and illustrates the different application of these indicators to a contract of service and a contract for services .

In Montreal v. Montreal Locomotive Works [F17] Lord Wright said: 'it is in some cases possible to decide the issue by raising as the crucial question whose business is it, or in other words by asking whether the party is carrying on the business, in the sense of carrying it on for himself or on his own behalf and not merely for a superior.' Similarly, in Stevenson, Jordan and Harrison Ltd v. MacDonald and Evans [F18] Denning LJ said: '... under a contract of service, a man is employed as part of the business, and his work is done as an integral part of the business; whereas, under a contract for services, his work, although done for the business, is not integrated into it but is only accessory to it.' From this, the notion of an 'integration' test (or organisation test as it is sometimes called) arose. While the label is not particularly illuminating, the underlying distinction drawn between an employee and an independent contractor may be a useful aid or reference point in determining the status of a worker, i.e., is the worker working on his or her own account (independent contractor) or in the service of the payer (employee)? [F19]

However, the notion of integration has been treated by Australian courts with some suspicion and certainly as subsidiary to the notion of lawful authority to command. [F20] Nevertheless, the courts have been prepared to use the concept as an ancillary check to reinforce conclusions based on the lawful authority to command concept. [F21]

Therefore, integration should not to be viewed as an alternative test but rather, as another relevant consideration to be taken into account in conjunction with lawful authority to command and other relevant factors.

The PAYE system includes payments made under a contract wholly or principally for the labour of the person to whom the payments are made, but excludes payments that are wholly or principally of a private or domestic nature (paragraph (a) of the definition of salary or wages in subsection 221A(1) of the Act). However, if the payment is a prescribed payment for the purposes of PPS, that system applies to the exclusion of the PAYE system.

The term prescribed payment is defined in subsection 221YHA(1) of the Act as a payment declared by the Income Tax Regulations to be a prescribed payment for the purposes of PPS. The term payment , also defined in subsection 221YHA(1), specifically excludes payments of salary or wages within the meaning of section 221A other than salary or wages to which paragraph (a) of the definition of salary or wages in subsection 221A(1) applies, i.e., payments wholly or principally for labour. For the purposes of this Ruling, a payment of salary or wages to a common law employee is always subject to the PAYE system but a payment to an independent contractor under a contract wholly or principally for labour is only subject to the PAYE system if it is not declared by the Regulations to be a prescribed payment.

For a payment to be a prescribed payment for PPS purposes, there are, in essence, four requirements to be met: • there must be a payment within the meaning of Division 3A of Part VI of the Act; • that payment must be made, or liable to be made, under a contract; • the contract must be for the performance of work that consists of carrying out certain prescribed activities; and • the work must be carried out for a prescribed person. Currently there are nine prescribed activities: • building and construction; • transportation by road of goods or materials; • architectural services; • surveying services; • engineering services; • professional building and construction services; • construction of items of joinery that are to become fixtures in any structure; • reconditioning, servicing, repair or maintenance of motor vehicles; and • cleaning of: - office, business, residential institutional or any other premises; and - roadways, thoroughfares, venues and other places. For more information about any one of these prescribed activities, as well as the other requirements of PPS, see the relevant PPS Bulletin (Nos 1-9).

An equivalent expression, a contract which is wholly or substantially for ... labour (as it appeared in paragraph (a) of the definition of salary or wages in subsection 221A(1) of the Act prior to amendment in 1983) was considered by the High Court in Neale v. Atlas Products (Vic) Proprietary Limited . [F22] The Court concluded that a contract under which the contractor is free to employ others to carry out the work is not a contract wholly or at all for the labour of the contractor. Rather, it is a contract to produce a given result.

The current terminology of the expression was inserted in 1983, along with an explanatory provision, paragraph 221A(2)(b), following the decision of the High Court in Neale's case. Paragraph 221A(2)(b) was intended to apply the expression where the person who was paid actually performed, or could reasonably be expected to perform, the whole or principal part of the labour under the contract. That is, a right of delegation that was not, or was not reasonably expected to be, acted upon other than in minor respects would be insufficient to take the contract outside the scope of the expression.

This amendment (along with the underlying expression) was considered by the NSW Court of Appeal in the World Book case. It found that paragraph 221A(2)(b) did not alter the High Court's interpretation of the expression. In effect, it is necessary for the contract to be characterised as a contract that is wholly or principally for ... labour before the paragraph can come into operation.

This interpretation of the expression was followed by the Full Court of the Supreme Court of South Australia in the later case of Filsell v. Top Notch Fashions Pty Ltd [F23] and again by the NSW Court of Appeal when it looked at similar words in subsection 12(3) of the Superannuation Guarantee (Administration) Act 1992 in the Vabu case.

While it is clear from the courts' decisions that the provision does not generally expand the scope of the PAYE system beyond common law employees, there are two significant residual areas of application: • payments under contracts for the performance of work by persons engaged by a labour hire firm; and • payments under contracts for performances by entertainers, sportspersons and the like.

Labour hire arrangements commonly involve at least two contracts. A user of labour (or service recipient) typically contracts with a labour hire firm for the provision of labour of a specified kind. The labour hire firm does not contract to perform the work; it merely contracts to provide labour to work under the direction of the user. The labour hire firm then ascertains the availability of suitable workers on its books. Contacted workers may accept or reject the work offer. On acceptance, a contract is formed between the labour hire firm and each worker.

The question of whether such a tripartite arrangement gives rise to an employment relationship was considered by the Full Federal Court in Building Workers' Industrial Union of Australia and Others v. Odco Pty Ltd . [F24] The Court found that an employment relationship did not exist between the worker and the user because a contractual relationship did not exist between these two parties; the user did not have an obligation to pay the worker. Similarly, the Court found that there was no employment relationship between the worker and the labour hire firm, although there existed a contractual relationship between these two parties, it was not in the nature of a contract of service. The workers were: • free to accept or reject offers of work; • not paid a weekly wage; • not subject to leave entitlements; and • not subject to control by the labour hire firm.

It is clear from the Odco case, that workers engaged under that particular type of labour hire arrangement are neither common law employees of the user nor the labour hire firm.

A question which the Federal Court was not required to consider (being an industrial case), was whether the contract between the labour hire firm and the worker may properly be characterised as one wholly or principally for labour and therefore within the scope of the PAYE system.

Such a contract is not properly characterised as a contract for a result. The contract is, in substance, a contract wholly or principally for labour, although to a third party, but nonetheless also for the benefit of the labour hire firm (enabling it to fulfil its contractual obligation to the third party). [F25] Therefore, the labour hire firm is liable to make PAYE tax instalment deductions from payments to contracted workers unless the payment is a prescribed payment within the meaning of PPS.

Paragraph 221A(2)(c) of the Act was introduced in 1983 (at the same time as paragraph 221A(2)(b)) as a response to the decision of the Supreme Court of Victoria in Deputy Commissioner of Taxation v. Bolwell [F26] (see the explanatory memorandum relating to the Income Tax Assessment Amendment Bill 1983). In the Bolwell case, Lush J, [F27] after considering the ordinary meaning of the term 'labour', found that the expression 'contract for the labour of a person': '... does not appear ... to cover the case of the artiste or for that matter the professional man whose efforts result in something of his own creation, defined and limited according to his talents ...' The provision is intended to ensure that the expression ('a contract that is wholly or principally for labour') encompasses performance payments and the like.

We believe this provision achieves its purpose as the opening words are drafted in an inclusive style. It is not necessary first to characterise the contract as being wholly or principally for labour. Rather, the provision says: 'a reference [i.e., in the definition of salary or wages in paragraph 221A(1)] to a contract that is wholly or principally for the labour of a person shall be read as including a reference to a contract that is wholly or principally: (i) for the performance or presentation by a person of, or the participation by a person in, any music, play, dance, entertainment, address, sport, display, promotional activity, exhibition, or any similar activity ... or for the performance of any services in connection with any such activity; or (ii) for the performance of services by a person in, or in connection with, the making of any film, tape or disc or of a television or radio broadcast'.

It is, of course, still necessary to establish that the contract is wholly or principally for the performance or presentation by a person, etc.

The PAYE system applies to any relevant payment to individuals. It does not apply to payments to partnerships, companies or trustees for the personal services of a third party - provided the arrangement is not a sham. Of course, any payments of salary or wages from the interposed entity to its employees would be subject to the PAYE system. Taxation Ruling IT 2121 refers to arrangements involving interposed entities for both income tax liability generally and the liability of employers to make tax instalment deductions under the PAYE system. If personal services income is diverted through a company, partnership or trust in an artificial, blatant and contrived manner to avoid the incidence of income tax, the general anti-avoidance provisions contained in Part IVA of the Act may apply.

The Commissioner cannot give a Private Binding Ruling on the issue of whether tax instalments are required to be deducted in the sense provided for by Part IVAA of the Taxation Administration Act 1953 (TAA) because those provisions do not apply to tax collection matters. While the Commissioner, in accordance with Taxation Ruling IT 2500, treats as administratively binding his opinions on such matters as the application of the PAYE provisions, such opinions do not give rise to objection, review and appeal rights provided in respect of Part IVAA rulings.

The only avenue of judicial review prior to the commencement of enforcement action is the declaratory writ process instituted in a court of appropriate jurisdiction. Otherwise, a person dissatisfied with the opinion of the Commissioner must wait until enforcement action is instituted - either prosecution or imposition of 'failure to deduct' penalties. In the case of 'failure to deduct penalties', the Commissioner has a general discretion to remit the culpability component of the penalty in whole or in part (see Taxation Ruling TR 97/8). A person dissatisfied with a remission decision of the Commissioner may object in the manner set out in Part IVC of the TAA.

This Ruling applies to years commencing both before and after its date of issue. However, the Ruling does not apply to taxpayers to the extent that it conflicts with the terms of a settlement of a dispute agreed to before the date of issue of the Ruling (see paragraphs 21 and 22 of Taxation Ruling TR 92/20).

Taxation Rulings IT 2009, IT 2108, IT 2129, IT 2137, IT 2396, IT 2511, IT 2541, IT 2576, IT 2677, and Taxation Determinations TD 92/191 and TD 93/228 will be withdrawn when this draft Ruling is finalised. To the extent that our views in those Rulings still apply, they have been incorporated in this Ruling.

If you wish to comment on this draft Ruling, please send your comments by 12 September 1997 to: Contact officer details have been removed following publication of the final ruling.