It’s Outdated! Why You Need Formal Contracts

It’s Outdated! Why You Need Formal Contracts

We accountants have been talking about this for eons.

So have legal people. But then again, legal people get aroused whenever it comes to small print.

But this time, the ATO is getting a bit excited. And that is usually a worry.

It has to do with several legal cases which, to be honest, I do not want to bore you about.

But the cases mean everything we accountants and lawyers have told you previously is, well, outdated.

The ATO has issued guidance on how it defines an employee and says businesses will need written agreements that reflect how tasks are performed to avoid the risk of a PAYG or superannuation audit.

You see, in the past, we accountants have told you that it does not necessarily matter what a contract says. What matters is what is happening in reality. E.g. you employ a contractor, and the contract says they can subcontract that work or they can appoint someone else to do the work. If that did not happen or is unlikely ever to happen, the ATO could argue that the clause is invalid.

But that has all changed.

Courts will no longer look to the conduct or behaviour of the parties in determining whether the worker is an employee or a contractor unless there is no written agreement/ contract.

As you all know, an employer has various tax obligations depending on whether workers are classified as employees or contractors. Superannuation and deduction of taxes are just a couple. Things like FBT on benefits are also impacted. So, determining if a worker is a contractor or not can have an effect on cash flow and tax payments.

The ATO has now said whether a worker was an employee was a question of fact and should be determined by reference to an ‘objective assessment of the parties’ relationship, legal rights and obligations.

These legal rights and obligations should be determined by reference to an employment contract according to established contractual interpretation principles.

The ATO has said a lot more, but to be quite honest, the language is so boring you will be prepared to kill someone within a few minutes.

The ATO talks about ‘contracts that comprehensively commit the terms of their relationship’ and ‘the contract between the parties must be considered holistically to determine …..’

See what I mean?

Anyway, in order to avoid mass murder crimes, here’s the ‘plain English’ version.

In a nutshell, what the ATO is saying is that the contract is the most important document in determining if you are employing a contractor or an employee.

The ATO will now use seven criteria between very low, low, medium and high-risk zones based on the actions taken by the parties when entering into them, such as their intentions, conduct and any advice they received.

If this is then written into a contract, it will determine if a worker is an employee or contractor.

In other words, the ATO is saying if you have a contract and it is basically what both sides wanted when they signed that contract, then they will assume the contract is correct and ignore what is happening in reality.

But I have noticed that for some reason, the ATO think they are at a kindy centre because they seem to be talking a lot about the colours green, amber, and red.

That’s because, for instance, a hypothetical courier service that hired overflow workers as contractors during busy periods without a comprehensive written contract would attract a medium-risk amber classification. Green is low risk, whereas red is high risk.

Reviews into PAYG or superannuation obligations could be triggered through its own “proactive case selection” (whatever that means) or through complaints from workers who were employed as contractors but suspected superannuation underpayment due to being incorrectly classified, the ATO said.

The ATO has further said that they will allocate resources to those with an amber or red classification.

In other words, if you do not have contracts, you will likely be in the amber zone, so get ready for some queries or, worse, an audit.

It is not unusual for employers to take on employees or contractors without a formal contract. If you continue down this path, there is a chance an audit may be coming your way.

Employment contracts is part of Step 3 (Efficient Operations) in working less, earning more and having financial freedom. If you would like to know more, contact Hitesh at or Ros at or call 07 3161 9548.