From our experience, many Not-for-Profits (NFPs) prefer to engage staff as contractors rather than employees. This approach is often chosen for its administrative simplicity and to reduce employee on-costs. However, this practice can lead to significant risks, particularly for directors.

Directors May Be Personally Liable for Incorrect Classifications

For directors, the risks of misclassifying contractors are considerable for several reasons:

• Personal Liability: Directors can be personally liable for an organisation’s tax debts related to PAYG Withholding (PAYGW) and Superannuation Guarantee (SG).
• Reputational Risk: NFPs may face reputational damage if they are perceived as non-compliant with their employer obligations.

When Are Contractors Considered “Employees” for Tax Purposes?

Directors and volunteers engaged by NFPs as contractors can often be classified as “employees” for PAYGW and SG purposes. This classification typically applies when individuals are compensated for attending board meetings or for providing their professional expertise voluntarily, rather than for producing a specific result or achieving a specific outcome.

An analysis of the entire relationship, focusing on the legal rights and obligations that constitute that relationship, is essential. The core question is whether the worker is operating within the business of the engaging entity. The Australian Taxation Office (ATO) provides guidance on distinguishing between employees and contractors in Taxation Ruling TR 2023/4.

Example Scenario

Consider the following scenario where a contractor is not treated correctly as an “employee” for tax purposes:

  • On 1 July 2023, Company A engages Mr. X and Ms. Y as non-executive directors under service contracts, paying each $50,000 per annum to attend monthly board meetings. Mr. X and Ms. Y must personally attend at least 80% of the board meetings each year.
  • Mr. X and Ms. Y are both employed full-time by separate Company B and claim the tax-free threshold with Company B. Neither Mr. X nor Ms. Y is registered for GST.
  • By 30 June 2024, Company A has made total payments of $100,000 to Mr. X and Ms. Y, recorded as contractor expenses in the profit and loss statement.

In this scenario, Mr. X and Ms. Y are likely considered “employees” of Company A according to the ATO’s guidance in TR 2023/4, as they are paid to work “in the business” and for their personal efforts. Treating them as employees for tax purposes has the following consequences:

  1. Underreported PAYGW: Company A has underreported its PAYGW by $28,080.
  2. Unpaid SG: Company A has not paid SG for Mr. X and Ms. Y. Since the current service contracts do not specify SG payments, SG will be paid on top of their “ordinary time earnings,” resulting in a total SG shortfall of $12,360.
  3. General Interest Charges: General interest charges (currently 11.34%) will apply to the underreported PAYGW and SG shortfall.

This example assumes the issue is identified quickly. The consequences would be much more severe if Mr. X and Ms. Y had been misclassified for several years.

How to Get It Right

Given these risks, it is best practice for organisations to regularly review their contractor engagements and assume new contractors are “employees” for tax purposes unless proven otherwise. We recommend having robust internal policies to ensure each contractor relationship is carefully considered by the appropriate staff.

For genuine contractors, organisations should work with their advisors to establish formal contracts that clearly support a legitimate contractual relationship.

How to Fix Past Mistakes

Organisations that have not complied with their PAYGW and SG obligations can self-correct by making a voluntary disclosure to the ATO for underreported PAYGW and lodging Superannuation Guarantee Charge (SGC) statements for previous underreported SG.

Conclusion

If you think that your organisation’s contractor engagements have not been appropriately reviewed, we recommend this is done immediately. Employers should work with their tax advisors to help identify “employees” from existing/future contractual engagements and to self-correct where necessary.

The potential consequences to directors can be severe, particularly where the contractual relationship has existed for many years and when the organisation does not have the funds to pay the PAYGW or SG shortfall.

Co-authored by Jordan Phung Senior Manager Tax Consulting Melbourne.