The ATO has brought in new rules as of the start of this month which impacts whether you can claim a tax deduction on payments made to your contractors or employees. If you do not follow the obligations set out by the ATO, they could deem your employee and contractor payments to be ‘non-compliant’ which means you would lose your tax deduction for these payments. This could result in a lot of money lost in additional tax paid by your business, so it’s important that you are aware of the obligations and follow them.
Here are some key points you need to know:
Differences between a contractor and an employee:
Before we go through the new rules for contractor and employee payments, it is important to first understand the differences between a contractor and an employee. Whilst the new rules do not change the way contractors and employees are classified, it is often an area which confuses a lot of clients. The ATO distinguishes between the two by saying that an employee is ‘a part of your business’ whereas a contractor ‘operates their own business’. They also provide guidance by outlining six factors which should be considered in making your determination:
- Ability to sub-contract/delegate – generally a contractor only would have the ability to sub-contract/delegate work.
- Basis of payment – generally an employee is paid for their time worked, the price of an activity performed or a commission. On the other hand, a contractor is generally paid for a result achieved.
- Equipment and tools – generally a contractor provides their own equipment and tools, whereas an employee uses those of an employer or receives a reimbursement/allowance if they use their own.
- Commercial risks – generally a contractor takes commercial risks and is legally liable for their work, whereas an employee does not.
- Control over work – generally a contractor has control over how they perform their work, whereas an employee does not
- Independence – generally a contractor is operating independently to your business, whereas an employee is a part of it
Taking into consideration the differences between contractors and employees, let’s look at the changes to the new ATO rules in relation to contractors and employees:
Contractor payments
If you engage a contractor, generally they will provide you with their ABN on their invoice. If they don’t provide you with their ABN, you must
- Ensure your own business is registered for PAYG Withholding. You will already be registered if you have withheld tax from staff pay and reported it to the ATO.
- Withhold tax at the top tax marginal rate (currently 45%) before paying them. For example, if a contractor did work for your business and charged you $1,000, you would deduct $450 from their payment, and pay them $550.
- Report the amount to the ATO through the online form PAYG payment summary – withholding where ABN not quoted. In the above example, this would be the $450 amount deducted from the contractors $1,000 bill.
Contractor payments
If you engage a contractor, generally they will provide you with their ABN on their invoice. If they don’t provide you with their ABN, you must
- Ensure your own business is registered for PAYG Withholding. You will already be registered if you have withheld tax from staff pay and reported it to the ATO.
- Withhold tax at the top tax marginal rate (currently 45%) before paying them. For example, if a contractor did work for your business and charged you $1,000, you would deduct $450 from their payment, and pay them $550.
- Report the amount to the ATO through the online form PAYG payment summary – withholding where ABN not quoted. In the above example, this would be the $450 amount deducted from the contractors $1,000 bill.
Employee payments
If you hire staff, your business must first be registered for PAYG Withholding. Then you are required to:
- Confirm your employee is legally permitted to work in Australia
- Provide them with a TFN Declaration Form and have this lodged once completed
- Withhold the appropriate PAYG tax from their gross pay. You can use the ATO’s Tax Withheld calculator to determine the applicable PAYG Tax.
- Report the amount of PAYG tax withheld to the ATO through your businesses’ activity statements and annual payment summaries / through your reporting with single touch payroll.
It’s important to ensure you follow the new tax rules stated above so that your payments to contractors and employees are considered by the ATO to be compliant. If you need help in contractor or employee payments, feel free to get in touch with us.
Not being aware of the rules associated with these payments could mean you lose your tax deduction for these payments which could cost your business a lot of money.
