Outsourcing and contracting - new obligations for principal contractors

From 1 July 2003, a principal contractor can be liable to pay the workers compensation insurance premiums and unpaid pay-roll tax of its subcontractors unless it verifies compliance with obligations. [1]

The new obligations complement existing provision in section 127 of the Industrial Relations Act that already can make principals liable along similar lines for unpaid wages of the employees of subcontractors. The new obligations create a similar scheme for insurance premiums and pay-roll tax.

Also, under section 20 of the Workers Compensation Act a principal can be liable to pay workers compensation to an injured employee of an uninsured contractor.

When does it apply

A principal contractor can be liable if:

• There is a contract for work between a principal contractor and a subcontractor.

• The subcontractor's employees carry out the work.

• The work is carried out in connection with the business undertaking of the principal contractor. In the case of workers compensation provisions there is an additional requirement that the subcontracted work be "an aspect of work" done by the principal.

Scope of the obligations

The obligations may apply even if the contractor is not a "subcontractor" in the typical sense. The legislation can apply to consultancy and similar arrangements and will apply to many "outsourcing" situations. The exact scope may differ according to whether it is pay-roll tax, workers compensation premiums or remuneration that is in question.

The rules only apply when there is the requisite degree of connection between the work done and the "business undertaking" of the principal. The degree of connection is unclear. Experience with section 127 of the Industrial Relations Act suggests the liability arises where the principal has contracted to do work, part or all of which is subcontracted. In effect the employees of the subcontractor are doing the work of the principal's business undertaking.

It is possible to read the amendments more widely to cover any contract involving work that is entered into in connection with a business. Such an interpretation would imply application beyond the currently accepted width of section 127 of the IRA Act, nevertheless that intrepretation is open.

What might have to be paid

The principal contractor may be liable to pay:

• The subcontractor's premium including any penalty. Where the subcontractor is uninsured the amount payable will be double the premium. Where there is an unpaid or partially unpaid premium, the principal contractor may be liable for both the unpaid amount and any fees for late payment.

• Unpaid pay-roll tax relating to the relevant remuneration of the subcontractor's employees.

• Unpaid remuneration of the subcontractor's employees.

The principal contractor has a right to recover any monies paid under the legislation as a debt from the subcontractor. This right may be of little worth in cases where the subcontractor has failed to pay because of insolvency.

How to prevent liability

A principal contractor can avoid liability if a written statement from the subcontractor is obtained that states for all periods of the contract:

• That the subcontractor's relevant obligations (to pay the tax, premium or remuneration) have been met. In the case of worker's compensation premiums this also requires obtaining a copy of a certificate of currency of the insurance.

• Whether the subcontractor is itself a principal contractor.

• If the subcontractor is itself a principal contractor, it must state whether it has been given a statement by its own subcontractors.

The statement has no effect and the principal contractor cannot escape liability if the principal had, at the time it was given the statement, reason to believe it was false. Any subcontractor who knowingly gives a false statement is guilty of an offence.

What to do in the face of refusal

The legislation says that if a subcontractor refuses to provide a statement, the principal contractor may withhold any payment due to the subcontractor up until the statement is provided. The legislation also states that any "penalty for late payment" does not apply to the withheld payment.

This raises a number of issues for principals including the effect such action may have on the ability of a subcontractor to avoid the contract or refuse to carry out work. It is not clear what the phrase "penalty for late payment" really covers.

What you need to do

Review contracts for work in light of these changes. It is important to note that there is no requirement for any contract to be in writing so the rules not only apply to written contracts but to all arrangements and agreements, whether oral or in writing and whether formal or informal.

We recommend that any organisation which engages contractors or consultants should obtain a statement from each of those contractors. All such subcontractors, whether they say they employ workers or not, should now be asked for a statement.

The changes apply to the period of the contract not just to the periods when work is being undertaken. Contracts should be reviewed to ensure clear commencement and termination dates and that a statement will be provided to cover all periods during which a contract is in force.

If a contract is long term, a fresh statement and certificate of currency will be needed in respect of worker's compensation premiums on or before the date the subcontractor's insurance policy expires.

This is a broad summary of the new measures as a client alert (implications for contracts must be reviewed individually). 

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[1]. The changes are in section 175B of the Workers Compensation Act 1987 and a new Part 5B of the Pay-roll Tax Act 1971.