20.01.2020

Sham contracting – The facts you need to know

With more and more Australian businesses relying on a flexible workforce, protecting genuine employees from sham contracting arrangements has never been more important. But despite a recent crackdown from the Fair Work Ombudsman and Australian Tax Office, many employers continue to feign ignorance as to their responsibilities. Here’s what you need to know about sham contracting – whether you’re an employer or an employee.

What is sham contracting?

Sham contracting occurs when an employer treats an employee as an independent contractor when they’re not. They may require the employee to have an ABN and submit invoices for work done, and often rely on a contractor agreement to formalise the working relationship.

Although some employers institute sham contracting agreements to avoid paying employee entitlements, it’s not always deliberate. But regardless of how the arrangement comes to be, it is illegal.

Under the Fair Work Act 2009, an employer must not:

  • Claim an employee is an independent contractor when they’re not
  • Make false statements to convince an employee to become an independent contractor
  • Dismiss, or threaten to dismiss an employee for failing to agree to become an independent contractor
  • Dismiss an employee and then re-hire them as an independent contractor to do the same work

But how do you know who’s an employee and who’s an independent contractor?

Independent contractors vs employees

There are a number of factors that set employees apart from independent contractors. These include:

 Employees

  • Work standard or set hours each week (casual employees’ hours may vary from week to week)
  • Perform work under the direction and control of their employer
  • Have an ongoing expectation of work
  • Bear no financial risk and are covered by their employer’s insurance
  • Are entitled to superannuation contributions paid by their
  • employer into a nominated fund
  • Are provided with tools and equipment, or a tools allowance
  • by their employer
  • Have income tax deducted from their pay by their employer
  • Are paid a regular income (weekly, fortnightly or monthly)
  • Are entitled to paid leave – annual leave, sick leave, long
  • service leave etc., or if a casual employee, receive loading in
  • lieu of leave entitlements

 Independent contractors

  • Are engaged for a specific task, and decide how many hours are required to complete it
  • Have a high level of control over how the work is done, and may hire others to assist
  • Are engaged to complete a specific task or for a specific period of time
  • Bear the risk of profit or loss on each job. They also usually assume responsibility and liability for poor work or injuries sustained while completing the task, and therefore have their own insurance
  • Pay their own superannuation (as a general rule)
  • Provide their own tools and equipment
  • Pay their own tax and GST (as a general rule)
  • Have an ABN and submit invoices for work done or are paid at the end of the project
  • Are not entitled to paid leave

It’s important to note there’s no single factor that determines someone as an employee or independent contractor. An employee can have an ABN and invoice for work done and still be an employee, while an independent contractor may carry out the same work as an employee. To make the right distinction, you should look at all the above factors in combination.

Why do people enter sham contracts?

Some employers prefer engaging people as independent contractors in the belief that they can:

  • reduce the overall amount of tax they have to pay;
  • avoid having to accrue for leave;
  • avoid paying superannuation; and
  • ignore the protections given to employees by law, such as for unfair dismissal, thereby creating a more ‘flexible’ workplace.

Some employers also believe that it can reduce their payroll tax obligations and workers compensation premiums.

If given the choice, some employees will prefer to be treated as independent contractors.

This is mainly for two reasons:

  • they may wish to structure their affairs in a way that reduces the amount of tax they have to pay; and
  • they may be able to command a higher rate of take-home pay than they could obtain as employee.

However, even where an employee wishes to be treated as an independent contractor, there are still risks for the employer.

Minimum entitlements and general protections

Because of their independent nature, independent contractors aren’t entitled to the same benefits as employees. However, they can negotiate things like leave and notice of termination in their contracting agreement.

This doesn’t mean they’re without protection though.

Under the Fair Work Act 2009 independent contractors and their principals are afforded limited workplace rights and are protected from adverse action, coercion and abuse of freedom of association – i.e. their right to engage, or not engage, in industrial activities.

They can also ask a court to set aside a contract if it’s found to be harsh or unfair under the Independent Contractors Act 2006.

Both employees and independent contractors may approach the Fair Work Ombudsman for assistance if they feel their rights have been contravened.

 

Protecting workers’ rights

Whether you’re an employer, employee or independent contractor, and are confused about workers’ rights and entitlements, you can contact the Fair Work Ombudsman for assistance. You can also visit their website to access fact sheets and further information. www.fairwork.gov.au

 

What are the risks for employers?

If you have ‘employees’, you must treat them as employees – for example, by paying the right amount of tax, by paying superannuation and providing leave, and by observing the unfair dismissal laws and other legislation giving protection to employees.

If you don’t, you can be required to remedy the situation and you can be fined.

Sham contracting is prohibited by the Fair Work Act. Employers can be fined for breaches, independently of the other consequences they can face for breaching legislative requirements (for example, in relation to tax or superannuation).

A person whose engagement is terminated may have recourse to unfair dismissal remedies even if their contract says they are an employee. In addition, they may have claims for unpaid leave and superannuation if they have not been paid.

Regardless of whether the issue ever comes to the attention of the authorities, if you ever intend to sell your business, this is an issue that any prospective purchaser (properly advised) will look at. If there is any risk that you have not paid the correct amounts or made the appropriate accruals, you should expect that they will take this into account when negotiating the purchase price.

Conversely, if you ever buy a business, this should be a key area of focus to ensure that you do not inherit any unwanted risks or liabilities.

In sum, employers should be extremely cautious before engaging anyone as an independent contractor. If the person falls on the wrong side of the employee/independent contractor divide, the arrangement could do far more harm than good in the long run.

As an employer, it’s important you remember that ignorance of the law is no defence. Even if you’ve mistakenly distinguished someone as an independent contractor when they’re not, you may still be subject to penalties under the law. If you’re unsure of how to distinguish between employees and independent contractors, you should seek legal advice.

Penalties

Because sham contracting can result in employees being denied their workplace rights and entitlements, non-compliance is taken very seriously. Penalties include, but are not limited to a maximum penalty of $51,000 per contravention (as at the time of writing) and compensation payments to employees suffering any loss.

Fair Work Inspectors may also apply to the courts for injunctions or interim injunctions if an employer attempts (or threatens) to dismiss an employee with the intention of re-hiring them as an independent contractor. An injunction in these circumstances would prevent the dismissal from occurring, or remedy the effects of the original action (the attempted or threatened firing).

The courts may also make other orders to have the employee reinstated or compensated.

Ian Macleod is the CEO of the legal publisher RP Emery and Associates. They provide cost effective legal contract kits for Individuals, SME’s and the legal fraternity.

 www.findlaw.com.au/articles/5706/shamcontracting–the-facts-you-need-to-know.aspx

 www.turtons.com/blog/sham-contracting

Greg Henry | Principal

Greg is a principal at Turtons and a senior commercial lawyer who acts for a range of clients mainly in the construction and technology sectors. Greg advises on both transactional and contentious matters.