“Sham contracting” occurs when an employer misrepresents or disguises the engagement of a person as an independent contractor when they are an employee.
The obligations that an employer owes its workers are defined by the worker’s status as an “employee” or “independent contractor”. All employees are entitled to the National Employment Standards, which set out the 11 minimum employment entitlements, including maximum weekly hours, annual leave, personal leave and notice for termination. Whereas an independent contractor is not necessarily owed any minimum entitlements and their benefits and entitlements are determined by agreement.
Many employers, therefore, prefer to engage independent contractors rather than employees as this limits their costs and obligations. However, where employers can find themselves in hot water is when they go so far as downplaying employment by understating their control over employees, or by entering into labour-hire agreements to avoid direct employment.
Treading the fine line between employee and independent contractor has potentially onerous consequences for employers under the Fair Work Act 2009 (Cth) (FW Act).
Employee or independent contractor?
Simply labelling a worker as an “independent contractor” will not define their employment status. Rather the circumstances of the relationship must be analysed to determine if the worker is considered an employee or independent contractor.
If the issue is brought before the Court it will apply a multi-factorial test to determine the true nature of the relationship, including, but not limited to assessing:
- Control – employees have little control or say in the work they perform.
- Finances – employees have their employer pay superannuation, taxation, and insurance.
- Leave – employees will have certain types of paid leave.
- Tools and equipment – employees will be provided with most tools and equipment by their employer.
- Uniform – employees may be required to wear a uniform.
Based on the circumstances of the engagement and a balance of the above factors the Court will determine the status of a worker. In circumstances where a worker who was purported to be an independent contractor is determined to be an employee, the employer may be liable under the sham arrangements provisions.
What are the sham arrangements provisions?
Sections 357 – 359 of the FW Act are designed to prevent employers from disguising employment relationships as independent contracting arrangements. The provisions prohibit employers from:
- Misrepresenting an employment relationship as an independent contracting arrangement (section 357 of the FW Act);
- Dismissing, or threatening to dismiss an employee in order to engage them in the same work as an independent contractor (section 358 of the FW Act); and
- Making statements that are known to be false in order to induce an employee to enter into an independent contracting arrangement (section 359 of the FW Act).
If the Court determines that an independent contractor is really an employee, the consequences for employers can include an order by the Court for compensation or reinstatement into employment as well as penalties of up to $66,000 for corporations or $13,320 for individuals.
Additionally, employers may also be liable to tax fraud implications. In this respect, the Fair Work Ombudsmen works closely with the ATO in addressing sham contracting.
Lessons for Employers
Employers have a responsibility to ensure that all their workers are classified correctly. Determining whether a worker is an employee or an independent contractor can be difficult given the number of facts to consider. Employers should exercise care when engaging anyone as an independent contractor and seek legal advice when entering into an independent contracting arrangement.
The terms of the actual contract will be crucial and it is important that the document is properly drafted to take into account the relevant factors and avoid uncertainty. Additionally, employers should review their independent contractor arrangements from time to time to ensure the relationship has not changed.