Every few years, the subject of sham contracting gets regulators’ attention and those regulators often collaborate with each other across jurisdictions. The Australian Taxation Office and the Fair Work Ombudsman have jointly announced that they are doing just that. And the Albanese Government changed the rules on what organisations need to be doing to ensure that they don’t engage in sham contracting. How does that change things?

What is sham contracting?

According to the Fair Work Ombudsman, “sham contracting happens when an employer misrepresents to a worker that an employment relationship is an independent contracting arrangement when the employer doesn’t reasonably believe this. This might be done in an attempt to avoid paying entitlements such as super, leave and workers’ compensation. This practice undermines or ignores workers’ rights and disadvantages honest businesses. Those who engage in sham contracting can face court-ordered penalties.”

It might also be when a worker proposes engagement as an independent contractor for the purposes of avoiding taxation liabilities. 

From recklessness to reasonableness

As of February 2024, the legal test for defending a sham contracting claim was updated to a “reasonableness” test. To avoid penalties, the principal in the relationship must now prove that, at the time of the arrangement, they reasonably believed the worker was a contractor. This replaced the previous, more lenient “recklessness” test, making it harder for employers to defend against claims.

So now there is a much higher onus on businesses to properly consider whether an arrangement is really that of an independent contractor rather than that of an employee.

Income matching and reporting

The Taxable Payments Reporting System requires businesses who engage contractors providing services in certain industries to report those payments to the Australian Taxation Office.. The nominated industries are:

• building and construction
• cleaning
• courier and road freight
• information technology
• security, investigation or surveillance.

If the revenue you receive from these services is 10% or more of total revenue, you are required to lodge a Total Payment Annual Report (TPAR) with the ATO.

If contracting businesses are generating a significant proportion of their revenue from one source, there will likely be a suspicion that it is a sham contracting arrangement. 

So what if you are found to be sham contracting

Under the Fair Work Act, courts can impose penalties against businesses or individuals for sham contracting. The maximum penalties for each contravention are:

• $19,800 for individuals
• $99,000 for businesses with fewer than 15 employees
• for businesses with 15 or more employees, the greater of $495,000 or three times the underpayment amount.

Apart from the penalties imposed by the Fair Work Act, businesses who incorrectly treat an employee as an independent contractor risk other penalties and charges, including:

• PAYG withholding penalty for failing to deduct tax from worker payments and send it to the ATO
• super guarantee charge (SGC), which is more than the super that would have been paid if the worker was classified correctly. SGC consists of:
  • super guarantee shortfall amount
  • nominal interest
  • an administration fee
• additional super guarantee penalties including the Part 7 penalty amount of up to 200% of the SGC under the Superannuation Guarantee (Administration) Act 1992.

A few pointers

1. The fact that someone has an ABN doesn’t make them an independent contractor.
2. If they are paid by the hour for doing work that an employee could do and there is an ongoing arrangement for the worker to continue to do that work (not just come in and do a finite job like servicing a machine or building a s structure), there would be exposure to a suspicion of sham contracting.
3. The fact that it might be the worker who proposes the contracting arrangement does not relieve the principal of the legal responsibility to ensure that they reasonably believe the relationship to be a genuine independent contracting arrangement.
4. The fact that a worker might have multiple ongoing contracts with different businesses does not necessarily mean that a valid contracting arrangement exists if they are personally performing all of the work under those contracts on a regular and systematic basis. They might actually be found to have multiple part-time jobs as employees. There has been a decision in the Fair Work Commission to that effect.
5. If, other than the way that someone is paid ie by invoice rather than through payroll, the worker has the characteristics of an employee, the odds are that they really should be an employee
6. Regardless of whether someone is engaged as a contractor if they are just or principally supplying their labour, they will likely be deemed to be an employee for the purpose of the superannuation guarantee. 

If you engage contractors, you should be assessing the relationships for genuineness in the legal context and there should be contracts for service which clearly set out the nature of the relationship and provide evidence of the worker’s genuine agreement to that contractual arrangement. Need a hand?  Send us a message through the “Tell us what you need help with” form below.

Note: much of the content in this blog is sourced from the websites of the Fair Work Ombudsman and the Australian Taxation Office.