Contractors v Employees: How to avoid ‘sham-contracting’

23 May 2019
Posted by Sarah Luttrell

The 2019 federal election has resulted in coalition government, and they are serious about cracking down on sham-contracting. The 2019/20 federal budget will see an extra $9.2 million of funding over four years to the Fair Work Ombudsman, which will help set up a dedicated unit to investigate sham-contracting. Along with promoting education and compliance, the unit will increase resources for enforcement and litigation of businesses engaging in sham-contracting.

Since many businesses in the creative industries engage independent contractors on an ‘as-needs’ or project-specific basis, it’s a critical time to ensure your engagement of contractors is legal to avoid serious penalties.

What is ‘sham-contracting’?

It is illegal to enter into a ‘sham-contract’, being a sub-contracting agreement (written or verbal) with an individual who should actually be engaged as an employee. Doing so deprives the individual of certain minimum entitlements they would otherwise be afforded at law as an employee, such as ‘pay as you go’ tax withholdings (PAYG), superannuation payments, paid and unpaid leave, long service leave and other employee entitlements. Failing to afford employee entitlements can result in compensation for the individual as well as penalties for the company under the Fair Work Act 2009 (Cth), up to a maximum of $63,000 per contravention.

Even if you have a written sub-contracting agreement in place with an individual (who is knowing and consenting to the arrangement), the courts may look beyond the contract and assess what is the real nature of the relationship.

Every time you engage, or propose to engage, an individual to work for your business, you should carefully consider whether the circumstances of their engagement put them into the category of employee or independent contractor. Making the distinction is crucial to understanding your obligations.

How do I make the distinction?

Determining whether an individual you engage to work for your business should be classified as an employee or an independent contractor is an important and sometimes difficult question. The Federal Court has adopted a multi-factor test to make this assessment. In general terms, some differences between employees and contractors which the court may consider when determining the correct nature of the relationship may include, without limitation:

– An employee may work set hours, where a contractor has more flexibility;
– An employee cannot sub-contract their work to others, where a contractor may delegate their work to other sub-contractors that it engages;
– An employee may be paid for hours worked, where a contractor may be paid on a more project-based or results-based model;
– An employee is directed by its employer, where a contractor has more control over their own work;
– An employee is often required to work exclusively for the business, where a contractor is considered independent.

The court does not typically place more importance on one factor compared to any other and every case is different. As a result, this area of law can be somewhat grey and uncertain at times and it means the particular circumstances of each individual engaged should be considered on a case-by-case basis.

Do I have to pay independent contractors superannuation?

The Superannuation Guarantee (Administration) Act 1992 (Cth) (Superannuation Act) has an expanded definition of ‘employee’, beyond the common law definition. This means that even if the individual is genuinely an independent contractor, they may still be deemed an employee for the purposes of the Superannuation Act. Essentially, under the Superannuation Act, an independent contractor is entitled to be paid superannuation contributions if they work under an arrangement that is ‘wholly or principally for the labour of the person’.

Failure to pay an independent contractor the minimum superannuation contributions they are entitled to under the Superannuation Act can have serious consequences. The business may be required to pay the ‘superannuation guarantee charge’ to the ATO (which can include the super owing to the individual, plus interest and administrative fees) as well as a range of potential penalties against the business and even its individual directors.

Reviewing your arrangements

It’s important to make the assessment of whether the individual should be engaged as an employee or independent contractor each time you engage an individual to work for your business. Keep in mind also that while you may have initially properly engaged an individual as a genuine independent contractor, the relationship may have changed over time to one of employer and employee.

If you would like further information or require assistance in reviewing your working relationships, please contact us on 03 9521 2128, or email us at hello@studiolegal.com.au.

DISCLAIMER

The information in this article is of a general nature. It does not constitute formal legal advice, and should not be relied on as such. Please see the full disclaimer in our website terms. Please contact Studio Legal if you are seeking advice about a specific legal matter.