Incorrectly treating an employee as a contractor is known as sham contracting, and can result in both corporate entities and individuals (such as managers and advisors) being liable for substantial back payments and penalties. In January 2019, the Fair Work Ombudsman succeeded in achieving penalties of over AU$200K against two labour hire companies and their directors for sham contracting arrangements.
It is very important that any consultants, freelancers, or contractors you hire are properly set up as genuine independent contractors—otherwise, you might unknowingly be creating serious liabilities under both employment and taxation legislation, as well as exposing your business (and any entities and individuals involved in any such arrangements) to civil penalties.
Is it safe to use independent contractors?
Of course! There are a number of good and legitimate reasons businesses and individuals prefer to have a relationship structured as a contractor relationship. However, the law examines the actual characteristics of how the engagement runs—not the preferences of the parties. This means that you need to be conscious that you are setting up the work arrangement properly, so that the characteristics of the relationship are consistent with a legal definition of a genuine contractor.
So, what’s the problem?
When an independent contractor agreement is genuine, it’s a great way to source flexible and specialised expertise. Most people like hiring independent contractors because you can pay a predictable all-up price for an “off-the-shelf” product or service, and not have to think too much about how the job gets done.
However, independent contractor arrangements are sometimes used as a method of avoiding having to pay a worker’s entitlements under the Fair Work Act 2009 (Cth) (which employees get, and contractors don’t). These entitlements vary depending on the type of the work, but in most cases, employees have enshrined rights to minimum wage rates, accrued leave, special allowances, penalty rates and loadings.
Okay, but I’m not trying to avoid anything—both me and the contractor are happy. Why should I care?
Even in situations where a business honestly isn’t trying to avoid paying anyone any entitlements, they can get caught out for sham contracting. It’s not just about intent—it’s about how the actual work is being done. There are many common myths about contractors. We set some of these out below:
|If the worker has an ABN, and issues invoices that charge GST, they are a contractor.||False. Having an ABN and charging GST tax invoices are just a couple of the factors taken into consideration by the courts, and do automatically validate a contractor arrangement.|
|The worker never accrued personal leave or annual leave, so the evidence suggests that that we’ve always treated them like a contractor.||False. This is a bit of a circular argument—being a genuine contractor has little to do with acquiescing to not being paid entitlements. In fact, the opposite is true—a worker might genuinely be an employee, and you might be on the hook for not having paid their entitlements!|
|I bought a contractor template or a service agreement template from a website that sets says that the parties are involved in a contractor type arrangement. Therefore, the contractor cannot later say that they were an employee.||This is false. It makes us sad, but there are a lot of services out there, including law firms, who will sell you a “contractor agreement” or a “service agreement” template on the cheap—but what is agreed on paper is not as important as the way in which the business and the worker actually work together, and that requires specialised advice.
Even if the parties sign a contractor agreement, and even if the contract has some terms that say “you agree that you are not an employee”, the law can (and often does) still come to a view that sham contracting has occurred due to other considerations.
|The worker is happy being an independent contractor, and we are happy with them being a contractor—if we keep on being happy with this arrangement, they’re still a contractor.||Not exactly correct. A court will determine if a contractor arrangement is genuine based a on consideration of any matters it deems relevant. It is very possible for a business and a contractor to be very happy with an arrangement, and for it to still at law be considered a sham contractor arrangement.
A business may go on for years with the parties being happy, which is why they might not notice—but if the relationship breaks down, there may be problems.
How do I know if the worker I’ve engaged is a genuine contractor or not?
The following table from the Fair Work Commission provides the following useful list of characteristics:
|Degree of control over how work is performed||Performs work, under the direction and control of their employer, on an ongoing basis.||Has a high level of control in how the work is done, often including delegation authority.|
|Hours of work||Generally, works standard or set hours (note: a casual employee’s hours may vary from week to week).||Under agreement, decides what hours to work to complete the specific task.|
|Expectation of work||Usually has an ongoing expectation of work (note: some employees may be engaged for a specific task or specific period).||Usually engaged for a specific task.|
|Risk||Bears no financial risk (this is the responsibility of their employer).||Bears the risk for making a profit or loss on each task. Usually bears responsibility and liability for poor work or injury sustained while performing the task. As such, contractors generally have their own insurance policy.|
|Superannuation||Entitled to have superannuation contributions paid into a nominated superannuation fund by their employer.||Pays their own superannuation (note: in some circumstances independent contractors may be entitled to be paid superannuation contributions).|
|Tools and equipment||Tools and equipment are generally provided by the employer, or a tool allowance is provided.||Uses their own tools and equipment (note: alternative arrangements may be made within a contract for services).|
|Tax||Has income tax deducted by their employer.||Pays their own tax and GST to the Australian Taxation Office.|
|Method of payment||Paid regularly (for example, weekly/fortnightly/monthly).||Has obtained an ABN and submits an invoice for work completed or is paid at the end of the contract or project.|
|Leave||Entitled to receive paid leave (for example, annual leave, personal/carers’ leave, long service leave) or receive a loading in lieu of leave entitlements in the case of casual employees.||Does not receive paid leave.|
Determining who is a contractor and who is an employee is about coming to an overall view in consideration of the factors in the table above. No single indicator is determinative—and actually, courts and tribunals have a wide discretion to consider any factors that they deem relevant to consider the overall nature of the relationship.
A couple of easy starting points to help ensure you handle things right:
- Your business is not like any other business, so your contracts shouldn’t be either. Get a contract tailored drafted for your needs, and don’t rely on a budget template you bought online.
- Source robust legal analysis of how your business uses the contractor.
If you’re looking for help in identifying issues and helping with your business’ workforce needs, please get in touch with us at Danny King Legal.
The above is simply general information, it does not constitute legal advice. For further information, please contact us.
 Fair Work Ombudsman, Independent Contractors and Employees <https://www.fairwork.gov.au/how-we-will-help/templates-and-guides/fact-sheets/rights-and-obligations/independent-contractors-and-employees.>