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Regulators crack down on sham contracting

By Kristin Ramsey16 May 2012

If it looks like a duck, walks like a duck, and quacks like a duck – can I call it a chicken?

A key issue that businesses often struggle with is the distinction between employees and independent contractors.

Just because you call someone an independent contractor doesn’t mean at law they will be viewed the same way. Like with the duck example, whilst you might call it a chicken, at the end of the day it is still a duck!

The issue of sham contracting is currently at the forefront of union and regulators minds with the result being increased scrutiny of purported independent contractor arrangements through the Fair Work Ombudsman's targeted audit and compliance program.

What is sham contracting?

Sham contracting is essentially treating a person as an independent contractor when really they are an employee.

Why does it matter?

Employees have different entitlements under legislation compared to independent contractors and businesses have different obligations towards employees than they do to independent contractors.

If a business attempts to engage a person as an independent contractor when really they are an employee, the business could find that it is exposed to claims for underpayment of wages, unpaid annual and personal/carer’s leave, additional taxation and superannuation. There may also be insurance and workplace health and safety ramifications.

How can we tell if someone is really an employee or an independent contractor?

Consideration needs to be given to a number of factors to work out if someone is an independent contractor or an employee. However, an assessment needs to be made of the totality of the relationship/arrangement rather than any single factor.

Some of the ways to identify employees from independent contractors are as follows:

An employee generally…      An independent contractor generally…

Works solely under the control of their        Works for more than one business

Work hours set by their employer               Decides when and how they will perform the 
                                                               required work

Has paid leave entitlements (ie annual         Has no paid leave entitlements
leave etc)

Is paid regularly based on the number          Is contracted for a set period of time or for 
of hours that they work                               a specific job

Has income tax deducted from their             Gets paid on invoice plus GST in gross

Has superannuation contributions made       Looks after their own superannuation
on their behalf by their employer  

Does not provide tools or equipment             Provides their own tools and equipment

Bears no financial risk in respect of the        Bears the risk if the work is performed poorly 
work they perform anddo not have to            and carries their own insurance
provide their own insurance                               

The above list is far from exhaustive.

What happens if we get it wrong?

The Fair Work Ombudsman has the power to investigate complaints of sham contracting and to prosecute businesses that have engaged people as independent contractors when really they are employees. In such circumstances, business face fines of up to $33,000 per contravention and individuals who have been involved in the business’ contravention (for example HR Managers) face personal fines of up to $6,600.

In addition to fines, businesses are also likely to be required to make back payments in respect of unpaid wages, leave, superannuation and/or income tax.

What should we do?

Many businesses purport to engage people as independent contractors but them treat them as employees – for example by providing paid leave, deducting income tax and requiring the person to work set hours and wear a company uniform. This can be problematic as it calls into question the true nature of the relationship between the parties.

It is important to be clear from the outset how you are engaging a person and ensure that the documentation and work practices reflect this relationship.

Every business must:

  • Audit their use of independent contractors and check that the work being performed is work that is suitable for an independent contractor arrangement;
  • Audit current practices in respect of independent contractors to ensure that they are not being treated as employees;
  • Seek legal review of contractor documentation to ensure the business is protected to the largest extent possible.

If you are not sure on any of this, we can help.  Do not get caught pretending a duck is a chicken!