Are your contracting arrangements compliant?

Beware of the sham contractor in an employee’s clothing

In the current economy, we are seeing more and more businesses shaping their workforces with a mix of both employees and independent contractors. While this kind of workplace structure provides many economic advantages, employers must beware of sham contracting arrangements.

To avoid being caught in a sham contracting arrangement, it’s crucial that employers clearly define a contract of service, which applies to employees, as opposed to a contract for services, which defines the relationship with independent contractors. The characteristics of each relationship are entirely different.

Sham contracting arrangements

As defined by Fair Work Australia, a sham contracting arrangement occurs where an employer attempts to disguise an employment relationship as an independent contracting arrangement. This is usually done for the purpose of avoiding the responsibility of paying employee entitlements.

Under the sham contracting provisions of the Fair Work Act 2009 (“FW Act”), an employer cannot:

  • misrepresent an employment relationship or a proposed employment arrangement as an independent contracting arrangement;
  • dismiss or threaten to dismiss an employee for the purpose of engaging them as an independent contractor; and/or
  • make a knowingly false statement to persuade or influence an employee to become an independent contractor.

The FW Act provides serious penalties for contraventions ranging up to $54,000 per contravention if an employer is found guilty.

The conversion of employees to contractors

It is important employers characterise their working relationships correctly from the outset. This becomes particularly important when employees wish to convert to being an independent contractor or vice versa, or when your workforce is made up of both types of service arrangements.

The recent case of Fair Work Ombudsman v Quest South Perth Holdings Pty Ltd (2015) provides a timely example. This case involved employees of Quest South Perth Holdings (“Quest”), converting to become independent contractors through a labour hire provider, Contracting Solutions.

Upon conversion to independent contractors, the workers continued a pattern of work which closely resembled the pattern of work they had previously followed when they were Quest employees. It appeared that after the employees’ conversion to independent contractors, not much changed for the Quest workers other than them acquiring an ABN.  The Fair Work Ombudsman (FWO) initiated proceedings against Quest on the grounds that Quest’s conduct in converting its employees to contractors contravened the sham contracting provisions of the FW Act.

The business test was applied by the Court to determine “whether the workers were engaged in the conduct of their own business or whether they were simply working in Quest’s business”.[1]

This case is further complicated by the involvement of Contracting Solutions and the role that the labour hire business played in converting the employees to contractors. The case is currently on appeal to the High Court so the final outcome is yet to be determined. However, the case demonstrates the importance of paying attention to the sham contracting provisions of the FW Act to minimise the risk of falling foul of sham contracting arrangements.

How to avoid the risk of falling foul of sham contracting 

Sham contracting can be avoided if employers ensure they have clearly defined relationships with contractors and employees. There is no room for misrepresenting an employment relationship or a proposed employment arrangement as an independent contracting arrangement.

Similarly, be aware that it is sham contracting if an employer dismisses or threatens to dismiss an employee for the purpose of engaging them (and thus effectively re-engaging them) as an independent contractor. Likewise, if an employer knowingly makes a false statement to persuade or influence an employee to become an independent contractor, this is sham contracting.

Clearly defined employment contracts of service for employees and clearly defined contracts for services for independent contractors will go a long way towards minimising the risk of sham contracting for employers.

Checklist – how to determine whether a worker is a contractor or an employee and thereby avoid sham contracting penalties

The following table[2] explains how the nature and manner in which work is performed can indicate whether a worker is an employee or a contract:


IndicatorEmployeeIndependent Contractor
Degree of control over how work is performedPerforms 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.
Hours of workGenerally 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 workUsually 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.
RiskBears no financial risk (this is the responsibility of their employer).Bears the risk of 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.
SuperannuationEntitled to have superannuation contributions paid into a nominated superannuation fund by their employer.Pay their own superannuation (note: in some circumstances independent contractors may be entitled to be paid superannuation contributions).
Tools and equipmentTools and equipment are generally provided by the employer, or a tool allowance is provided.Use their own tools and equipment (note: alternative arrangements may be made within a contract for services).
TaxHas income tax deducted by their employer.Pay their own tax and GST directly to the Australian Taxation Office.
Method of paymentPaid 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.
LeaveEntitled 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.

If your business would like to review its contractor agreements to avoid the risk of sham contracting arrangements, please contact us to discuss.

[1] Employment Law Practical Handbook, October 2015, p11.

[2] Fair Work Commission