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Sham contracts: your questions answered

14 April 2011


Sham contracts: your questions answered

Maria Crabb, Associate

This year the Fair Work Ombudsman (“FWO”) is taking steps to identify and cut down on employers entering into sham contracting arrangements. In this article, we make suggestions on how to avoid falling foul of the provisions of the Fair Work Act 2009 (the “FW Act”).

What is it?

Sham contracting is where a person misrepresents to an individual that they are engaged as a contractor, when in reality the relationship is that of employer and employee. The FW Act also prohibits an employer from dismissing or threatening to dismiss an individual in order to re-engage them as a contractor performing substantially the same work, and making representations which are false to persuade an employee or previous employee to become a contractor performing substantially the same work for the employer.

Why enter into a sham contracting arrangement?

Employers who create a sham contracting agreement may receive numerous perceived benefits, including not paying payroll tax, superannuation contributions, and workers compensation. The individual entering into the sham contracting arrangement also has fewer rights as an independent contractor compared to an employee (which might preclude them from, for example, bringing an unfair dismissal claim).

Defence to sham contracting arrangements

There has been some criticism of these provisions of the FW Act, due to the ease with which employers and persons can avoid being found in contravention of the sham contracting provisions. The employer has to be able to show that at the time they made the representation, they did not know and were not reckless as to whether the contract was a contract of employment as opposed to a contract for services.

To date, there is yet to be a successful case against an employer or person in breach of the sham contracting provisions of the FW Act. Although there were some prosecutions 1996 (“WR Act”), which had similar provisions about sham contracting arrangements, the FW Act provisions are yet to be tested.

Consequences of a breach

If prosecuted, employers face civil penalties of up to $33,000 per offence, and persons entering into sham contracting arrangements may also be held personally accountable if they have aided and abetted the breach. They will be liable for a civil penalty of up to $6,000 per offence.

Employers may also face tax fraud implications. There have been numerous investigations by the Australian Tax Office (“ATO”) in recent months to crack down on sham contracting arrangements.

In light of the FWO and the ATO joining forces to address sham contracting arrangements, employers and persons engaging staff should pay careful attention to the relationship with the individual concerned.

The Australian Building Construction Commission (“ABCC”)

The ABCC is currently hosting a government and industry round table inquiry into eliminating sham contracting in the building  construction industries. The ATO is also taking part in these discussions. This will ensure that sham contracting is to be the focus of a number of influential governmental groups, meaning that employers need to be on their guard to ensure that they are not in breach of these provisions.

Part of the review is to suggest that Fair Work Australia has more powers when making orders where sham contracting has been entered into, including the granting of injunctions. It will be interesting to see how this area of law develops over the next twelve months.

Employee or Contractor?

Determining whether an individual is a contractor or an employee is a difficult task as it will often depend on the particular circumstances.

A court applies a common law test where a number of factors will assist in demonstrating whether the individual is engaged as an independent contractor. These include:

  • the individual having control over the way they perform a task;
  • the individual supplying and/or maintaining their own tools or equipment;
  • the individual working varied hours to those of employees;
  • the individual being paid for the work actually performed instead of a wage;
  • the individual being able to work for others;
  • the individual being able to delegate any of their work;
  • the individual being responsible for their own tax; and
  • the individual not receiving leave and/or sick pay etc.

The above list is non-exhaustive and employers should take steps not to blur the distinction between contractors and employees.

Case

The case of Fair Work Ombudsman v Land Choice Pty Ltd & Anor [2009] FMCA 1255 was a decision in which the FWO prosecuted a small business for breaching the sham contracting provisions.

Although they were found to be in breach under the old provisions of the repealed WR Act, the court ordered the payment of penalties by the employer, and the person who was involved in misrepresenting the employment contract as a contract for services. It was irrelevant that the company was a small business, which demonstrates how these provisions apply to all businesses.

What steps can you take?

Organisations should consider the following:

  • Ensure your employee and contractor agreements are reduced to writing. You should take steps to show that the independent contractors are engaged as such and that their terms vary from your employee terms and conditions
  • Take steps to implement the independent contractor’s contract
  • Review all your independent contractor arrangements – if, over time, the relationship has altered, consider engaging the contractors as employees or review the way in which their work is carried out to clearly establish an independent contractor relationship
  • Ensure that independent contractors have some degree of flexibility in performing their work
  • Notes should be kept of any negotiations which occur whilst entering into contracts for services to demonstrate the true nature of the employment relationship and the parties’ intentions
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