The Consequences of Sham Contracting
How the dangers of incorrect employee classification can hinder your business…
When engaging workers it can be difficult to determine as a business owner how the worker is to be categorised to fit the position and type of job that you need performed. Small to medium business owners are usually not aware that a work relationship should be classified as either an employment relationship or an independent contractor relationship.
As an employer it is essential for you to ensure that workers are classified correctly to safeguard the business from penalties and sanctions that can be imposed for sham contracting arrangements.
What is Sham Contracting?
The provisions of the Independent Contractors Act 2006 and the Fair Work Act 2009 serve to identify sham contracting arrangements and penalise employers who breach the Act. An independent contractor relationship is seen where an individual or entity in business for themselves is engaged to provide a specific service to another individual or entity in business (usually the principal), for an agreed price.
Sham contracting is found where an employer has improperly structured the working relationship with the worker being seen to provide services to the employer rather than perform services as an employee. A relationship that has been entered into as an independent contractor will bear no discernible difference to that of an employee relationship.
A rather unique and succinct summary used to describe the classification of workers comes from the Courts; “the parties cannot create something which has every feature of a rooster, but call it a duck and insist that everybody else recognise it as a duck.”
The Courts have developed the following factors to assist in determining whether a worker should be classified as an employee or an independent contractor:
- How the worker was engaged and the background to the relationship.
- The degree of control over how work is performed and who holds the control for the performance of the work.
- Hours of work.
- The worker’s expectation to receive continued work.
- Who bears the risk for the work performed.
- The worker’s ability to delegate the work required to be performed.
- Any requirements to make superannuation contributions for the worker.
- Who is required to supply the tools, equipment and materials for the performance of work.
- Any tax withheld on behalf of the worker.
10. Whether entitlements for annual leave and sick leave are provided to the worker.
The Courts will collectively examine the factors to determine the totality of the circumstances surrounding the relationship with no one factor being provided with more weight over any other factor.
Why is Sham Contracting an issue?
The sham contracting provisions were implemented within the Independent Contractors Act and the Fair Work Act to protect workers in circumstances where employers are seen to be avoiding their responsibilities.
Examination of sham contracting arrangements has been seen to come about by employers attempting to limit liability and evade obligations imposed by Modern Awards and legislation through the engagement of workers as independent contractors.
The independent contractor relationship is appealing to employers as the employer can save significant costs due to not having to comply with Modern Award provisions, annual leave or sick leave, workers compensation, payroll taxes, superannuation contributions, insurance contributions or termination processes.
One of the main factors from a liability perspective, is to analyse whether the business owner is variously liability for the actions of that person.
Vicarious liability arises when an employer is held responsible for the loss and damage suffered by a third party as a result of an employee’s actions. The distinction occurs where an employer will not be held responsible in circumstances where loss and damage is suffered by a third party as a result of an independent contractor’s actions.
The Courts developed an approach for assessing the factors and determining on a balance whether or not the worker was classified as an employee or an independent contractor. This determination would then result in whether the employer would be liable for the injury sustained by the third party or not.
To limit liability it was seen to be more attractive for employers to classify their workers as independent contractors rather than employees.
Consequences of Incorrect Classification
Serious financial penalties and sanctions are enforced in circumstances where it is found that employers have tried to squeeze a work relationship into an independent contractor classification where the factors and circumstances of the relationship point towards an employment relationship.
Under the sham contracting provisions provided for in the Fair Work Act, an employer must not:
- misrepresent an employment relationship or a proposed employment arrangement as an independent contracting arrangement;
- dismiss or threaten to dismiss an employee for the purposes of engaging them as an independent contractor; or
- make a knowingly false statement to persuade or influence an employee to become an independent contractor.
Where a complaint is made by workers in relation to sham contracting arrangements, the Fair Work Ombudsman may investigate the employer and seek to impose penalties, sanctions and compensations orders by way of court proceedings. The provisions of the Fair Work Act allow the Court to impose penalties of up to $54,000.00 per contravention.
Real life examples of incorrect employee relationship classifications:
In Fair Work Ombudsman v Maclean Bay Pty Ltd, the Fair Work Ombudsman conducted an investigation into the company forcing employees to sign independent contractor agreements to reduce costs. The Federal Magistrates Court found the employer to be in breach of the sham contracting provisions and levied a fine of $280,500.00 against the company. The Court went further and imposed a $14,000.00 penalty personally against a former director of the company for being personally aware and involved in the contravention. These penalties were in addition to the compensation that the company was ordered to pay to the employees in back pay.
In Director of the Fair Work Building Industry Inspectorate v Linkhill Pty Ltd (No.9), the Fair Work Building Inspector conducted an investigation into the classification of 10 tradespersons that had been engaged on a building site for a period of three years as independent contractors. The Court found that the company had deliberately engaged in sham contracting arrangements with the workers resulting in an underpayment of wages of approximately $150,000.00. The Court levied a penalty against the company of approximately $300,000.00 with the extremity being a direct result of the company’s attitude and behaviour throughout the investigation and proceedings.
The cases highlight the seriousness with which the Courts consider contraventions of sham contracting arrangements and the penalties that they are prepared to impose against employers who breach these provisions.
Checklist for Assisting in Classification
It is essential for employers to adopt processes to determine the classification of workers correctly at the outset of the relationship.
In acting for small to medium businesses, we find that our clients are generally unaware of when workers should be classified as independent contractors or employees.
The following questions have been developed to assist employers in determining whether their workers should be classified as employees or independent contracts:
- Does the worker have control over how the perform the work and when they perform the work or do you dictate this to the worker?
- Does the worker supply the materials to perform the job or do you?
- Does the worker provide the tools and equipment to perform the work or do you supply this to the worker?
- Does the worker set the hours of work that are needed to perform the work or do you set the hours of work per day?
- Is the worker paid weekly or fortnightly for the hours of work performed or are they paid on completion of a specific job performed?
- Is the worker paid as an individual or as a company?
- Does the worker engage other workers to assist in performing work or do you engage the other workers to assist the worker?
- Is the worker able to assign the work to a third party to perform or is the work required to be performed by the worker?
- Would the worker be engaged by you to perform services for 80% or more of a financial year?
- Does the worker perform services for other entities and individuals or solely for you?
- Do you pay workers compensation insurance or superannuation contributions for the worker?
- Do you make any deductions from the worker’s wages for taxation purposes?
If the answer to any of the above questions is yes then this may indicate that the worker should be classified as an employee rather than an independent contractor.
Streten Masons Lawyers can assist your business by providing advice on whether your workers have been classified correctly and to ensure that the correct documentation is in place for employee arrangements and subcontractor arrangements. If you wish to know more, please email us at firstname.lastname@example.org.