Employee or Contractor? What the law says about Sham Contracts

What are the new changes, and how can my business defend itself against sham contracting claims?
Employment relationships can be complex, and understanding how to manage them is often key. Most would think that the law was clear on who is considered an employee, and who is a contractor? In this case, you would be wrong.
This makes it challenging to manage an employment relationship you didn’t even know existed, and raises questions about how you can best protect your workplace against claims of sham contracting.

What is sham contracting?

The two most usual ways for businesses to engage an individual’s services are either:

  1. As an employer / employee relationship; or

  2. As a principal / contractor relationship (including independent contractors).

Sham contracting occurs when workers who should be regarded as employees are knowingly or recklessly misclassified as independent contractors. Approaches to sham contracting have changed several times, and are again changing with the Government’s Closing Loopholes Act updates.

Businesses need to be aware of the up-to-date requirements, and closely consider their employment and contractor arrangements accordingly.

For employer to employee relationships, the Fair Work Act regulates a series of worker entitlements such as annual leave and general protections. For principal (business) to contractor relationships, the obligations are much less clear.

What is clear is that, generally, employees have significantly more workplace entitlements than contractors. This usually means more costs to businesses.

These arrangements have led to an ongoing concern that the enhanced entitlements available to employees act as an incentive for employers to engage in ‘sham contracting’. However, we also see situations where contractor agreements have been entered into in good faith, only to be found to be employment relationships at a later date. Where this happens, businesses can be exposed to costly claims.

How were contractor relationships determined in the past?

The Courts have played a key role in deciding if an employee or contractor relationship exists. The approach by the Courts has been to apply a test (known in law as the ‘multi-factorial test’) which balances multiple factors including:

  • The degree of control exerted by the worker;
  • The provision of equipment by the business to the worker (and what the worker supplies themselves); and
  • The ability of the worker to delegate work to others.
This test has meant that the genuine status of employment arrangements can be quite ambiguous.
More recently, the High Court changed this approach and determined that the test should only applied purely to the written provisions of the employment or contractor agreement.

What are the changes from the Closing Loopholes Act?

The new changes from the Closing Loopholes Act basically work to re-establish the test back to one that also considers the substance and practical reality of the employment or contractor relationship, not just the terms of the contractor or employment agreement.

This means that the Courts will need to consider both the written contract, and also what happens in your workplace.
Who is exempt from the changes?

Contractors earning over the ‘contractor high income threshold’ (currently is yet to be determined) will be able to opt out of the new definition of an employee through a notification scheme (telling the Government that you’re opting out).

This will mean that, for those contractors, only the written contract will be considered when determining the employment relationship – not how the relationship looks to the disinterested observer (e.g. the Courts) to be operating at some time in the future.
While yet to be determined, the ‘contractor high income threshold’ is likely to focus on ‘guaranteed’ income rather than potential income. There will be some transition provisions where contractors can choose to have the previous ‘written terms only’ test apply to them.

How can businesses defend themselves against claims of sham contracting?

The Closing Loopholes Act also narrows the defences available for responding to claims of sham contracting. Businesses (other than small businesses) will soon need to prove that they reasonably believed that an agreement was a contract for services, and not an employment type relationship.
Whether or not this can be established will depend on the relevant circumstances surrounding the claim. This will need to be tested in court to establish what is and isn’t reasonable. As always, having robust written policies and procedures in place can always assist businesses exposed to claims. These might include clearly defining employee and contractor categories, and when they apply within the business.
Further to this, the threshold for what will constitute a serious contravention has also changed, from one that is done knowingly and systematically, to one that is done either knowingly or recklessly. An accidental, inadvertent misclassification of an employment relationship, or a case of a genuine mistake, will not meet this threshold, protecting businesses caught up in these changes.

What are the new (increased) penalties?

The amendments also signify that new civil penalties for underpayments will apply in instances of sham contracting. This means fines. Companies who are not small businesses face maximum penalties of:

  • $469,500 (1,500 penalty units) - this is five times the current maximum; or

  • three times the amount of the underpayment, if the applicant seeks this kind of penalty.

The maximum penalties for most provisions will not change for individuals and small business employers.

New protections for small businesses

There is still good news for businesses grappling with all these changes. In the case of small businesses, evidence of compliance with a ‘Voluntary Small Business Wage Compliance Code’ will mean that a small business will not be prosecuted if they underpay their employees. Details of the Code are yet to be released.
If you have any questions about the changes, and how you best protect your business against claims of sham contracting, please do not hesitate to contact Warwick Ryan, Partner in Workplace Relations, Employment & Safety.

Article written by Hicksons’ Partner, Warwick Ryan, and Solicitor, Zoe Waskett.

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