Contractor or employee? The sham contracting trap

Paying workers by invoice instead of payslip saves leave loading, payroll tax and superannuation, which is exactly why some businesses dress employees up as contractors. The problem is that the label on the paperwork decides nothing. If the relationship is genuinely one of employment, calling it something else is sham contracting, and it carries serious financial and legal consequences under the Fair Work Act 2009¹ (Cth)²³.

Why getting it right matters

The distinction determines which obligations attach:

Misclassification therefore creates a growing debt: unpaid leave entitlements, unremitted super, penalties and interest. For the worker, it can mean no protection when they are injured, underpaid or abruptly cut off.

What decision-makers actually look at

There is no single magic test. Decision-makers weigh several factors, with modern cases placing real weight on the terms of the written contract, checked against how the relationship operates day to day. Key indicators include:

• Control: who directs how, when and where the work is done?
• Delegation: can the worker send a substitute, or must they personally perform?
• Payment: paid per project or result like a business, or a regular wage for time worked?
• Equipment and risk: whose tools are used, and who bears responsibility for defective work?
• Integration: does the person operate as part of your business or run their own enterprise with multiple clients?
• Independence markers: own insurance, advertising, premises and other customers point towards contracting.

A worker can have an ABN, sign a contractor agreement and still fail these tests. Conversely, genuinely autonomous specialists can be contractors even when they work full-time hours for one client for a period.

A quick illustration shows the contrast. A bookkeeper who sets her own hours, uses her own software licences, services five other clients and quotes per job is a contractor even if most of her work comes from one firm. Her colleague placed by the same agency, working the same desk every weekday under the finance manager’s direction, on a monthly invoice that mirrors a salary, is almost certainly an employee regardless of the paperwork both signed.

Payroll tax and other knock-on exposure

Classification problems rarely stay contained to Fair Work issues:

• Payroll tax: contractor payments can be caught by payroll tax provisions specifically designed to stop avoidance through contracting arrangements
• Workers compensation: insurers reassess premiums where contractors were really workers, sometimes with penalties
• Superannuation: the ATO can pursue unpaid guarantee charge plus interest directly from the business
• Fair Work audits: complaints from departing workers trigger broader reviews of entire workforces

Because several regulators share information, an issue surfacing in one forum frequently spreads. Businesses discovering classification problems should model exposure across all these fronts before choosing a response.

What makes it sham

Not every mistake is sham contracting; honest classification errors are usually fixed by back-payment rather than punishment. Sham conduct involves deliberately disguising employment as contracting. The classic patterns include:

1. Terminating an employee, then rehiring the same person on an ABN doing identical work
2. Requiring staff to obtain ABNs as a condition of keeping their jobs
3. Issuing contractor agreements while dictating rosters, uniforms and supervision like an employer
4. Using labour hire structures to strip out entitlements that clearly should exist

Where the misrepresentation is knowing or reckless, civil penalties attach, and the Fair Work Ombudsman actively investigates reports of these arrangements.

Fixing a questionable arrangement

If you suspect some of your workforce sits on the wrong side of the line, fix it early rather than waiting for an audit or complaint:

• Audit current engagements honestly against the factors above
• Redraft contracts so the paper matches reality, whichever way that points
• Backfill missed entitlements such as leave and superannuation
• Get advice before restructuring, because clumsy transitions can create dismissal claims
• Keep records showing why each engagement is classified as it is

Voluntary correction is viewed far more favourably than conduct exposed by a regulator. Businesses that self-identify problems, quantify entitlements and put workers back on proper footings generally face penalties at the lighter end of the range, if any. Those who wait for a complaint usually pay more, both in money and in workforce trust. Budget for the correction properly: retrospective leave and super across several workers adds up quickly, and discovering the true figure mid-negotiation weakens your hand.

If you are the worker

If you are engaged as a contractor but treated like an employee, you may be missing out on leave, super and protections. Start by raising it with the business in writing. The Fair Work Ombudsman provides assistance for suspected sham arrangements, and the ATO deals with unpaid superannuation. Where significant amounts are involved or the relationship has soured, get legal advice before signing anything that might compromise your position.

Keep your own evidence file as you go: messages about rosters and supervision, invoices, uniforms supplied, equipment provided and any requests to obtain an ABN. Classification disputes turn on these details years later, and memories fade quickly once relationships end. Workers who document the reality of their engagement recover entitlements far more reliably than those relying on recollection alone.

Unsure how to classify your workforce? Contact Bell & Senior Lawyers for a free initial chat, and see our commercial practice, contract law resources and startup resources for related guidance.

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