Misclassifying employees as independent contractors, known as sham contracting, is one of the most serious compliance risks for Australian businesses today. The Fair Work Ombudsman, Australian Taxation Office, and State revenue offices have ramped up enforcement, and penalties can be financially devastating.
This guide, by our employment law team, explains what sham contracting is, outlines the key legal risks, shares recent case law, and provides a compliance checklist to help you protect your business.
Key Takeaways
Sham contracting happens when someone is treated as a contractor but legally qualifies as an employee.
The Fair Work Act 2009 (Cth) prohibits sham contracting and imposes civil penalties of up to $187,800 per breach for companies.
Courts use a multi-factor test to determine the true nature of the relationship, not just what’s written in a contract.
Key red flags include control over hours, exclusive service, and integration into your business.
Businesses should audit their contractor arrangements and ensure compliance with superannuation, PAYG withholding, and payroll tax laws.
What is Sham Contracting?
Sham contracting arises where one party represents to a worker that they are an independent contractor when, on the true facts, the worker is an employee. Sections 357–359 of the Fair Work Act 2009 (Cth) (FWA) expressly prohibit:
- Misrepresenting an employment contract as an independent contracting arrangement
- Dismissing or threatening to dismiss an employee in order to re-engage them as a contractor
- Knowingly making false statements to induce a worker to perform services as a contractor
Legal Framework in Australia
Source | Key Provision | Effect |
Fair Work Act 2009 (Cth) | ss 357-359 | Prohibits sham contracting conduct |
Independent Contractors Act 2006 (Cth) | s 12 | Allows Federal Court review of “unfair contracts” |
Superannuation Guarantee (Administration) Act 1992 (Cth) | s 12(3) | Extends super obligations to certain contractors |
Payroll Tax Acts (State/Territory) | Various | Deems certain contractors to be employees for payroll-tax purposes |
The Multi-Factor Test: Employee v Contractor
Australian courts assess the totality of the relationship, not just the label in the contract, considering factors such as:
- Degree of control over how, when and where work is performed
- Provision of tools and equipment
- Ability to delegate or subcontract
- Method of remuneration (hourly wages v results-based)
- Obligation to work set hours or exclusivity
- Extent to which worker is integrated into the business
- Contract terms describing the relationship
Signs Your Contractor May Actually Be an Employee
Red flags that indicate potential sham contracting:
Wearing company uniforms
Fixed start/finish times or rosters
Restriction from working for others
Paid by the hour rather than by task/project
Company supplies all tools/equipment
Contractor lacks business expenses, tax invoices, or insurance
If your business engages consultants or freelancers, it’s also important to understand the common risks in consulting contracts to ensure your agreements are legally sound.
Consequences of Sham Contracting
Consequence | Details |
Civil Penalties | Up to AUD 187,800 per breach for corporations (600 penalty units × AUD 313) |
Accessorial Liability | Directors, HR managers and accountants can be personally liable under s 550 FWA |
Back-Pay Orders | Courts can order repayment of wages, leave, penalties, super and interest |
Tax Re-Assessments | ATO may issue PAYG and SG Charge (interest + admin fee) |
Workers’ Compensation Premiums | Insurers may retrospectively adjust premiums and recover shortfalls |
Case Examples
Fair Work Ombudsman v Quest South Perth Holdings Pty Ltd
In Fair Work Ombudsman v Quest South Perth Holdings Pty Ltd, hotel staff were re-engaged as contractors through a labour-hire firm. However, Quest still controlled their hours, uniforms, and daily tasks, indicating an employment relationship.
The court found it to be a sham contracting arrangement and imposed $174,000 in penalties.
Fair Work Ombudsman v Skyter Trade Pty Ltd & Dong Zhao
A franchisee was fined $216,700 for misclassifying a delivery driver as a contractor. The court found the arrangement a deliberate sham, aggravated by false records and ignoring franchisor advice. The worker was underpaid and denied basic employee entitlements.
Sham Contracting Compliance Checklist for Employers
- Conduct an annual audit of all contractor arrangements
- Use a written contract that accurately reflects the real working relationship
- Include genuine delegation/subcontracting rights if the worker is to remain a contractor
- Ensure contractors issue tax invoices and carry their own insurance
- Confirm superannuation status under s 12(3) SGAA 1992
- Review payroll-tax contractor exemption criteria in each State/Territory
- Keep detailed records to demonstrate compliance
Need help drafting or reviewing contractor agreements? Talk to our workplace lawyers today.
Frequently Asked Questions
What is the difference between a contractor and an employee under Australian law?
Courts apply a multi-factor test, weighing control, delegation rights, payment methods and integration into the business. Recent High Court decisions place significant weight on the written contract, provided it is not a sham and genuinely reflects the working reality.
Can sham contracting be accidental?
Yes. An employer may unintentionally misclassify a worker. However, lack of intent is not a defence to civil penalties under the Fair Work Act.
What penalties apply for sham contracting?
Corporations face up to 600 penalty units per contravention (currently AUD 187,800) and individuals up to 120 units. Additional liabilities include unpaid wages, superannuation and payroll tax.
How can a company rectify past misclassification?
Conduct an internal audit, calculate underpayments with interest, pay outstanding superannuation and voluntarily disclose issues to the Fair Work Ombudsman and ATO to mitigate penalties.
Does engaging a worker through an ABN guarantee independent contractor status?
No. Possession of an ABN is only one factor. If the substantive relationship resembles employment, the arrangement may still be found to be sham contracting.
What can a worker do if they’ve been misclassified as a contractor?
If you believe you’ve been incorrectly classified as an independent contractor when you’re actually an employee, you have several options:
Lodge a confidential report with the Fair Work Ombudsman
File a claim in the Federal Circuit and Family Court to recover unpaid entitlements
Request a superannuation review through the Australian Taxation Office (ATO)
Claim long service leave under your relevant State or Territory legislation
It’s important to act early to protect your legal entitlements and avoid missing any limitation periods.
