In brief – FWO and ATO determined to pursue employers for sham contracting
Employers need to be careful to avoid entering into sham contracting arrangements with their workers in view of the increased investigations into this practice by the Fair Work Ombudsman (FWO) and the warnings by the Australian Taxation Office (ATO) that it expects to review more than 17,500 complaints regarding unpaid superannuation.
While uncertainties remain regarding the status of contractors, employers need to be aware that the previous protections afforded to them have been dismantled, making it easier for the FWO and the ATO to prosecute them for sham contracting.
Benefits and risks of engaging contractors
For small to medium-sized enterprises, structuring the labour force to be engaged as contractors rather than employees may seem an attractive option because it can reduce costs and administration and increase flexibility, as there is no need to pay superannuation contributions, PAYG withholding tax, workers comp premiums, annual leave, personal/carer's leave, long service leave, notice of termination, redundancy pay or minimum wages in modern awards.
However tempting this option may be, employers need to weigh the benefits carefully against significant risks:
- Prosecution by the FWO for sham contracting and breach of modern awards and National Employment Standards, which can incur penalties of up to $33,000 per breach for a company and $6,600 for an individual
- Prosecution by the ATO for unpaid superannuation contributions and PAYG taxation
- Unfair dismissal and adverse action claims from a dismissed Worker
Inconsistent legislation related to contractors
What is poorly understood is that there are five separate tests under the different legislation for whether or not a worker is a contractor. Further, the test under workers compensation legislation in most states is different from that for payroll tax, which is also different from the test for the obligation to comply with the superannuation guarantee contribution legislation.
This unwieldy situation causes great confusion for employers and heightens their exposure to prosecutions by the various regulatory authorities.
Associated Translators & Linguists and the ATO – superannuation legislation test
This case involved a business which provides interpreting and translating services. The business structured its labour so that clients would initially be assigned to its two full-time employees. Where this was not possible, the client would be assigned to one of the 1,000 plus panel interpreter/translators.
The panel interpreter/translators did not receive superannuation contributions. The ATO commenced proceedings on the basis that they were employees rather than independent contractors and therefore entitled to such contributions.
The Administrative Appeals Tribunal (AAT) found that the panel interpreter/translators were employees, despite the fact that the terms of engagement between the parties described the relationship as one of principal-contractor rather than employer-employee.
The AAT highlighted the uncertainty in this area, stating that there is "no one final and definitive test as to whether a person is an employee" and pointing out that the test is highly discretionary, as the tribunal/court must consider "the totality of the relationship between the parties".
Factors which determined contractor status
The AAT was unmoved both by the parties' written terms of engagement and by the workers' ability to engage in business on their own account. The decision was particularly influenced by three factors:
- The business could not operate in any reasonably efficient way in the absence of the panel interpreters/translators. This was because they did not simply provide an input service, but rather an entire service to clients.
- The business had effective control over the panel interpreters/translators. Once they accepted client engagements, they were required to abide by industry standards and report the details of the assignment to the business within 24 hours.
- The workers did not have a general power to delegate the performance of their services to a third party.
Even if a business passes these three tests, it does not necessarily mean that the employer is safe. The FWO can pursue an employer under the Fair Work Act if it considers that the business has engaged its workers as contractors to avoid minimum standards under the award.
Land Choice and the FWO – sham contractor finding
The case of Land Choice Pty Ltd is an example of how serious the FWO is about pursuing an employer for sham contracting arrangements.
Real estate agency Land Choice engaged a salesperson who only received commission payments under an independent contractor agreement. The validity of this agreement was tested when she was dismissed after six months and lodged a complaint with the FWO.
The FWO commenced a claim for unpaid minimum wages under the award for the duration of her engagement, annual leave, accrued annual leave, annual leave loading, payment in lieu of notice and a vehicle allowance. The FWO further sought penalties against Land Choice for misrepresenting the contract as a principal-contractor relationship rather than an employer-employee relationship, otherwise known as sham contracting.
Land Choice admitted that it had engaged in sham contracting, so it was up to the court to determine the penalty. Ultimately, Land Choice was ordered to pay the employee $20,119.07 and received a fine of $24,600. The director of Land Choice was found to have been knowingly involved in sham contracting and was fined $4,480.
Factors leading to the sham contracting decision
The court found that the conduct of Land Choice and its director was reckless in terms of misrepresenting the contract as a principal-contractor relationship, but was not deliberate or intentional. The court also took into account the general cooperation of Land Choice with the investigations.
Nevertheless, the court attached significance to the limited amount of contrition and corrective action of Land Choice in relation to the admitted outstanding liability, particularly in view of the fact that the underpayment had a significant impact on the worker as a single mother with two children.
In its finding, the court underlined the need to deter real estate agents from engaging in sham contracting by sending a warning to employers of the seriousness of underpayment of workers.
The crucial lesson for small businesses in this decision is that the court refused to accord weight to the small size of Land Choice, even though a substantial penalty could have the effect of winding up the business, pointing out that "obligations by employers for adherence to industrial instruments arise regardless of their size".
General Protections of the Fair Work Act and reverse onus
Sham contracting is specifically dealt with under the General Protections provisions of the Fair Work Act. The alarming aspect for employers of this positioning of sham contracting within the legislation is that there is a reverse onus on employers to prove that they have not misrepresented a contract of employment as a contract for services under which the worker is treated as a contractor.
This makes it much easier for the FWO to prosecute employers for sham contracting because they no longer have to prove their case. Rather, the burden falls upon employers to prove that they have not engaged in sham contracting.
The FWO has already launched targeted campaigns throughout Australia in response to information about possible sham contracting and has recommended further campaigns.
Lessons for employers
Employers need to heed the warnings of the FWO and the ATO regarding sham contracting.
To avoid scrutiny and possible prosecution, you should review contractual arrangements with your workforce. In particular, you should assess any contractual arrangements with independent contractors against the different statutory tests applicable to the various employment related obligations - superannuation, workers comp, payroll tax and so on.
If there is an element of doubt as to the status of workers, you should engage independent contractors as casual employees. Not only will this enable your business to avoid the substantial risks outlined above, but it will also mean that you steer clear of unfair dismissal claims and obligations to pay annual leave and personal/carer's leave.
The ATO website has an online decision making tool to help both employers and individual workers determine whether contractor or employee arrangements are appropriate in their circumstances.
Swaab Attorneys was the highest ranking law firm and the 13th best place to work in Australia in the 2010 Business Review Weekly Best Places to Work Awards. The firm was a finalist in the 2010 BRW Client Choice Awards for client service and was named the winner in the 2009 Australasian Legal Business Employer of Choice Awards.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.