Employee or Contractor? The risks of getting it wrong are about to increase

Independent contractor arrangements – while they have their place, they can be risky and it looks like the risks are about to increase considerably.

It is vitally important for businesses to correctly identify the persons performing work for them as either an employee or a contractor.  By this we mean a true employee or a true contractor.

The risks of getting it wrong are high and you may breach not only your workplace relations obligations but also your taxation, superannuation and workers’ compensation obligations.

This can result in significant consequences, and with the re-elected Federal Government about to crack down on sham contracting and related breaches, it looks like the risks are about to increase.  Think higher penalties, a reduced ability to defend and more funding for the Fair Work Ombudsman (FWO) to investigate and prosecute.

Now is a good time to review your independent contractor arrangements to ensure you have correctly engaged your contractors.

In this month’s update we will look at:

  • the differences between employees and contractors;
  • the risks of misclassifying an employee as a contractor;
  • recent cases where employers have received large penalties;
  • the potential changes that will increase the risks of getting it wrong; and
  • what to do if you have independent contractor arrangements.

Employee or independent contractor?

The ‘employee or contractor’ distinction is widely regarded as a complex and difficult one for businesses to make.

Generally, an employee performs work for someone else in a subordinate capacity whereas an independent contractor has their own business and performs work (services) for clients or customers of their business.

There is no one factor that determines whether a relationship is one of employment or contractor.

Various factors are considered, including:

  • who controls the way the work is performed (e.g. hours, location);
  • who supplies the tools and equipment;
  • who is liable for any defects in the work;
  • who handles the tax and superannuation and who holds the insurances;
  • whether there is a right (and an exercise of that right) to work for other businesses;
  • whether there is the ability to delegate or subcontract work;
  • whether payment is by salary or wages or on completion of tasks;
  • whether personal, annual or long service leave is paid;
  • whether there is an ABN and invoices for payment are submitted; and
  • whether the person is held out as being part of the employer’s business (e.g. uniform, works at employer’s premises, business cards) or whether they run their own business (e.g. own logo, work from own premises).

This is not an exhaustive list and the courts will give different weight to different factors depending on the circumstances of each matter.

Key question:  Is the person working in and for their own business as a representative of that business, or as a representative of the business for which the work is being performed?

The above factors might get you thinking about your own arrangements.  It is important to note that it is definitely not as simple as both parties having agreed to the contracting, that the contractor has an ABN and issues invoices or that this is just how your industry operates.

If you are concerned about your independent contractor arrangements or just want to get them checked it is best to seek legal advice.

Risks of getting it wrong

There are various risks for a business of misclassifying an employee as an independent contractor.  These include:

  • breaching your workplace relations obligations in Awards and the Fair Work Act (e.g. sham contracting and underpayments) potentially resulting in investigation and prosecution by the FWO, large financial penalties and back payments;
  • subsequent claims by contractors that they are in fact employees in unfair dismissal claims and underpayment claims;
  • breaches of your taxation, superannuation and workers’ compensation obligations potentially resulting in investigation and fines by the ATO or WorkCover, as well as back payments of superannuation contributions.

Sham contracting

One of the most significant risks for employers in getting the ‘employer or contractor’ distinction wrong is breaching the Fair Work Act sham contracting provisions.

Sham contracting occurs when an employment relationship is wrongly presented as an independent contracting arrangement and usually occurs to take advantage of the different workplace relations and tax obligations.

Penalties for each breach of the sham contracting provisions is up to $12,600 for an individual and $63,000 for a corporation.

Employers fined for ‘clumsy’ and ‘reckless’ sham contracting

The Federal Circuit Court has recently handed down large penalties to ‘clumsy’ and ‘reckless’ employers (even where they have relied on external advice) for sham contracting and related underpayments.

FWO v Ava Travel

The court ordered penalties of over $165,000 against a Gold Coast Tour Bus company and its director for sham contracting and underpaying wages and entitlements.

The company engaged bus drivers as employees but later requested the drivers to obtain ABNs on the basis that they would be engaged as independent contractors in the future.  The drivers continued to be paid the same flat rate and performed the same work in the same manner.

The employer and its director admitted to sham contracting and other breaches of the Award and Fair Work Act.

Even though the court found that the sham contracting was clumsy and inadvertent rather than a deliberate attempt to avoid obligations and the employer co-operated fully, it still fined the employer and director over $165,000 for the breaches.

The company was also ordered to conduct audits across multiple years for all employees and rectify any breaches.

FWO v Care Providers

In this decision the court issued penalties of over $216,000 against two personal care companies and their senior employees for sham contracting and consequential underpayments and other breaches.

On the advice of their accountant and tax advisor, the employers engaged the personal care workers as independent contractors.  The court found this was a strategic decision made to save money and that ‘It was extremely reckless to embark on such a course on the advice of an accountant without making further enquiries.

During the FWO investigation, the businesses and senior employees admitted to being reckless as to whether the workers were employees rather than independent contractors.

The sham contracting led to various breaches of the Award (failure to pay allowances, penalty rates, overtime rates and superannuation) and the Fair Work Act and NES (failure to pay personal leave and keep records and unlawful deductions for insurance).

These breaches soon added up and cost the businesses over $200,000 and the two senior employees almost $8,000 and $6,000 respectively for their personal involvement in the contraventions.  These fines were in addition to back paying the employees.

Balemian v Mobilia Manufacturing

In this case the court found that a contractor who had been engaged for 21 years was in fact an employee.  The business was ordered to pay the employee over $140,000 in unpaid annual leave, long service leave and penalties.

This case arose from a claim for underpayments brought by the former contractor rather than a FWO investigation.

The court found that the relationship was one of employment, noting that the company had control over how work was performed, the employee was paid for the hours worked not the tasks completed, the employee worked at the employer’s premises and was provided with equipment and materials, the employee did not hold himself out as having his own business but was presented as a person working for the employer and that the employee had no capacity to delegate work.

The court found the employer knew or ought to have known that he was an employee and that it at least recklessly disguised the true nature of the relationship.

The company was ordered to pay 425 days of annual leave, over 18 weeks of long service leave and interest on those amounts as well as a penalty directly to the employee, costing over $140,000.

Lessons for employers

Businesses need to be vigilant to ensure they have correctly engaged their workers and that they are meeting their obligations under the Fair Work Act and Awards.

In particular, these cases show that:

  • it does not have to be a deliberate attempt to avoid obligations to result in large penalties – clumsy, inadvertent or reckless sham contracting can result in significant financial penalties;
  • it may not be enough to simply rely on the advice of an accountant or tax advisor without further inquiry;
  • claims can come from the FWO or former contractors who later claim to be employees;
  • where misclassification of employees occurs, there are usually related breaches and financial penalties can quickly mount in these circumstances.

Changes coming – dedicated sham contracting unit, increased penalties and easier prosecutions for the FWO

The Federal Government has stated it will crack down on sham contracting and related breaches such as underpayment of employees.

The recent budget included $9.2 million over 4 years for a dedicated sham contracting unit within the FWO from 2020.

The new unit will increase compliance and enforcement activities as well as dedicate additional resources to investigating and litigating sham contracting.

The Federal Government has also stated it will introduce tougher penalties for both sham contracting and underpayments (a common consequence of misclassifying an employee as a contractor).

It is likely that the re-elected government will also look at implementing some of the 2017 Black Economy Taskforce recommendations on sham contracting.  These included a recommendation to reduce the legal threshold of the sham contracting defence which would make it easier for the FWO to prosecute sham contracting and harder for businesses to defend.

What should you do?

Businesses need to be aware that there are various risks if your employees are misclassified as contractors and that these risks are about to increase.

Now is a good time to review your independent contractor arrangements and consider whether you have correctly identified the persons performing work for your business as an employee or a true independent contractor.

Having a good contractor agreement is important to set out the rights and obligations of both your business and the contractor.

However, this is only the starting point and if it is not a true independent contracting arrangement, it will not prevent a sham arrangement, investigation by the FWO or a claim from a contractor seeking employee entitlements.

Contact us for assistance

If you have any concerns about your independent contractor arrangements or just want to get them checked, please contact us.

Disclaimer: The information contained this article is general and intended as a guide only. Professional advice should be sought before applying any of the information to particular circumstances. While every reasonable care has been taken in the preparation of this update, Aitken Legal does not accept liability for any errors it may contain. Liability limited by a scheme approved under professional standards legislation.