Sham contracting in Australia: the penalties and the reverse onus

What sham contracting is

Sham contracting involves employers engaging individuals in a way that disguises a genuine employment relationship. This can take several forms, all of which are prohibited under Australian law. Specifically, sections 357-359 of the Fair Work Act prevent employers from falsely portraying an employment relationship as an independent contractor arrangement.

Another form of sham contracting occurs when an employer dismisses an employee and then re-engages them as an independent contractor to perform the same work they were previously doing as an employee. Finally, employers are prohibited from making false statements with the intention of persuading an employee to become a contractor.

These actions are unlawful and carry consequences. Each instance of failing to comply with sections 357-359 of the Fair Work Act attracts a civil penalty.

The reverse onus

The legislation includes a specific evidentiary burden relating to sham contracting claims. Section 357(2) dictates that if a worker alleges misrepresentation about their employment status, the employer must prove they did not know, and could not reasonably have known, that the work was actually employment. This places an onus on the employer to demonstrate their lack of awareness regarding the true nature of the working arrangement.

Changes to this process came into effect from 27 February 2024. The Closing Loopholes No. 1 legislation modified the employer’s defence. Now, to successfully argue against a sham contracting claim, an employer must also demonstrate that the misrepresentation was reasonable, taking into account the employer’s size, resources, and the nature of the engagement.

This heightened requirement means employers face a more difficult task in defending against allegations of sham contracting.

The penalties

Civil penalties are imposed for each instance of sham contracting. The size of the penalty depends on factors such as whether the employer is a company or an individual, and the seriousness of the contravention. penalty estimator provides a tool to assist in understanding potential penalty amounts.

From 1 January 2025, the Fair Work Act will introduce criminal offences for intentional underpayment of employee entitlements. Individuals found to have committed this offence may face imprisonment for a period of up to 10 years.

The potential for multiple penalties is significant, as an employer can be found to have engaged in sham contracting with multiple workers. This means exposure to penalties can quickly increase.

How to manage the risk

To mitigate the risk of sham contracting, organisations should conduct a thorough contractor audit. This audit should be performed using the new whole-of-relationship test, which came into effect on 26 August 2024. The audit’s purpose is to assess whether a worker is genuinely engaged as an independent contractor.

Maintaining robust documentation is crucial. Organisations should keep records that demonstrate genuine contractor indicia, including the contractor’s Australian Business Number (ABN), ownership of equipment, possession of their own clients, and the contractor’s control over how the work is performed.

For situations that are unclear or where the contractor’s status is questionable, seeking employment-law advice prior to engagement is recommended. If misclassification is identified, the organisation must promptly reclassify the worker and provide any back-entitlements they are owed.