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Employees, independent contractors and sham contracting

Please note: This article is intended to be brief information only and should not be relied or acted upon as legal advice. You should always seek legal advice tailored to your own individual circumstances. Please also note that this article is current as at the date of publication and the law may have subsequently changed since.

Regulation of employment and independent contractor relationships

In Australia, many pieces of legislation govern the employment relationship and impose various statutory obligations on employers in respect of their employees. Often such legislation will rely on the common law meaning of “employee” in imposing such obligations (although some Acts include specific definitions of who constitutes or is deemed to be an “employee”).

Whilst there is a significant amount of legislation which regulates the employment relationship, the same cannot necessarily be said in respect of the independent contractor relationship.

In this sense, engaging a worker as a genuine independent contractor may be beneficial to a business to the extent that employee entitlements and other employment-related statutory obligations can potentially be avoided or minimised. Engaging a worker as a contractor may also be beneficial to the extent it can potentially limit a principal’s vicarious liability for any negligent acts or omissions of the worker.

What is the difference between a contract of service and a contract for services?

Employees and independent contractors are ordinarily engaged by an employer or a principal by contractual means.

A contract for services is usually used to refer to a contract under which a person provides services as an independent contractor. On the other hand, a contract of service (also known as a contract of employment) is usually used to refer to a contract under which a person provides their service as an employee.

However, it is ordinarily not enough to simply use a particular form of contract or particular wording to characterise or designate a worker as an employee or independent contractor, as Courts generally look to the substance of the relationship to determine if a particular worker is an employee or an independent contractor.

When is a person an independent contractor?

There are significant risks, including in respect of potential penalties and backpay of entitlements and breaches of other statutory obligations, if an employer were to misclassify and treat a worker as a contractor when they are really an employee (including arising out of non-compliance with employer obligations under the Fair Work Act 2009 (Cth) (FW Act) and other legislation relating to tax, workers’ compensation, payroll tax etc).

Ordinarily, the fact that the person is described as an “independent contractor” in any contract, or has their own ABN, is not determinative of their status for the purpose of applicable legislation. It’s usually a matter of substance over form as to whether the person is truly an employee or a contractor carrying on their own business and all the facts and circumstances of the person’s engagement will usually need to be considered (see discussion below). It is also important to note that a relationship may change over time and what was once a genuine contractor relationship may become an employment relationship.

Distinction between employees and independent contractors: the multifactorial test

The “multifactorial test” continues to be the legal test currently applied by the Courts (noting that there are currently some cases before the High Court involving the employee-contractor distinction) to determine whether a worker is an employee or independent contractor at common law: see e.g. Hollis v Vabu (2001) 207 CLR 21. In its simplest form, the distinction between the two is that an employee serves the employer in the employer’s business and an independent contractor carries on a trade or business of their own.

To determine whether a worker is an employee or contractor at common law, the Courts usually consider a number of factors (hence the name “multifactorial test”) to ascertain whether a worker is an employee or truly carrying on their own business. These factors usually include the following considerations:

  • An employee is typically engaged to provide his or her personal services to the company (often indefinitely or for a defined period of time). However, a contractor however is usually engaged to achieve a defined result or to perform a single task or series of tasks, is usually not engaged to provide services personally and may delegate the work to others, and may be engaged via an interposed company.
  • An employee is usually subject to a right of control by the employer regarding the work and the manner in which it is performed. On the other hand, a contractor will often retain a high degree of discretion about how the tasks are performed (which might be evident in matters such as when the worker starts and finishes, the method used to perform the work and where the work is performed).
  • An employee is usually required to work a minimum or set number of hours, whereas a contractor is often able to set their own hours of work, provided the task for which he or she is engaged is completed.
  • An employee usually has to work exclusively or primarily for their employer. A contractor, by contrast, is often able to work for several other principals or persons.
  • An employee is often required to perform the services at the employer’s premises using the employer’s equipment. A contractor will generally provide their own tools and equipment (which is ordinarily provided at the contractor’s own cost).
  • An employee is invariably reimbursed for his or her work-related expenses. A contractor will generally be responsible for their own costs and expenses.
  • An employee is rarely exposed to commercial risk. A contractor however stands to make a profit or loss on their activities and will bear the commercial risk of poor performance. In this sense, a genuine contractor usually stands to make an increased profit if the work can be performed in less hours than anticipated or a loss if completion of the tasks takes longer than anticipated. A contractor will usually also be required by their contractual arrangements to have their own professional indemnity, public and product liability insurance.
  • An employee is ordinarily paid a salary, hourly rate, piece rate or award rate. On the other hand, a contractor will often be paid according to the result achieved.
  • An employee is usually entitled to paid leave entitlements such as annual leave, personal/carer’s leave etc. A contractor will usually not receive these entitlements from the principal.
  • An employment relationship can be terminated at the initiative of the employer. A contractor is usually engaged to complete a given task and the relationship will end once that task is over.

It is important to note that, even when an interposed company or entity other than the individual worker in his or her own name is used as the contracting party, this may not be determinative of an independent contractor relationship: see Roy Morgan Research Pty Ltd v Commissioner of Taxation [2010] FCAFC 52.

In this sense, it is important to also note that particular legislation may have specific statutory definitions of the phrase “employee” which may prevail over the common law definition. Such statutory definitions may “deem” particular persons to be “employees” for particular purposes.

Sham contracting prohibitions

To combat the situation where employers attempt to pass off employees as “independent contractors” to avoid paying employee entitlements and avoid otherwise complying with other employment-related obligations, the FW Act contains certain provisions which have the effect of imposing civil penalties on certain employers that engage in sham contracting arrangements.

However, in Western Australia, the FW Act does not cover all employers, with some employers instead being “state system employers” covered by the state industrial relations system under the Industrial Relations Act 1979 (WA) (ordinarily sole traders, partnerships and non-trading corporations). If you are not sure whether an entity is a national or state system employer, you should seek legal advice.

The relevant provisions under the FW Act, which are civil remedy provisions contained in sections 357 to 359, prohibit certain conduct by an employer in relation to sham contracting arrangements.

The provisions generally prohibit:

  • misrepresenting to an individual that a contract of employment is a contract for services under which the individual performs or would perform work as an independent contractor (although this does not generally apply if the employer proves that, when the representation was made, the employer did not know and was not reckless as to whether the contract was a contract of employment rather than a contract for services);
  • dismissing, or threatening to dismiss an individual who is an employee and who performs work for the employer, in order to engage the individual as an independent contractor to perform the same or substantially the same work under a contract for services; and
  • making false statements designed to persuade or influence an employee or former employee to enter into a contract for services under which the individual will perform, as an independent contractor, the same or substantially the same work for the employer.

The maximum civil penalty which can usually be imposed against a body corporate for a breach of a civil remedy provision under the FW Act is currently to $66,600 for a body corporate (with more significant penalties possible for serious contraventions). Furthermore, persons involved in a contravention (such as company directors, payroll and HR staff) may also be personally liable as an accessories and liable to personally pay compensation and separate penalties (which the maximum penalty per contravention for an individual currently being $13,320).

What if someone is truly an independent contractor?

Even where a worker is truly an independent contractor (also commonly referred to as a “genuine” contractor), parties should be mindful of superannuation and unfair contract term considerations (in addition to the many other statutory obligations imposed on principals and/or contractors, such as under occupational health and safety and tax legislation).

Superannuation contributions

A common misconception is that superannuation contributions do not ever need to be made in respect of a worker who is truly an independent contractor.

In actual fact, the extended definition of the phrase “employee” contained in section 12(3) of the Superannuation Guarantee (Administration) Act 1992 (Cth) will usually result in superannuation contributions being required to be made on behalf of an individual who is truly an independent contractor if they receive payment for work under a contract that is “wholly or principally for their labour”.

Unfair contract terms

Even where a worker is truly an independent contractor, then the principal and contractor will need to be mindful that particular contractual terms may be rendered void by the unfair contract terms provisions of the Australian Consumer Law.

Furthermore, to the extent that one of the parties to a true independent contractor/services agreement is a trading corporation (among other things), then a party may also be able to make an application to a relevant court under the Independent Contractors Act 2006 (Cth) to review the agreement on the grounds that the agreement is unfair or harsh (and seek to vary or set aside part or all of the agreement).

Further information

If you require advice or assistance, please do not hesitate to contact us.