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How to avoid a sham contracting claim

Updated: 3 November 2022

Are you thinking of hiring a contractor for your business? This is a fantastic idea when you do not need another employee. But you need to be careful. While a contractor can cost you less because you only pay for the hours they actually work, and you do not need to pay for sick days or holidays, you need to ensure it will truly be an employee-contractor relationship. You do not want a sham contracting claim made against you in the future. It can cost you a lot of money.

So, what exactly is sham contracting?

Meaning of sham contracting

Contractors have different rights and obligations than employees do. Sham contracting occurs when an employer misrepresents a job as a contractor’s role when it is really an employee role.

A contractor is truly independent. They have a lot of control over where, when and how they work as opposed to an employee who follows their employer’s instructions.

So why would an employer misrepresent an employment opportunity as a contract position?

Sometimes it is because they make a mistake. But usually it is so the employer can avoid paying employee entitlements such as annual leave, sick pay and superannuation.

So, misrepresenting an employee’s job as a contracting job is illegal. And there are penalties for sham contracting if it goes to court. The penalties can be up to $13,320 for an individual and up to $66,600 for corporations for each occurrence. So do not do it.

How do you know if you should hire an employee or a contractor?

There are major differences.

And, if you are in doubt, always get advice.

Difference between a contractor and an employee

It is important to know what the differences are between an employee and a contractor.

For example, contractors have more autonomy about how they complete the work, they may set their own work hours and have insurance to cover their work.

On the other hand, employees receive direction about when and how to complete work, they do not need insurance, and receive paid entitlements like annual and sick leave. You can read more about the differences here.

The following will help you decide whether it is an employee or a contractor you want to hire:

Employee 

You want to hire an employee if you:

• Pay them a salary or wage for the work they do.
• Withhold tax from their pay.
• Tell them what hours you expect them to work.
• Pay sick and annual leave, and superannuation.
• Cover them under your workers compensation.
• Require them to fill out timesheets to receive payment.
• Supply all equipment or tools.

Contractor 

A contractor:

• Pays some of their business expenses.
• Invoices you to receive payment.
• Works the hours they want and how they want to.
• Can contract someone else to do the work.
• Can work for other businesses.
• Pay their own tax and superannuation.
• Have their own place of work.
• Use their own equipment and tools.

Now, which one of the above sounds more like what you expect to do after hiring someone new?

Changing contractor status to become an employee

Sometimes you may want to change the status of a contractor to become an employee. Of course you need to discuss this with them and get their agreement. But keep in mind, some people actually prefer to be a contractor rather than an employee.

But if you are giving the contractor lots of direction, need them to work set times or your project was extended so they spend most of their time at your business they may no longer fit the definition of a contractor. In these cases you may want to consider changing the contract agreement to an employee agreement. And, if your contractor does not want to become an employee, you may need to change how you work together or hire a new employee.

Read more about when to make the switch from a contractor to an employee agreement right here.

I wish you every success in your ventures!

And, as always if you need advice, get in contact.