There is a fine balance as to whether a worker is properly an employee or independent contractor, and there are serious implications if you get it wrong, writes Gordon Williams
As part of an organisation’s overall recruitment strategy, it may consider the benefits of engaging workers as independent contractors instead of employees. However, it’s not all plain sailing, as some recent cases highlight. While many independent contractors are legitimately engaged that way, it’s important to properly understand and assess the risks.
What’s been happening?
Independent contractors have been in the spotlight recently – and for all the wrong reasons. Back in 2012, the Australian Taxation Office (ATO) announced that targeting sham contracting arrangements would be a key focus.
Around that time, the Federal Court of Australia decided that nearly 2000 interpreters and translators were in fact employees – notwithstanding some of them conducted their own business. In 2013, the Full Court of the Federal Court upheld an earlier finding that five insurance sales agents (who had been engaged as independent contractors over many years) were in fact employees – and entitled to over half a million dollars (between them) for accrued annual leave, sick leave and long service leave entitlements.
And in June this year, the Federal Circuit Court of Australia imposed fines on a company within the Roy Morgan Group (Linkhill Pty Ltd) totalling $313,500 for sham contracting and related contraventions of the Fair Work Act 2009 (FW Act) arising out of Linkhill’s engagement of construction workers to renovate its offices. These penalties are in addition to orders requiring Linkhill to rectify the various underpayments and credit annual leave.
Linkhill has appealed the finding that it engaged in sham contracting.
What is sham contracting?
Essentially, a sham contract is one under which a worker, who is properly an employee, is instead engaged as an independent contractor.
Section 357 of the Fair Work Act prohibits an employer from representing to an employee that a contract of employment is, in fact, a contract for services under which the employee would work as an independent contractor.
In addition, sham contracting contraventions are invariably coupled with failures to comply with employee minimum entitlements, such as the National Employment Standards and applicable award provisions.
Why is it important?
Sham contracting is viewed seriously by the Courts on the basis that it undermines the protections afforded to employees by Australian industrial relations laws and enables employers to avoid legal obligations such as payment of payroll tax, workers compensation premiums, employee entitlements and superannuation contributions. Additionally, it arguably distorts competition to the disadvantage of employers who honour their statutory obligations.
Importantly, Linkhill submitted that the proceedings ought not have been brought against it on the basis that it had simply been mistaken – it had made a wrong call as to whether the workers in question were engaged as independent contractors, rather than employees. It submitted that the law in this area is complex and whether a worker is properly an employee or independent contractor can be finely balanced. It also submitted that the 10 workers in question were not engaged in the core business of the Roy Morgan Group, but were carrying out “one-off” work completing renovations and fit-outs at various city buildings owned by the Roy Morgan Group – work commonly carried out by independent contractors.
However, the court found that Linkhill’s conduct was “deliberate” because a deliberate decision was taken by it as to how it would engage the workers. The finding was not made on the basis of whether Linkhill intended to engage in sham contracting or not. Rather, in making its deliberate decision as to how it would engage the workers, Linkhill was found to have showed “reckless disregard to the true status of the contracts”.
Why are companies getting it wrong?
Unfortunately, there is no simple way of distinguishing between an independent contractor and an employee. Ultimately, it is a question of fact determined by all the surrounding circumstances.
Importantly, a person is not an “independent contractor” just because the company refers to him or her as such, including in any documentation between the company and the contractor. That said, getting the documentation right is absolutely essential, and careless or inaccurate drafting will work against you.
So what is an independent contractor?
As most readers will appreciate, at law, there is a distinction between employees and independent contractors. This is reflected in the FW Act and other employment legislation which restricts benefits and entitlements (for example, annual leave, unfair dismissal rights etc) to employees as distinct from independent contractors.
In essence, an independent contractor is in business by him or herself and works for his or her clients, whereas an employee is in a “master–servant” relationship with his or her employer – that is, a relationship of personal service.
Who decides who’s an independent contractor and who’s an employee?
If there is a dispute, it will usually be up to a Court or the ATO to decide whether an individual is an employee or independent contractor. They will do this by considering and balancing a number of factors. Traditionally, one of the most important factors is whether the company has the right to control the way in which the individual works. If the company has this right, it weighs heavily in favour of the individual being an employee.
More recently though, the Courts have been focusing their attention on the independent contractor’s business and whether he or she has multiple clients, not just the company. Where this is not the case, and the company is the only client, it can significantly increase the risk of the contractor being found to be an employee.
What happens if a company gets it wrong – and the independent contractor is found to be an employee?
In addition to the sham contracting risks outlined above, if a contractor is found to be an employee, there could be other serious implications. For example:
- the person will be entitled to employment benefits under legislation and any applicable industrial instrument (including annual leave, long service leave, superannuation and possibly overtime and other penalties or loadings)
- the person may have unfair dismissal rights
- the company will have likely breached its income tax withholding obligations and possibly its payroll tax obligations
- the company may have breached its workers compensation insurance obligations by not fully reporting its wages bill
- the company would be vicariously liable for the employee’s negligent acts.
What should you do?
If you engage independent contractors directly (not through a company), particularly on a full-time basis, you should be reviewing your practices and testing whether – in actual fact – the independent contractors should instead be employees.
Even if a person is an independent contractor and not an employee, he or she may still be entitled to superannuation and workers compensation (and the company may be liable for payroll tax), because the relevant legislation specifically extends to some independent contractors. For example, under superannuation legislation, contributions may be triggered if an independent contractor is engaged principally to provide their labour, is unable to delegate and is not paid to achieve a result.
Key points for HR
- Determining whether an independent contractor is really an employee can be difficult and will ultimately be determined by a Court or the Australian Taxation Office.
- There are serious implications if you get it wrong – including liability for underpayments (particularly annual and long service leave), unpaid superannuation and tax and penalties for sham contracting.
- Increasingly, the Courts are focusing on the independent contractor’s business and its client base. If the company is the only client, it can significantly increase the risk of the contractor being found to be an employee.
- If you engage independent contractors directly (not through a company), particularly on a full-time basis, you should review your practices and test whether – in actual fact – the independent contractors should instead be employees.
- Even where a person is a “real” independent contractor, in some cases a company may need to make superannuation contributions on the contractor’s behalf (increasing the associated costs by 9.5%).
