Employee versus contractor: Beware the traps

The Fair Work Ombudsman, Nicholas Wilson, has released the findings of his office’s audit into sham contracting in the cleaning services, hair and beauty, and call centre industries. He found a number of problems.

The audit looked at potential contraventions of the sham arrangements provisions of the Fair Work Act. Sham contracting occurs when an employer attempts to disguise an employment relationship as an independent contracting relationship, thereby avoiding obligatory rates of pay and other entitlements such as superannuation.

Of course, the Fair Work Ombudsman is not the only person looking at sham contracting. The Tax Commissioner also has a keen interest in this area in seeking to ensure employers properly meet their tax withholding requirements – and whether a worker is treated as an employee or contractor influences the result here.

An independent contractor is someone who is self-employed and contracts their services to clients, such as a plumber who is hired by a business to fix a burst pipe. The plumber attends the business with his own tools and employees, fixes the pipe then bills the business for the cost of the job.

Although an independent contractor may perform work for a business, they are not regarded as an employee and will generally have different rights to employees.

Telling the difference between an independent contractor and an employee is not always a straightforward process. The Ombudsman said some employers misrepresent or disguise employment relationships as independent contracting arrangements to avoid paying legal minimum rates of pay, tax and entitlements, such as annual leave and sick leave. Arrangements such as these are not genuine and may be regarded as sham contracting.

Wilson said the Sham Contracting Operational Intervention began in April 2011 in response to intelligence from various sources and concerns raised by key stakeholders, including employee and employer groups and members of Parliament.

The report states that a number of trading enterprises engaged contractors who should more properly have been classified as employees. Mr Wilson said that while Fair Work inspectors found that most of these arrangements were not deliberate, they did identify a number of employers whom they believe knowingly or recklessly misrepresented the employment relationship to their workers as one of independent contracting. Legal action is being considered in some instances, he said.

The Ombudsman said he found misclassification of employees in each of the three industries that were investigated (cleaning services, hair and beauty, and call centres), but he does not believe the problem is confined to these industries alone. Misclassification can lead to a contravention of the National Employment Standards (NES), minimum wage orders and terms of a Modern Award or Enterprise Agreement. It can also result in contraventions of employer obligations to provide employee records and pay slips and may expose employers to back-payment of outstanding entitlements and superannuation payments and there may be consequential taxation implications.

Of the 102 enterprises audited, 11 had employee-only workforces or did not engage contractors. Of the remaining 91 enterprises that were trading and did engage contractors, 21 (23%) were assessed as having misclassified employees as independent contractors and one third of those were assessed as either knowingly or recklessly having done so and are therefore suspected of having contravened the sham arrangement provisions of the Fair Work Act.

In one case audited, a large cleaning company engaging in excess of 150 companies was found to almost exclusively engage other cleaning companies to perform its cleaning work. A sample of 13 of the contracted companies was audited. The companies typically consisted of a director who was also the sole worker for the company. The Ombudsman said an analysis of the working relationship indicated employment, yet ostensibly the working arrangements were contractual in nature and between two companies. He said the matter remains under investigation.

The Ombudsman said a number of employers had received advice from accountants on how to structure their operations. Since workplace law is different to taxation law and financial accounting practices, the Ombudsman said it appeared the legality or appropriateness of the arrangements under relevant workplace laws was often not considered. He said the audit highlighted the important role accounting firms play in providing advice to businesses and the role they can play in highlighting business risk in certain contracting relationships.

Employing someone as an employee or contractor is a decision many SMEs will make. They just need to ensure they get that decision right.

Terry Hayes is the senior tax writer at Thomson Reuters, a leading Australian provider of tax, accounting and legal information solutions .

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