Independent Contractor or Employee? Understanding Sham Contracting
- 9 hours ago
- 5 min read
It usually starts with what feels like a practical business decision.
The business is growing quickly, work become less predictable, labour costs increase, and flexibility becomes important.
Someone says they would rather invoice than go on payroll, or perhaps that's simply how the arrangement has always been done in the industry.
On the surface, it can seem straightforward enough.
You engage someone as a contractor, they send an invoice each week, everyone is happy, and the work gets done.
The difficulty is that contractor arrangements aren't determined simply by what the parties call the relationship. In Australia, the question is whether in practice the arrangement genuinely operates like an independent business relationship.
That's where many businesses unintentionally get themselves into trouble.
Sham contracting is one of those areas of workplace compliance that often catches business owners off guard. Not because they're deliberately trying to avoid obligations, but because the line between contractor and employee isn't always as obvious as you might expect.
What Is Sham Contracting?
In simple terms, sham contracting occurs when a business represents a worker as an independent contractor when they should actually be an employee.
Sham contracting arrangements are sometimes set up by businesses to avoid paying legal entitlements to employees.
Unless the business can prove that they reasonably believed the employee was a contractor, the working relationship may be considered a sham contracting arrangement.
Sometimes this happens deliberately, but more often it happens because the arrangement hasn't been properly assessed from the beginning.
Why This Matters
For many businesses, contractor arrangements can feel commercially sensible. They may offer flexibility during busy periods, reduce administration, or suit workers who prefer autonomy.
But if a contractor arrangement is later found to be an employment relationship, the consequences can quickly become expensive.
The risks aren't just limited to backpay of wages. Businesses can also face claims relating to unpaid annual leave, personal leave, superannuation, overtime, penalty rates, and unfair dismissal protections depending on the circumstances.
In some cases, Fair Work may also investigate whether the arrangement amounts to deliberate sham contracting under the Fair Work Act.
What makes this particularly challenging is that issues often surface years after the arrangement began. A business may have engaged someone as a contractor for a long period without any concerns, until a dispute arises, the relationship breaks down, or someone seeks advice externally.
At that point, the arrangement is examined closely, often against the reality of how the work operated day to day rather than what the agreement says on paper.
Contractor vs Employee?
A common misconception is that simply having an ABN automatically makes someone a contractor. This isn't the case.
Likewise, invoicing the business, signing a contractor agreement, or agreeing verbally that someone is a contractor doesn't automatically determine the legal relationship either.
To determine whether a worker is a contractor vs employee, Fair Work looks at the overall nature of the arrangement.
The focus is generally on questions such as:
Is the worker genuinely operating their own business?
Do they have control over how they perform the work?
Can they work for other clients?
Do they supply their own tools and equipment?
Are they exposed to commercial risk?
Can they delegate or subcontract the work?
Is the relationship project based and outcome focused, or does it operate like ongoing employment?
Importantly, no single factor determines the answer on its own. It's the overall picture that matters, and this is where businesses can become confused, because many modern working arrangements sit somewhere in the middle.
For example, a tradesperson may invoice as a contractor but work exclusively for one business, wear the company uniform, use company tools, follow a roster, and work under close supervision. In practice, that arrangement may look much more like employment than genuine independent contracting.
On the other hand, a specialist consultant who sets their own hours, services multiple clients, controls how the work is delivered, and invoices per project is far more likely to be operating independently.
If you have contractors in your business, it's worth considering a few indicator signs to help identify whether the arrangement deserves a closer look. Importantly, no single factor determines the answer on its own, but it's the overall picture that matters:
Employee indicator signs
They are paid for time, such as hourly, weekly or monthly
You set their hours
You direct how, where and when work is performed
You supply tools, equipment or uniforms
They work only for you
They take leave, and you pay for it
You supervise their work
You carry the cost if something goes wrong
Contractor indicator signs
They invoice for work or outcomes
They choose their own hours
They can subcontract or delegate work
They work for multiple clients
They use their own tools, equipment and PPE
They take on commercial risks
They have their own branding, website, email or business cards
They pay their own tax and insurance
Where Businesses Can Often Get It Wrong
One of the biggest issues is businesses applying a “one size fits all” approach to contractors because it's common within their industry.
Construction, transport, allied health, hospitality, and professional services are all industries where contractor arrangements regularly appear. Sometimes appropriately and sometimes not.
A business owner may inherit arrangements from a previous owner, follow what competitors are doing, or rely on assumptions that have circulated within the industry for years.
Another common issue is where the arrangement starts genuinely flexible, but gradually shifts over time.
Someone may initially come in as a contractor for overflow work a few days a week. Then the business grows dependent on them. They become embedded in the team, begin working regular hours, attend staff meetings, use internal systems, and operate almost identically to employees.
The paperwork hasn't changed but the reality of the relationship has.
We also see businesses unintentionally undermine their own contractor arrangements through day to day operations.
For example:
directing contractors in the same way as employees
requiring strict start and finish times
restricting their ability to work elsewhere
providing all tools and equipment
approving leave requests
paying fixed weekly amounts regardless of output or project delivery
Individually, some of these factors may not be an issue, but collectively, they can significantly weaken the argument that the person is a genuinely independent contractor.
High-Income Contractors Exception
There is an exception that allows high-income contractors to opt out of being treated as employees.
As of 1st July 2025, the contractor high income threshold is $183,100 per year, and this figure is adjusted annually.
Where a contractor earns above that threshold for work performed under the arrangement, they can provide a written opt out notice to the business engaging them.
If they do so, the relationship will generally be assessed under the older start of relationship test rather than the newer whole of relationship test.
Importantly, the contractor must give the opt out notice in writing and state that they believe their earnings under that relationship exceed the contractor high income threshold at the time the notice is given.
Final Thoughts
Sham contracting is rarely about a single document or one isolated factor, it's about making sure the arrangement reflects how the work actually operates.
In many cases, a small adjustment early on can prevent a much larger issue later.
If you are unsure whether your contractor arrangements are structured appropriately, it is worth getting them reviewed before they become a problem.
Sometimes a short conversation and a practical sense check can provide clarity quickly and help avoid unnecessary risk down the track.
Book a free discovery call today, and let’s explore how we can take the HR off your plate, so you can focus on growing your business.
Need help? Contact us today - sandra@hrconsultingtas.com.au or 0408 408 225
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