In October 2015, the ABC’s 7:30 program ran a story featuring ‘David’ (not his real name).

David had been engaged as a subcontractor by labour hire firm INCI Corporation, which in turn had worked for Myer’s cleaning contractor Spotless Group. Whereas casual cleaners under award rates earned $23 to $25 plus super and applicable penalty rates, however, David’s subcontract entitled him to a flat rate of just $20 per hour.

Yet David’s arrangement looked similar to that of an employee, featuring scheduled hours, a pay rate, supervision by the company and the submission of timesheets.

David alleged that he was a victim of sham contracting – the practice of misclassifying those who are employees in essence as independent contractors often to avoid the need to pay minimum wages, superannuation, workers compensation, leave entitlements and payroll tax.

Myer is not the only company to become caught up in alleged sham contracting arrangements. Delivery drivers of Pizza Hut have reportedly been paid as little as $6 per hour under such arrangements, whilst charity collectors at outsourcing firm Appco were allegedly paid as little as $2.50 per hour under sham contracting arrangements.

In construction, the prevalence of such arrangements is disputed. In 2011, the Construction, Forestry, Mining and Energy Union said a conservative figure for those working as contractors under employment like conditions was 110,000. Employer groups such as the Master Builders Association say these numbers are exaggerated.

With this in mind, it is important to look at some of the misconceptions surrounding sham contracting as well as what the law says about the practice, how the Fair Work Act 2009 differentiates between contractors and employees and what employers can do to ensure that any workers whom they engage on a contract basis are indeed legitimate contractors under the law.

According to Matthew Rouse, founder of commercial law firm Rouse Lawyers, misconceptions about sham contracting fall under a number of categories.

First, there can be a sense that situations under which people are employed as contractors rather than employees necessarily represents unscrupulous conduct on the part of the employer. This, Rouse says, is not necessarily the case as there will be many situations whereby a contracting relationship genuinely suits both parties. Nor, he said, will arrangements which appear to be advantageous to the employer (such as those in which pay rates are less than award wages) necessarily meet the test for sham contracting under the Act.

Further, Rouse says another misconception is that workers become contractors simply by obtaining an ABN or by signing a contract which states they are a contractor. Indeed, he says, the Act largely looks through these matters and deems a person to be an employee or otherwise based on the substance of the relationship. Where a person essentially acts as an employee (arriving at set hours, working under supervision and using the company’s tools etc. – see below), Rouse says the Fair Work Act will generally deem them as such.

A final misconception is that a person can be deemed to be a contractor where their employer persuades them to create another entity such as a company or trust through which the employer in question will contract. This may involve sham contracting or even give rise to personal liability for anyone knowingly convened in a contravention of the Act.

Master Builders Association of Victoria chief executive officer Radley de Silva said there are a number of misconceptions which reflect both the complexity of the law and a desire on the part of some (i.e. unions) to reduce the role which independent contractors play in the building sector. These include beliefs that pyramid subcontracting (whereby a contractor wins a package of work and subcontracts out part of that work passage) is sham contracting or that engaging a sole trader is necessarily a sham arrangement.

So what does the law say? Under the sham contracting provisions of the Fair Work Act, it is unlawful for employers to misrepresent an employment relationship or proposed employment relationship as a contracting relationship, to dismiss or threaten to dismiss workers for the purpose of engaging them as independent contractors or to knowingly make false statements in order to persuade employers to become independent contractors.

According to de Silva, however, even though the Act prohibits an employer from misrepresenting an employee as an independent contractor, it does not actually make such misrepresentation a breach unless the misrepresentation is reckless or done with a ‘state of knowledge’. In other words, he says, the legislation recognises the complexity of this area of law by providing a defense that one did not know and was not reckless in engaging someone as an independent contractor when they were in fact found to be an employee.

It is important to note that there are a number of factors which may contribute to determining whether a worker is a contractor or an employee under the Act and that courts look at the totality of the relationship.

According to the Fair Work Ombudsman’s web site, a typical a typical contractor might exert a high level of control over how the work is done, choose their own hours (under agreement), be engaged for specific projects or tasks, bear risk of making a profit or loss on each task, pay their own super and tax, provide their own tools, have their own ABN, submit invoices for work at the completion of a contract or project and not receive paid leave.

An employee, by contrast, might perform work under the direction and control of employers, work standard or set hours, have an expectation of ongoing work, use tools and equipment provided by their employer, be paid regularly (e.g. weekly, monthly), have tax deducted by their employer and be entitled to superannuation and paid leave.

Asked about attributes which would serve as a ‘red flag’ that a contractor should really be classified as employees, Rouse said these would include regular standard hours and prohibitions or restrictions with regard to working for others.

“Take a tradesperson doing regular work for one principal and they are setting up 8:30am to 5pm on site and they are expected to do that day in, day out,” Rouse said. “That to me would indicate that they are an employee.”

“To me, if someone is spending all of their time during regular work hours on site and they are expected to be there on time and not work for someone else, it doesn’t matter whether they bring their own ute or tools, they should be correctly classified as an employee.”

Furthermore, it should be noted that the Act has wide reach in terms of who could potentially be held liable for underpayment of workers up the construction chain – be it through sham contracting or accessorial liability. In the well-publicised investigation of 7 Eleven, for example, the Fair Work Ombudsman looked at whether a franchisor should be responsible for the underpayment of workers by its franchisees.

Applying this to construction, where a principal or head contractor engages a sub-contractor on a regular basis and has intimate knowledge of its sub-contractor’s breaches of the Act, Rouse says it may be possible that the principal or head contractor might find themselves fronting the Fair Work Ombudsman.

de Silva says the ultimate question is whether the person in fact conducting a business of his or her own or alternatively is ‘a servant of another in that other’s business.’

“It is fair to say most independent contractors run their own business, control their own working times and decide how and where they undertake work,” de Silva said. “Many independent contractors also advertise their business, provide their own tools and equipment and may pay others to carry out work on their behalf.

“In contrast, employees are typically subject to controls on how, where and when their work is performed. They are paid regularly and cannot pay someone else to do their work for them. These are the sort of things that should be looked at from a ‘red flag’ perspective (in terms of sham contracting).”

In order to protect themselves, Rouse says employers should have clear written employment agreements and ensure that they have assessed the relevant award. Principals and head contractors, meanwhile, should consider due diligence around their subcontractors employment practices, and ensure their written agreement with subcontractors clearly sets out the nature of the engagement and ensures that the subcontractor will comply with the Act’.

de Silva agrees about the importance of written contracts and adds that it is important to ensure that new contractual arrangements be entered into where the nature of that contract evolves over time.

He encourages builders to use a decision making tool provided by the Australian Tax Office which assists builders and others to self-assess the status of their workers using common law tests.

Sham contracting has no place on construction work sites.

With a little care, employers can ensure that all workers they employ are correctly classified as either contractors or employees.