Tax and super implications of sham contracting

Group of Multiethnic Mixed Occupations People

A fine line often exists between what constitutes an employee and an individual contractor. We have seen a shift away from ‘traditional’ employment over recent years, with flexible working arrangements and freelancing becoming increasingly common. Accompanying this trend is the risk of businesses engaging workers as contractors when they should actually be treated as employees.

 


A common reason for a business to engage a contractor instead of hiring an employee is the desire to avoid paying employee entitlements, including tax and superannuation obligations. If these issues are handled incorrectly, however, the consequential payments and penalties could have a far greater impact on the business.

Penalties of sham contracting

Sham contracting occurs when an employer is seen to be treating a worker as an independent contractor in an attempt to avoid meeting employee entitlements. The risks of sham contracting can be costly, with penalties including:

1. Civil penalties under the Fair Work Act 2009 (Cth) of up to:

  a) $54,000 (per contravention of the Fair Work Act) for an employer; and

  b) $10,800 for an individual (Director, HR Manager or other Senior Personnel);

2. Payments to the employee for unpaid wages and other entitlements (annual leave etc.); and

3. Tax and superannuation payment obligations.

When you consider the above penalties in relation to a worker who has been with an employer over many years, you are facing a potentially crippling amount for any business.

Superannuation guarantee contributions

An employer’s payment of superannuation contributions will differ depending on whether the worker is classified as an employee or an independent contractor. As of 1 July 2015, an employer is required to make superannuation guarantee contributions to an employee’s superannuation fund equivalent to 9.5% of the employee’s annual pay.

A number of factors determine whether a principal is required to pay superannuation for an independent contractor, so it is important to determine which classification each worker falls under.

A principal or hirer is required to make superannuation guarantee contributions on a contractor’s behalf if the contract between the principal and contractor is wholly or principally for labour.

A contract with a worker is wholly or principally for labour if the value of the labour component of the contract is more than 50% of the total value of the contract. This will be the case if the contract satisfies the following conditions:

1. The worker is remunerated (either wholly or principally) for their personal labour and skills;

2. The worker performs the contractual work personally and does not have the right to delegate the work to others;

3. The worker is paid for an hourly rate for work performed rather than to achieve a result.

A principal does not have to make superannuation contributions if the contractor has a right to delegate work to others (even if the right to delegate is not exercised), nor if the contract provides for payment of a fixed sum upon satisfactory completion of the work.

If an employer is not upholding their superannuation obligations they will have to pay any unpaid superannuation guarantee contributions to the worker, and will also suffer interest and penalties on those payments (in addition to the penalties and payments imposed under the Fair Work Act 2009 (Cth)).

Taxation implications

An employer’s tax obligations differ for each classification of worker. When dealing with employees, an employer must withhold and remit tax on their behalf under the PAYG withholding scheme, whereas no such obligation exists for payment of contractors.

If an employer fails to withhold PAYG for a worker, the Commissioner of Taxation is able to seek recovery of the amount that should have been withheld and remitted. The Commissioner must first provide a written notification to the employer of their reasonable estimate of the amount, and can then commence recovery proceedings. Interest on the amounts that should have been remitted will also be charged.

Find out more

Whilst sham contracting can be an intentional act for those attempting to avoid paying employee entitlements, for many employers it is simply a case of confusion around which classification applies to workers within their business. Although your clients may engage a worker as a contractor, the nature of their engagement may mean the worker is, in fact, an employee and therefore entitled to the related benefits.

Redchip recently held an information session for business owners, HR personnel and business advisers on the topic of sham contracting. The session looked at the distinction between contractors and employees by using practical case studies, and provided tools to help guard you and/or your clients’ businesses from risk.

To find out more on this information session, or to register for an upcoming employment law information session, please email Redchip’s Marketing Manager Jennifer Newbury on jennifern@redchip.com.au. Alternatively, contact lawyer Manja Lalovic directly with your queries by emailing manjal@redchip.com.au.

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