New inquiry targets sham contracting

So-called sham contracting arrangements – essentially where (often young) employees are classified as independent contractors instead of employees – have been the subject of increasing attention by government agencies like the ATO and the Australian Building and Construction Commission.

The Australian Building and Construction Commissioner, Leigh Johns, recently released a Discussion Paper containing the Terms of Reference for the Australian Building and Construction Commission’s Inquiry and Roundtable into sham contracting in the building and construction industry. Johns said the roundtable was a crucial first step in addressing the problems associated with sham contracting and labour hire arrangements in the industry.

I had previously noted that the ATO had indicated it would be prepared to take part in the roundtable.

The ATO is concerned that many employers may prefer to treat workers as contractors as it can enable them to cut costs in terms of workers’ compensation, payroll tax and superannuation guarantee. They can also negotiate pay rates outside of normal wages and conditions, and do not withhold tax.

The Tax Commissioner says the ATO is particularly concerned about employers not complying with their PAYG and super guarantee responsibilities and also instances of contractors not returning income.

A “sham arrangement” or “sham contract” involves misrepresenting or disguising an employment relationship as one involving a principal and contractor under a contract for services. This most commonly occurs in one of three ways:

structuring contracts to emphasise features of a contracting arrangement rather than an employment relationship;
engaging workers through third party labour hire agencies; and/or
interposing an entity that contracts with the business, rather than the worker in his or her personal capacity.

The discussion paper – Sham Arrangements and the use of Labour Hire in the Building and Construction Industry – sets out the terms of reference for the inquiry which include consideration of:

the sham arrangement provisions in the Fair Work Act 2009;
the current definitions of “employee” and “independent contractor” at common law and in statutes;
the evasion by employers of responsibilities owed to employees in the building and construction industry by use of devices including subcontracting and labour hire arrangements; and
the evasion by workers in the building and construction industry of taxation and other responsibilities by use of devices including creating businesses and partnerships.

The paper seeks to find a framework for finding ways to eliminate the use of sham arrangements.

The Paper also poses key questions for consideration, including:

What is the extent and nature of sham arrangements in the building and construction industry?
What factors are relevant in determining whether a construction worker is an employee or a subcontractor?
How well are the differences between subcontractors and employees clearly understood in the industry?
How could the ABCC assist all stakeholders in the building and construction industry to ensure labour hire practices are both fair and efficient?

The discussion paper notes that the effects of sham contracting and labour hire arrangements were discussed at length in a 2002 discussion paper released by the Cole Royal Commission and were also addressed in its final report. Of particular concern was the effect of evasion by employers of their responsibilities to employees and others, such as to pay payroll tax, workers’ compensation premiums, employee entitlements (such as annual and long service leave) and superannuation.

The paper notes that there are a number of key factors that courts have taken into account when determining whether a worker is a contractor or an employee. These include:

Status as a contractor: the worker chooses how, where and when to perform tasks; the worker works on a number of different projects for different principals; the worker provides and maintains his or her own equipment; the worker is responsible for business expenses such as income tax and insurance; the worker is paid by reference to completion of tasks.
Status as an employee: the employer exercises, or has the right to exercise, control over the manner in which work is performed, place of work and/or hours of work; the worker works exclusively for the employer; the employer deducts income tax and makes superannuation contributions on the worker’s behalf.

The Paper also examines the so-called “Odco arrangements” involving labour hire arrangements where a labour hire agency provides workers to work at an employer’s premises under the general supervision of the employer business. These arrangements have been subject to a number of cases before the courts and the discussion paper considered these cases demonstrate that courts and tribunals are now more inclined to look beyond the terms of the documents entered into by the parties, and consider whether the arrangements are legitimate or merely set up to avoid employee entitlements.

Consultation and submissions

Roundtable conferences will be held in Sydney, Melbourne, Brisbane, Canberra and Perth commencing in late March 2011, to discuss submissions and examine strategies for eliminating sham contracting. Submissions to the inquiry are due by 7 March 2011.

Although this review by the Australian Building and Construction Commission is looking at sham contracting in the building and construction industry, don’t be surprised if its findings extend beyond that industry. As such, SMEs need to be aware of the inquiry and its outcome.

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