Inside the sham contracting crackdown

The issue of “sham contracting” is coming in for increasing attention from the Government and its agencies.

While the Treasurer says there are no provisions in the tax law enabling prosecutions for sham contracting, the ATO does refer cases for possible prosecution for pay as you go (PAYG) withholding offences to the Commonwealth Director of Public Prosecutions. The DPP then decides whether to prosecute a particular case.

The ATO is concerned that some businesses are engaging in sham contracting to falsely lower their labour costs and avoid their PAYG withholding and super guarantee responsibilities. They do this by incorrectly engaging employees as contractors.

“Sham contracting” arrangements aim to avoid an employer’s obligations to their workers, including PAYG withholding, superannuation guarantee and a range of other obligations such as insurance and workplace entitlements. Employers often require workers to obtain an Australian Business Number in an attempt to portray the underlying employment relationship as a contract with a business operator.

Although the ATO says it recognises that the majority of Australia’s 800,000 employers do the right thing, it says there is evidence that some employers seeking to reduce their costs via sham contracting arrangements obtain a competitive advantage over complying employers’ businesses.

The ATO conducts field audits to discourage this behaviour and it says that many of the businesses it selects to audit have been reported to it through a community referral.

The ATO targets businesses engaging contractors based on criteria that indicate risk of non-compliance. The criteria include, but are not limited to, the industry involved. Tax Office compliance activity has already been conducted across a wide range of industries including building and construction, cleaning, retail, hospitality and accommodation, restaurants and cafes, information technology, security services, call centres and telemarketing, education, health and aged care, agriculture and fishing, meat and chicken packing and processing, transport and logistics, professional services, real estate, and sports and entertainment.

ATO audits have revealed evidence of sham contracting, and consequent non-compliance with taxation and superannuation obligations, in all these industries, with particular concentration identified in the building and construction and cleaning industries.

Not surprisingly, the ATO has been collecting and examining data that has enabled it start to build a good picture of how businesses are using contractors and how contractors are engaging in the tax system. The ATO now says it can differentiate between legitimate contracting and arrangements that demonstrate some effort to comply with the law but are ultimately fudged to fit pre-determined outcomes, through to flagrant and blatant abuse of the tax system and the employers’ responsibilities to their workers.

In addition, the ATO receives government program information that provides it with information to follow up and investigate. This includes payments to business recipients of the economic stimulus packages, tip-offs from competitors who resent the unfair playing field, citizens’ advocacy groups, migrant resource centres, tax agents and even concerned parents.

The Tax Office received funding under the banner of “Promoting a Level Playing Field” for Australian business in the 2009-10 Federal Budget to target sham contracting. Under this work, the ATO expects to complete just over 4,300 field audits by the end of 2013.

From 1 July 2009 to 31 December 2010, the ATO says that 1,474 field cases were completed, raising average adjustments of $24,078 per case, nearly a third of which was superannuation guarantee.

In tough economic times, the pressure is great for business to reduce their costs. Employing contractors can be one way to do this. But it has to be done legally – employment, tax and other laws need to be complied with.

Very recently, the Federal Magistrates Court ordered the sole director of a failed financial services company to pay $13,400 in penalties to 9 workers for wages lost during a sham contracting arrangement – Fair Work Ombudsman v Centennial Financial Services Pty Ltd & Ors [2011] FMCA 459. The company’s former HR manager was also ordered to pay a separate penalty of $3,746 to the same workers.

The Court found the director of Sydney-based Centennial Financial Services (CFS) and its HR manager guilty of breaches of the sham contracting provisions of the Workplace Relations Act in 2007. Federal Magistrate Robert Cameron found the HR Manager was involved in 9 CFS sales staff being underpaid $39,533. He ordered the fines be paid to the workers to partially rectify their underpayments.

The Court heard CFS dismissed the 9 workers, told them to obtain ABNs and then immediately rehired them as independent contractors to perform the same duties under the employer’s direction. CFS then paid them on a commission-only basis and no longer paid them employee-related entitlements, including wages and leave entitlements.

The Independent Contractors Act 2006 and provisions in the Fair Work Act 2009 clarify the status of independent contractors and offer protection from sham arrangements and unfair services contracts. Contraventions of independent contractor laws can incur penalties of up to $33,000.

The case illustrates the difficulties employers can get into when employing contractors.

With the ATO and the Fair Work Ombudsman now looking closely at this area, and the Australian Building and Construction Commission conducting an inquiry into sham contracting in the building and construction industry, employers are on notice to ensure they are correctly employing contractors.

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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