Sham Contracting Penalties, what Triggers Them and What They Cost

Calling a worker a "contractor" does not make them one. When an employer misrepresents what is really an employment relationship as an independent contracting arrangement, the Fair Work Act 2009 (Cth) (the Act) calls it sham contracting, and the cost of getting caught has climbed sharply. Penalties are calculated in penalty units that are indexed each year, and at the current unit value the maximum for a single contravention is $109,200 for a company and $21,840 for an individual. Because each affected worker and each separate contravention attracts its own penalty, exposure adds up fast.

This article explains how the sham contracting rules operate: the behaviours that trigger them, who enforces them, how penalties are calculated, and what a contravention can actually cost your business.

What sham contracting is and why the law prohibits it

Employees come with entitlements that independent contractors generally do not have: minimum wages under an award or the national minimum wage, paid and unpaid leave, superannuation, and income tax withheld by the employer through PAYG. An employer who misclassifies a worker as a contractor avoids all of those costs, which is exactly why the practice is prohibited.

The prohibitions sit in Part 3-1, Division 6 of the Act, under the heading "sham arrangements". They are civil remedy provisions, meaning they are enforced through the courts rather than prosecuted as criminal offences. The Act also contains parallel protections for casual employment in Subdivision B of that Division, added by the Closing Loopholes reforms, but the core rules deal with three specific behaviours.

The three prohibited behaviours

Misrepresenting employment as independent contracting

Section 357 of the Act makes it unlawful for an employer to represent to an individual that their contract of employment is a contract for services, that is, a contract under which the individual performs work as an independent contractor. This is the most common form of sham contracting: telling a worker who is, in substance, an employee that they are a contractor, or putting that characterisation in their paperwork.

There is a defence. The employer is not liable if it can prove that, when the representation was made, it reasonably believed the contract was a genuine contract for services. In deciding whether that belief was reasonable, the court must have regard to the size and nature of the employer's enterprise. A large employer with an HR function is therefore held to a higher standard than a small business with none.

Dismissing a worker to re-engage them as a contractor

Section 358 prohibits an employer from dismissing, or threatening to dismiss, an employee who performs particular work, in order to engage that individual as an independent contractor to perform the same, or substantially the same, work. The classic pattern is a restructure that converts an employee into a contractor doing the identical job, often announced as "you'll now need to invoice us through your own ABN".

Making false statements to convert a worker into a contractor

Section 359 prohibits an employer from making a statement it knows is false in order to persuade or influence an individual to enter into a contract for services under which they will perform the same, or substantially the same, work for the employer as an independent contractor. This catches the sales pitch built on claims that are untrue, such as telling a worker they will earn more, pay less tax or keep more flexibility when none of that is accurate.

Each contravention is separate. If an employer misclassifies five workers, that is five contraventions, each carrying its own maximum penalty. The same conduct can also breach multiple provisions at once.

Who enforces the sham contracting rules

The scheme involves a small cast of players:

• The Fair Work Ombudsman (FWO): investigates suspected sham arrangements, audits businesses, and brings proceedings in the Federal Court or the Federal Circuit and Family Court of Australia.
• Workers: an individual can apply for orders in their own right, although in practice most litigation is brought by the FWO.
• The courts: impose pecuniary penalties, grant injunctions and make orders to remedy the effects of a contravention.
• The Australian Taxation Office: separately pursues the superannuation guarantee and PAYG withholding obligations that the arrangement concealed.

One point that surprises directors and managers is that they can be pursued personally. Section 550 of the Act makes a person who is involved in a contravention liable for it in the same way as the employer, which is how company officers end up with penalties in their own names.

The penalty framework: units, caps and current dollar values

The maximum penalty for a sham contracting contravention is expressed in penalty units, not dollars. Section 539 of the Act sets the base maximum at 60 penalty units, and section 546 provides that the maximum for a body corporate is five times the base figure, or 300 penalty units. Where a contravention is a serious contravention, meaning the employer knowingly contravened the provision or was reckless as to whether the contravention would occur (see section 557A), the maximum is ten times the base figure: 600 penalty units for an individual and 3,000 penalty units for a body corporate.

The dollar value of a penalty unit is indexed over time. The current value is $364, in force from 1 July 2026, having been $330 from November 2024 and $313 before that (see the AFSA penalty unit table). Applying the current value, the maximum penalties per contravention are:

Two features of this framework matter in practice. First, penalties are imposed per contravention, so a company that misclassifies a team of ten workers faces ten separate maxima. Secondly, penalties are paid to the Commonwealth, not to the workers. The workers' own remedies, such as back-pay of the wages and entitlements they were denied, are separate and are dealt with below.

What else a sham arrangement can cost you

The pecuniary penalty is only one layer of the cost:

• Back-pay of entitlements: A worker found to have been misclassified is entitled to the award or national minimum wage rates, casual loading, penalty rates, overtime and leave entitlements they would have received as an employee, often calculated retrospectively.
• Superannuation guarantee charge: Missed superannuation contributions are pursued by the ATO, and the superannuation guarantee charge includes interest and an administration component, not just the contributions themselves.
• PAYG withholding penalties: Where the employer failed to withhold and remit income tax as it should have, it can face penalties for those failures as well.
• Injunctions and remedial orders: Under section 545 of the Act, a court can grant an injunction to stop a threatened dismissal and make orders to remedy the effects of a contravention, including reinstating a dismissed worker or ordering compensation.
• Personal liability: Directors, managers and anyone else involved in the contravention can be penalised personally under section 550.
• Reputation: The FWO publishes the outcome of every penalty case, and enforcement action against a named business is a matter of public record.

Two cases that show how penalties are imposed

Fair Work Ombudsman v Australian Sales and Promotions Pty Ltd [2016] FCCA 2804

Australian Sales and Promotions ran charity fundraising services. It engaged a 26-year-old worker for about four months in 2013, paying him between $50 and $67 per day plus commission, rather than a minimum hourly rate with casual loading. He was told he was a contractor, shown how to register for an ABN, required to have invoices issued through another company, and had public liability insurance deducted from what he earned. The court found he was in reality an employee: the company controlled when and how he worked, he could not delegate his work, and he was not running a business of his own.

The court imposed a penalty of $100,000 on the company and $24,000 on its director personally, a combined $124,000, for sham contracting, underpayment of minimum wages and casual loading, and record-keeping failures. The worker had been underpaid nearly $8,000. The court also noted the company had been prosecuted for similar conduct in 2012, which counted against both the company and the director.

Fair Work Ombudsman v Quest South Perth Holdings Pty Ltd [2015] HCA 45

Quest operated hotels in Perth. The FWO alleged that Quest used a third-party services provider, Contracting Solutions, in arrangements under which housekeepers were represented as independent contractors, and that a receptionist was threatened with dismissal so she could be re-engaged as a contractor. The High Court unanimously allowed the FWO's appeal, confirming that the sham contracting prohibitions apply even where a third party sits in the engagement chain. An employer cannot immunise itself by routing the paperwork through an intermediary.

In the later penalty decision, Fair Work Ombudsman v Quest South Perth Holdings Pty Ltd (No 4) [2017] FCA 580, the Federal Court fined Quest $54,450, made up of two penalties of $16,500 for misrepresenting the employment of two housekeepers and one penalty of $21,450 for threatening to dismiss the receptionist. Quest's former manager was fined $4,290 for his involvement in that contravention.

The employee-contractor test after the 2022 High Court decisions

For decades, courts determined whether a worker was an employee or a contractor by weighing the "totality of the relationship", including how much control the business exercised, whether the worker could delegate, who bore commercial risk, and how the worker was paid. In 2022 the High Court refocused the test in Construction, Forestry, Maritime, Mining and Energy Union v Personnel Contracting Pty Ltd [2022] HCA 1 and ZG Operations Australia Pty Ltd v Jamsek [2022] HCA 2: where the parties have a comprehensive written contract that genuinely reflects their arrangement, the rights and obligations in that contract are the primary reference point for deciding the worker's status.

That makes the written contract the key document, but only if it reflects reality. A court will look behind an engagement letter that says "independent contractor" where the actual working relationship is that of an employer and employee. The label on the document never decides the question by itself. The traps commonly include:

• Labour-hire and intermediary chains: Using a third party to engage the worker does not protect the business that controls the work, as Quest shows.
• Contracts that contradict practice: A contract giving the worker "full control" means nothing if the business sets the hours, directs the work, provides the equipment and forbids delegation.
• Casual misclassification: The Closing Loopholes reforms added parallel prohibitions covering dismissal or misrepresentation to engage a worker as a casual employee (Subdivision B of Division 6), so the same compliance logic applies to casual conversions.
• Assuming the reasonable belief defence will save you: The onus is on the employer to prove the belief was reasonable, and the size and sophistication of the enterprise is weighed against it.

When to involve a lawyer

The point at which legal advice pays for itself is before the engagement, not after the penalty notice arrives. A lawyer can review the way your business currently engages workers and flag classifications that do not withstand scrutiny, draft or revise contractor agreements so they reflect a genuine contracting relationship, and advise on how the Closing Loopholes changes to the Act affect your workforce, including the expanded protections for employee-like workers.

If the FWO comes knocking with an audit or a compliance notice, that is the second moment to get advice, because how a business responds shapes what follows. If proceedings are already underway, a lawyer's role is to make submissions on penalty: courts weigh the nature and seriousness of the conduct, whether it was deliberate, the employer's compliance history, and whether the employer cooperated and corrected underpayments promptly, and a lawyer can marshal those factors and negotiate outcomes where possible. Engaging a specialist early is far cheaper than the first penalty, let alone a serious contravention finding.

Getting the classification right before the FWO comes knocking

The decision that concentrates almost all of the risk in this area is the classification decision made when a worker is first engaged or converted from employee to contractor. Since 2022 that decision starts with the written contract, which means the drafting moment is where you have the most leverage: a well-drafted agreement that genuinely reflects the relationship is the best protection available, and a contract that merely asserts "independent contractor" is a liability dressed up as compliance.

The asymmetry is stark. A classification review by an employment lawyer costs a fraction of one standard penalty, which for a company is now over $100,000 per contravention at current penalty unit values, before back-pay, superannuation guarantee charge and legal costs. Remember that the dollar figures move with indexation, so check the current penalty unit value rather than relying on figures quoted in older articles. If you are about to restructure a workforce, convert employees to contractors, or move work into a labour-hire arrangement, that is the moment to take advice rather than to assume the paperwork will hold up.