Wrongly treating an employee as an independent contractor is illegal, and sham contracting can expose a business to penalties of up to $546,000 for each contravention. The Fair Work Ombudsman lists maximum penalties of $21,840 for individuals, $109,200 for businesses with fewer than 15 employees, and $546,000 for businesses with more than 15 employees, as published on its official page and checked 2026-10-01. Directors should also check the separate ATO consequences, including PAYG withholding penalties and superannuation charges.
What is sham contracting?
Sham contracting occurs when a business represents that a worker is an independent contractor but does not reasonably believe that is true, according to the Fair Work Ombudsman’s official guidance, checked 2026-10-01.
The following conduct is also described as illegal by the Fair Work Ombudsman, checked 2026-10-01:
- Knowingly saying something false to persuade an employee to become a contractor to perform the same or mostly the same work.
- Dismissing or threatening to dismiss an employee before engaging that person as a contractor to perform the same or mostly the same work.
- Representing that a worker is a contractor when the business does not reasonably believe the worker is engaged as a contractor.
The Fair Work Ombudsman’s sham-contracting guidance, checked 2026-10-01, also says that courts may impose penalties against businesses or individuals.
What are the maximum sham contracting penalties?
The maximum penalty for each contravention is:
| Person or business | Maximum penalty per contravention | Source and checked date |
|---|---|---|
| Individual | $21,840 | Fair Work Ombudsman, official Sham contracting page, checked 2026-10-01 |
| Business with fewer than 15 employees | $109,200 | Fair Work Ombudsman, official Sham contracting page, checked 2026-10-01 |
| Business with more than 15 employees | $546,000 | Fair Work Ombudsman, official Sham contracting page, checked 2026-10-01 |
These are maximum penalties for each contravention, not a statement that a court will impose the maximum amount in a particular matter. The official page does not state that every case will result in the maximum penalty.
What changed on 27 February 2024?
Since 27 February 2024, an employer defending a sham-contracting claim must prove that, when the representation was made, the employer reasonably believed the worker was engaged as a contractor. This change came into effect on 27 February 2024, according to the Fair Work Ombudsman’s official Independent contractor changes page, checked 2026-10-01.
The change replaced the previous recklessness-based approach with a requirement to assess what the employer reasonably believed at the time. The official page does not state that a genuine label, an ABN or a signed contract automatically establishes that belief.
A director should therefore document the basis for the classification rather than rely only on the title used in the engagement. The official material provided for this article does not state the specific questions to ask in a classification tool, and the relevant ATO tool details are not stated on the official page reviewed for this article.
Does having an ABN prove someone is a contractor?
No. The Australian Taxation Office states that having an ABN makes no difference to whether a worker is an employee or independent contractor for a job, according to its official Myths and facts page, checked 2026-10-01.
The ATO also states that:
- A business should not request or pressure an employee to obtain an ABN on the mistaken belief that doing so makes the employee a contractor.
- Submitting an invoice does not make a worker an independent contractor.
- Being paid on invoice does not make a worker an independent contractor.
- Holding a registered business name does not determine the relationship.
These statements come from the ATO’s official Myths and facts page, checked 2026-10-01.
Can invoicing or a registered business name defeat a sham-contracting claim?
No conclusion follows from those formalities alone. In the Fair Work Ombudsman’s example, a worker was told to obtain an ABN and invoice the company, but the actual arrangement involved employment-like conditions: direction and control, no profit or loss, provision of tools, no ability to subcontract, and fixed hours. The Fair Work Ombudsman said the arrangement could constitute sham contracting, based on its official page checked 2026-10-01.
Directors should compare what is written in the arrangement with how the work is actually performed. The Fair Work Ombudsman says it cannot determine whether an individual is a contractor or employee; its official guidance states that this is best handled by seeking legal advice, checked 2026-10-01.
What ATO penalties and charges can arise from misclassification?
Misclassification can create liabilities that are separate from sham-contracting penalties under workplace law. The ATO says that incorrectly treating an employee as an independent contractor can result in penalties and charges, according to its official page checked 2026-10-01.
| Possible ATO consequence | What the ATO says | Source and checked date |
|---|---|---|
| PAYG withholding | A penalty may apply where tax was not deducted from worker payments and sent to the ATO | ATO, Employees incorrectly treated as independent contractors, checked 2026-10-01 |
| Superannuation | The super guarantee charge may be more than the super that would have been paid if the worker had been classified correctly | ATO, Employees incorrectly treated as independent contractors, checked 2026-10-01 |
| Additional superannuation penalty | A Part 7 penalty of up to 200% of the SGC may apply | ATO, Employees incorrectly treated as independent contractors, checked 2026-10-01 |
The ATO also states on its official Your tax and super obligations page, checked 2026-10-01, that wrongly treating an employee as an independent contractor is against the law and may lead to penalties.
What should a director check before using contractor labels?
A director’s checklist should include:
- Whether the worker is an employee under the applicable rules rather than merely the label used in the contract.
- Whether the business genuinely believed the worker was engaged as a contractor when it made the representation.
- Whether the worker is being directed and controlled in a way that may indicate employment.
- Whether the worker bears the relevant business risks and provides the business’s tools.
- Whether the worker can subcontract the work.
- Whether the working hours are fixed.
- Whether an ABN, invoice, payment arrangement or registered business name is being treated as conclusive.
- Whether PAYG withholding and superannuation obligations have been assessed for the actual working relationship.
The sham-contracting, payment, invoicing and control examples above are drawn from the official Fair Work Ombudsman and ATO pages, each checked 2026-10-01. The official material does not state that one checklist item by itself determines the classification in every case.
What should happen after a possible sham-contracting allegation?
A prudent response is to preserve the engagement documents, invoices, ABN details, payment records, instructions, rosters, timesheets and records showing who supplied tools or bore business risks. Those records are relevant to reviewing the actual arrangement rather than its label; the official material reviewed for this article does not specify a mandatory evidence checklist.
The business should also separately review its PAYG withholding and superannuation position. Sham-contracting penalties and ATO penalties or charges arise under different rules and should not be treated as interchangeable.
The Fair Work Ombudsman’s official guidance states that it cannot tell an individual whether they are a contractor or employee and recommends seeking legal advice, checked 2026-10-01.
Sources
- Australian Taxation Office — Myths and facts
- Australian Taxation Office — Employees incorrectly treated as independent contractors
- Australian Taxation Office — Your tax and super obligations
- Fair Work Ombudsman — Sham contracting
- Fair Work Ombudsman — Independent contractor changes
Frequently asked questions
Does an ABN automatically protect a business from penalties?
No. The ATO states that having an ABN does not determine whether a worker is an employee or independent contractor for a job.
Does requiring invoices automatically prevent sham contracting?
No. The ATO states that submitting an invoice or being paid on invoice does not make a worker an independent contractor.
Can a company and worker agree that the worker is a contractor?
An agreement or label is not enough to answer that question by itself. Under the sham-contracting defence, the employer must prove that it reasonably believed the worker was engaged as a contractor when the representation was made, according to the Fair Work Ombudsman’s official guidance.
Does the ATO decide whether someone is an employee or contractor?
The Fair Work Ombudsman states on its official page that it cannot determine whether an individual is a contractor or employee. It says this is best handled by seeking legal advice.