What Is a Sham Contract and How Is It Illegal?

In Australia’s employment landscape, the line between independent contractors and employees can sometimes be blurred. One key area of concern is sham contracting—a practice where an employer misrepresents an employment relationship as an independent contracting arrangement. While it may seem like a loophole to reduce business costs, sham contracting is illegal under Australian law and can lead to serious legal and financial consequences.

What Is a Sham Contract?

A sham contract is when an employer deliberately disguises an employment relationship as an independent contractor agreement. On paper, it may look like the worker is self-employed, issuing invoices and managing their own tax and super, but in practice, they are working under conditions that mirror traditional employment—such as set hours, direction from a manager, and lack of control over how work is done.

Why Do Businesses Use Sham Contracts?

Some businesses intentionally use sham contracts to:

• Avoid paying superannuation,

• Sidestep employee entitlements such as sick leave or annual leave,

• Evade payroll tax and workers compensation insurance,

• Reduce responsibilities for unfair dismissal claims.

While this may reduce short-term costs for employers, it undermines workers’ rights and breaches workplace laws.

How Is It Illegal?

Under the Fair Work Act 2009, it is illegal for an employer to:

• Knowingly or recklessly misrepresent an employment relationship as a contracting arrangement,

• Dismiss or threaten to dismiss an employee to then hire them as a contractor doing the same work,

• Make false statements to persuade a worker to become a contractor.

These provisions are in place to protect workers from exploitation and ensure they receive the entitlements they’re legally owed.

Penalties for Sham Contracting

Employers found guilty of sham contracting can face:

• Civil penalties (up to $18,780 for individuals and $93,900 for companies per breach),

• Orders for backpay, including unpaid wages, leave, and super,

• Reputational damage and loss of trust from the workforce.

In some cases, regulators such as the Fair Work Ombudsman (FWO) will investigate and take legal action to recover unpaid entitlements.

How Can Workers Protect Themselves?

If you’re unsure whether you’ve been misclassified:

• Ask yourself: Who controls my work? Am I free to set my own hours and methods?

• Seek advice from Fair Work Australia, a union, or a legal advisor.

• Keep detailed records of your work conditions, hours, and communications.

Sham contracting isn’t just a technicality - it’s a serious violation of employment law that can significantly harm workers and expose businesses to risk. Employers must be diligent and transparent in how they engage contractors, and workers should stay informed about their rights. A legitimate contracting arrangement should benefit both parties, not just the business.

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Resources:

• Fair Work Ombudsman – Sham Contracting

• Contractor vs Employee Tool – Australian Tax Office