Sham Contracting in Australia: Penalties and How to Avoid It (2026)

Quick Answer

Sham contracting is when a business treats a worker as an independent contractor when they are legally an employee, denying them entitlements like minimum wages, paid leave and superannuation. It is illegal under sections 357 to 359 of the Fair Work Act 2009 (Cth). From 1 July 2026, maximum penalties are $21,840 per contravention for individuals and up to $546,000 (or three times the underpayment, whichever is greater) for companies with 15 or more employees.

In our experience working with over 10,000 Australian businesses, most sham contracting is accidental rather than deliberate. The law penalises both.

This guide explains how sham contracting happens, what it costs in 2026 and the practical steps that keep your contractor arrangements on the right side of the Fair Work Act.

Click on any of the questions below to jump to that section of this legal guide.

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What Is Sham Contracting?

Sham contracting is an arrangement where an employer disguises an employment relationship as an independent contracting arrangement. The worker is told they are a contractor, but in law they are an employee.

Some businesses do this deliberately to avoid paying minimum wages, superannuation, annual leave, sick leave and workers’ compensation. Just as often, we see it happen through ignorance. A business copies an arrangement that “everyone in the industry uses” without checking whether it is legal.

The Fair Work Ombudsman (FWO) treats both the same way. Good intentions are not a defence, and neither is industry practice.

What is an example of sham contracting?

The most common example of sham contracting is requiring a worker to get an ABN and submit invoices for what is really an employee role:

• Set hours
• Ongoing work for one business
• Using the business’s tools, and
• Under the business’s direction

The second classic example is dismissing an employee (or threatening to) and re-engaging them as a contractor to do substantially the same job.

Picture a Brisbane landscaping business that tells its full-time labourer to “go get an ABN”, so it can stop paying super and leave. He works the same hours, on the same sites, with the boss’s equipment. Nothing about the relationship has changed except the paperwork. That is sham contracting.

Is sham contracting illegal in Australia?

Yes. Sham contracting is illegal under the Fair Work Act 2009 (Cth), which contains three specific prohibitions in sections 357, 358 and 359.

The Fair Work Ombudsman investigates complaints, audits high-risk industries and prosecutes breaches in the Federal Court. Courts impose civil penalties on both the business and any individuals involved in the contravention, which can include directors, HR managers and even external advisers.

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Sham Contracting Laws: Fair Work Act Sections 357 to 359

The Fair Work Act creates three separate sham contracting contraventions. Each one covers a different pattern of behaviour, and a single arrangement can breach more than one.

The three sham contracting offences explained

• Section 357: misrepresentation. An employer must not represent to an employee that they are an independent contractor. This applies even where the employer did not intend to mislead, unless the employer reasonably believed the arrangement was genuine contracting.
• Section 358: dismissing to re-engage. An employer must not dismiss (or threaten to dismiss) an employee in order to re-engage them as a contractor doing substantially the same work.
• Section 359: false statements. An employer must not knowingly make a false statement to persuade an employee to become a contractor for the same work.

What changed in 2024: the Closing Loopholes reforms

The Closing Loopholes reforms made sham contracting significantly harder to defend. Two changes matter most.

First, from 27 February 2024, the defence to a misrepresentation claim changed. Previously, an employer only had to show it was not reckless. Now the employer must prove it reasonably believed the contract was a genuine contracting arrangement. The size and sophistication of your business are relevant, so “we didn’t know” carries little weight for an established company.

Second, from 26 August 2024, a new section 15AA restored the whole-of-relationship test for deciding who an employee is. Courts now look at the real substance, practice and conduct of the arrangement, not just the written contract. This reversed the contract-first approach from the High Court’s 2022 decisions for most Fair Work Act purposes.

Be careful with older articles on this topic. Anything written before these reforms, and plenty written after, still describes the old law.

When does a contractor become an employee?

A contractor “becomes” an employee when the overall reality of the relationship shows employment, regardless of what the paperwork says. In law, they were an employee all along, which is why back-pay claims are so dangerous.

There is no automatic conversion after a set period. But the longer someone works exclusively for one business, at its direction, integrated into its team, the harder it becomes to argue they are running their own business.

If you are engaging contractors for the first time, our guide on how to hire an independent contractor walks through the process step by step.

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Sham Contracting Penalties in 2026

What is the penalty for sham contracting in Australia?

The maximum penalty for sham contracting in Australia is $21,840 per contravention for individuals and up to $546,000 per contravention for companies with 15 or more employees. These figures reflect the Commonwealth penalty unit of $364 that applies from 1 July 2026.

Who breached the Act	Maximum penalty per contravention (from 1 July 2026)
Individual (director, manager, adviser involved)	$21,840
Company with fewer than 15 employees	$109,200
Company with 15 or more employees	$546,000 or 3x the underpayment, whichever is greater

The phrase “per contravention” matters. Each misrepresentation to each worker is a separate contravention. Five misclassified workers can mean five sets of penalties, and separate underpayment contraventions stack on top.

Penalty units are indexed, so always check the Fair Work Ombudsman’s sham contracting page for current amounts.

Is sham contracting a criminal offence?

No. Sham contracting itself is a civil penalty provision, not a criminal offence, so it results in fines rather than imprisonment.

But the picture changed on 1 January 2025, when intentional underpayment of wages and entitlements became the criminal offence of wage theft. A business that deliberately misclassifies workers and knowingly underpays them can now face criminal prosecution alongside civil sham contracting penalties, with fines running into the millions and up to 10 years imprisonment for individuals.

The real cost: back-pay, superannuation and tax exposure

Fair Work penalties are usually the smaller part of the bill. Once a worker is found to be an employee, the business owes everything that employee should have received.

• Back-payment of wages, penalty rates, overtime and leave entitlements, generally recoverable for up to 6 years
• The ATO’s superannuation guarantee charge, which is non-deductible and includes interest and administration fees per worker per quarter
• PAYG withholding amounts that should have been withheld
• Payroll tax reassessments and workers’ compensation premium adjustments at state level

The superannuation exposure is frequently the largest number. We cover this in detail in our guide to contractor superannuation, including the situations where even genuine contractors are owed super.

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How to Avoid Sham Contracting

Avoiding sham contracting comes down to one discipline: make sure the substance of each working relationship matches its label. From what we’ve seen across thousands of Australian small businesses, problems almost always start with an arrangement that was never assessed properly at the beginning.

The employee vs contractor test: 7 factors

No single factor decides the question. Courts weigh the whole relationship under section 15AA. These seven factors cover the ground that matters.

Factor	Points to employee	Points to genuine contractor
Control	Business sets hours and how work is done	Worker decides when and how to work
Tools and equipment	Business provides them	Worker supplies their own
Financial risk	Business bears the risk	Worker quotes, invoices and fixes defects at own cost
Delegation	Worker must do the work personally	Worker can subcontract or delegate
Exclusivity	Works only (or mostly) for one business	Free to serve multiple clients
Payment	Regular wage for hours worked	Paid per project or result
Entitlements	Receives or expects leave and super	Manages own leave, super and tax

If an arrangement matches four or more factors in the employee column, treat it as high risk and fix it before a regulator or an ex-worker’s lawyer finds it.

Do you need an ABN to be a contractor in Australia?

Most genuine contractors need an ABN, but holding an ABN does not make a worker a contractor. This is the single most common misconception we see.

An ABN is a tax registration, not an employment classification. A worker with an ABN, invoices and a signed “contractor agreement” can still be an employee if the relationship looks like employment in practice.

What is the 80% rule for contractors?

The 80% rule is a tax rule about personal services income (PSI), not an employment law test. If a contractor earns 80% or more of their PSI from one client, they may lose access to certain business deductions unless they obtain a personal services business determination from the ATO.

Failing the 80% rule does not automatically make someone an employee under the Fair Work Act. But heavy dependence on a single client is also one of the factors courts weigh, so a contractor at 100% of income from your business for years is a red flag under both regimes.

Put the right contract in place

A genuine contracting arrangement still needs a written contract that accurately reflects it. The contract should cover scope, deliverables, payment terms, the right to delegate, who supplies equipment, insurance obligations and how either party can end the arrangement.

Our Contractor Agreement template is drafted for Australian law and this exact risk. It documents the factors that demonstrate genuine contracting, which is your first line of defence if an arrangement is ever questioned.

Our advice: Review every contractor arrangement at least annually, and immediately whenever the working relationship changes (more hours, more control, fewer other clients). Based on the legal documents we’ve helped businesses create, the cheapest time to fix a classification problem is before anyone complains.

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What to Do If You Think You’re Already Exposed

If you suspect an existing “contractor” is really an employee, act now. Voluntary correction is dramatically cheaper than an FWO investigation or a claim from a former worker.

1. Audit the arrangement against the 7 factors above. Be honest. Assess what actually happens day to day, not what the contract says.
2. Quantify the exposure. Estimate back-pay, superannuation and leave for the period of misclassification. This tells you the size of the problem and informs how urgently to move.
3. Restructure or convert. Either make the arrangement genuinely independent (real autonomy, own tools, multiple clients, results-based payment) or offer employment on proper terms. Cosmetic changes to paperwork alone fix nothing under the whole-of-relationship test.
4. Document the outcome and get advice. Complex situations, especially with years of history or multiple workers, deserve professional review before you approach anyone.

This is general information, not legal advice for your specific situation. If you want a confidential assessment of your arrangements, book a call with our Practice Director, and we will work through your exposure and the cleanest path out of it. Your workplace policies should also be updated to reflect how you engage workers going forward.

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Frequently Asked Questions

What is a sham contract?

A sham contract is an arrangement where an employer presents an employment relationship as independent contracting. The Fair Work Ombudsman describes it simply: when an employee is incorrectly told they are a contractor, this can be sham contracting. The “contract for services” is a sham because the true relationship is employment.

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What to do if you’re being sham contracted?

If you believe you are in a sham contracting arrangement, gather your records first: your contract, invoices, payslips or payment records, rosters and any messages about how your work is directed. Then contact the Fair Work Ombudsman on 13 13 94 or through fairwork.gov.au for free, confidential advice.

The FWO can investigate, recover unpaid entitlements and prosecute your employer. It is unlawful for your employer to punish you for asking questions about your rights.

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Is sham contracting a general protections claim?

Yes. The sham contracting prohibitions sit within the general protections provisions of the Fair Work Act. A worker can bring a general protections claim over sham contracting, and adverse action taken against a worker for raising it can ground a separate claim.

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Can independent contractors be unfairly dismissed?

Genuine independent contractors cannot make unfair dismissal claims, as those protections only apply to employees. But a misclassified worker who is legally an employee can bring an unfair dismissal claim despite being labelled a contractor. This is one more reason misclassification is dangerous: it hands the worker a menu of claims, including unfair dismissal, back-pay and general protections.

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How long can a contractor work for the same company in Australia?

There is no legal time limit on how long a contractor can work for the same company in Australia. Duration alone does not convert a contractor into an employee.

However, a long-running, exclusive, business-as-usual arrangement is exactly the pattern regulators scrutinise. The longer it runs, the larger the potential back-pay if it is ever reclassified.

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How do I report sham contracting?

You can report sham contracting to the Fair Work Ombudsman online at fairwork.gov.au or by phone on 13 13 94, including anonymously. For the tax side (superannuation and PAYG), you can also make a tip-off to the ATO. Since March 2026, the two regulators share data on suspected misclassification, so a report to one can trigger both.

About the Author: Vanessa Emilio

Vanessa Emilio (BA Hons, LLB, ACIS, AGIA) is the Founder and CEO of Legal123.com.au and Practice Director of Legal123 Pty Ltd. Vanessa is a qualified Australian lawyer with 20+ years experience in corporate, banking and trust law. Click for full bio of Vanessa Emilio or follow on LinkedIn.

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