Blog · Compliance & Legal
Sham Contracting: Rules, Penalties and Offshore Staff
What sham contracting is, the three things the Fair Work Act prohibits, how employee status is decided, the penalties, and what it means for offshore staff.
Prateek Sahni
Published: 9 October 2026 · 13 min read
Sham contracting is one of the most common ways Australian businesses end up in trouble with the Fair Work Ombudsman and the ATO at the same time, usually without meaning to. A worker is set up on an ABN, invoices every fortnight and everyone calls them a contractor. Then the relationship is examined, and it looks exactly like employment.
In March 2026 the Fair Work Ombudsman and the ATO announced a joint focus on it. This guide explains what sham contracting is, how the law now decides who is an employee, what the penalties are, and the question more businesses are asking - how it applies when the "contractor" works offshore.
Quick answer: Sham contracting is when a business tells a worker they are an independent contractor when the relationship is really employment. Under sections 357–359 of the Fair Work Act it is illegal to misrepresent employment as a contracting arrangement, to dismiss an employee in order to re-engage them as a contractor, or to make false statements to persuade them to switch. Maximum penalties run to A$495,000 per contravention for larger businesses, plus unpaid wages, super and tax.
What is sham contracting?
Sham contracting is a disguised employment relationship. The paperwork says "independent contractor", but the way the work is actually done says "employee". A sham contract is the agreement used to dress it up - often titled "Independent Contractor Agreement" or "Services Agreement" – while the worker keeps fixed hours, takes daily direction, uses the business's tools and works for no one else.
Businesses do it for different reasons. Some want to avoid super, leave, payroll tax and workers' compensation. Many simply copy an arrangement that has always been used in their industry, without checking whether it still holds up. The law treats both the same way: what matters is the substance of the relationship, not the label.
The three things the Fair Work Act prohibits
The Fair Work Act 2009 contains three sham contracting prohibitions.
Section | What it prohibits | Example |
|---|---|---|
s 357 | Representing to an employee that their contract of employment is a contract for services as an independent contractor | Telling a new hire they will be "on an ABN" when the role is a normal, supervised job |
s 358 | Dismissing, or threatening to dismiss, an employee in order to re-engage them as a contractor for the same or substantially the same work | Ending a receptionist's employment and offering the same job back as a contractor |
s 359 | Knowingly making a false statement to persuade an employee to become a contractor for the same or substantially the same work | Telling staff "the law now requires everyone to be a contractor" |
All three apply to the person or business making the representation. They can also extend to anyone "involved in" the contravention, such as a director or manager who knowingly took part.
How the law decides: employee or contractor?
Since 26 August 2024, section 15AA of the Fair Work Act requires the relationship to be assessed by looking at its "real substance, practical reality and true nature". In practice that means the whole working relationship, including how it operates day to day – not just what the written contract says. This change reversed the narrower contract-focused approach the High Court took in 2022 in Personnel Contracting and Jamsek.
No single factor decides it. These are the indicators courts and the Fair Work Commission weigh up:
Indicator | Points towards employee | Points towards contractor |
|---|---|---|
Control | Business directs how, when and where the work is done | Worker decides how the work is done to deliver an agreed result |
Hours | Set hours or rostered shifts | Worker sets their own hours |
Payment | Paid per hour, day or week | Paid per result, project or quote |
Tools and equipment | Supplied by the business | Supplied by the worker |
Delegation | Must do the work personally | Can subcontract or send someone else |
Integration | Part of the business, often in its uniform, email signature and team | Runs their own business, with their own branding and several clients |
Risk | Business carries the commercial risk | Worker bears the risk of loss and must fix defective work at their own cost |
Duration | Ongoing and open-ended | For a defined task or period |
An ABN does not make someone a contractor. Nor does an invoice, a contract titled "contractor agreement" or the worker's own preference. If most indicators sit in the left column, the arrangement is very likely employment.
There is one exception. Contractors earning above the contractor high income threshold – set by the Fair Work Commission and indexed each 1 July – can give a written opt-out notice so the common law test, rather than section 15AA, applies to their relationship. It does not apply to most workers.
Sham contracting penalties
The Fair Work Ombudsman lists these maximum penalties per contravention:
Who | Maximum penalty per contravention |
|---|---|
Individuals | A$19,800 |
Businesses with fewer than 15 employees | A$99,000 |
Businesses with 15 or more employees | A$495,000, or three times the underpayment if that is higher |
Those are the Fair Work penalties alone. A misclassified worker is usually owed everything an employee would have received: minimum wages under the relevant award, overtime and penalty rates, annual and personal leave and notice. Each underpaid entitlement can be a separate contravention.
Then there is the tax side. The ATO treats a contractor who is paid mainly for their labour as an employee for superannuation guarantee purposes, so unpaid super attracts the super guarantee charge and interest, and the Part 7 penalty can reach up to 200 per cent of the charge. The business can also face penalties for failing to withhold PAYG tax. From 1 July 2026, Payday Super requires contributions to reach the employee's fund within seven business days of each payday, which makes late discovery of a misclassified worker more expensive.
The "reasonable belief" defence
A business does not contravene section 357 if, when it made the representation, it reasonably believed the contract was a genuine contract for services. Before 27 February 2024 the test was easier to meet: the business only had to show it did not know and was not reckless as to whether, the arrangement was employment.
The current test is objective. The court asks whether the belief was reasonable, considering the size and nature of the business and any other relevant matters. A large business with HR staff and legal advisers will be held to a higher standard than a sole trader – but in either case, "everyone in our industry does it" is unlikely to count as a reasonable belief.
The ATO and Fair Work are working together
Sham contracting is no longer only an employment-law issue. In its March 2026 joint statement with the Fair Work Ombudsman, the ATO said it uses Taxable Payments Annual Reporting data, matched against tax returns, ABN records, super reporting and Single Touch Payroll, to spot warning signs. In 2024–25, almost 185,000 businesses reported payments to more than 1.4 million contractors through TPAR.
Building and construction and road freight are the main focus. In 2024–25, around 20 per cent of more than 7,000 tip-offs in building and construction alleged sham contracting, as did nearly 25 per cent of more than 800 tip-offs in road freight. Cleaning, courier, security and IT businesses, which also report through TPAR, are on the list too.
Does sham contracting apply to offshore workers?
This is where many Australian businesses get caught out. Hiring a virtual assistant or paralegal in the Philippines or India directly, on a "contractor agreement" and an hourly rate, feels like it sits outside Australian employment law. It may not.
In Pascua v Doessel Group Pty Ltd [2024] FWC 2669, a Philippines-based paralegal had worked for a Queensland business for 20 months under an "Independent Contractor's Agreement", paid an hourly rate. When the engagement ended, she lodged an unfair dismissal claim and the business objected that she was a contractor and so could not bring one. The Fair Work Commission found that she took daily instruction and was supervised in her work and concluded that, despite the contractor label, she was an employee. The Full Bench upheld that finding on appeal ([2025] FWCFB 43).
Lawyers caution against reading too much into it: the business did not argue in detail that the Fair Work Act should not apply to work done entirely in the Philippines, so the case is not a blanket rule for every offshore worker. But it shows three things clearly. A contract label does not decide the outcome. Daily direction and close supervision point to employment wherever the worker sits. And an offshore worker can bring a claim in Australia.
There is also the worker's own country to consider. The Philippines applies its own four-fold test – selection and engagement, payment of wages, power of dismissal and, most importantly, control over how the work is done and misclassification there carries its own liabilities. A direct offshore arrangement can leave a business exposed under two legal systems at once.
Warning signs: a sham contracting checklist
Run through these questions for anyone you engage as a contractor. The more "yes" answers, the higher the risk.
Do they work set hours or shifts that you decide?
Do you tell them how to do the work, not just what result you need?
Are they paid by the hour or week rather than by the job?
Do they use your equipment, systems, email address or uniform?
Do they work only for you, ongoing, with no end date?
Would they be unable to send someone else to do the work?
Did they previously do the same job as an employee?
Were they told they had to get an ABN to be offered the work?
If several of these apply, get advice before the arrangement continues. Fixing it early, by converting the role to employment or restructuring it genuinely, costs far less than back pay, super, penalties and interest later.
How to avoid sham contracting
Decide what the role really is before you hire. If you need someone working your hours, under your direction, as part of your team, that is an employee. Engage them as one, or engage a provider that employs or engages them for you.
Use contractors for genuine contracting. Defined projects, specialist outputs and work where the contractor controls the method, uses their own tools and can work for others.
Make the practice match the paper. Under the whole-of-relationship test, a well-drafted contractor agreement will not help if the day-to-day reality looks like employment.
Review existing arrangements. Especially long-running "contractors" who have become part of the team, and offshore staff engaged directly.
Get advice. Employment status turns on facts. A short review by an employment lawyer or your accountant is cheap compared with a Fair Work prosecution. This guide is general information, not legal or tax advice.
What workers can do
Workers who believe they are in a sham contracting arrangement can call the Fair Work Ombudsman on 13 13 94, make a tip-off to the ATO, or seek independent legal advice. The Fair Work Ombudsman says it cannot tell an individual whether they are a contractor or an employee, but it can explain the rules and, where appropriate, investigate.
Outside Australia
Other countries have their own versions of this problem. In the United States, the IRS and Department of Labor apply their own tests for independent contractor status. In the United Kingdom, the IR35 rules decide whether contractors should be taxed as employees. New Zealand and Canada each have their own employment tests. The principle is the same everywhere – substance beats the label – but the tests, thresholds and penalties differ, so check the rules in the country where both the business and the worker sit.
How My Virtual Mate helps
When you hire offshore staff through My Virtual Mate, you are not engaging the worker directly. My Virtual Mate handles the employment or contractor relationship with the staff member, along with payroll and local compliance and you receive a single invoice for the service. That keeps the classification question and the payroll obligations that come with it – off your desk.
You still get a dedicated person working your hours, in your systems, as part of your team. Every client has a dedicated Project Manager who handles onboarding, performance check-ins and escalation, plus a 6-Week Performance Guarantee and a 5-Day Replacement promise. No recruitment fees, no lock-in. Our staff work whichever time zone you need, sign confidentiality agreements as standard, and arrive trained on the AI tools most businesses use. We work with clients in more than 15 countries.
Rates start from A$9/hour (around US$7, £5 or €6), depending on the role and scope, confirmed on a Discovery call. Book a call and we'll walk you through how the arrangement works and where you should still talk to your own adviser.
Related reading
Frequently asked questions
What is sham contracting?
Sham contracting is when a business presents an employment relationship as an independent contracting arrangement. The worker is called a contractor, often on an ABN, but the way the work is actually done – set hours, direction and control, the business's tools, ongoing exclusive work, makes them an employee. It is prohibited under sections 357 to 359 of the Fair Work Act 2009.
What is a sham contract?
A sham contract is an agreement, usually titled "independent contractor agreement" or "services agreement", that describes a relationship as contracting when in reality it is employment. Since 26 August 2024, the Fair Work Act looks at the real substance and practical reality of the whole relationship, so the contract's wording does not decide the outcome.
Is sham contracting illegal in Australia?
Yes. The Fair Work Act prohibits misrepresenting employment as a contract for services, dismissing or threatening to dismiss an employee to re-engage them as a contractor and knowingly making false statements to persuade an employee to become a contractor. A business has a defence only if it reasonably believed the arrangement was a genuine contract for services.
What are the penalties for sham contracting?
The Fair Work Ombudsman lists maximum penalties per contravention of A$19,800 for individuals, A$99,000 for businesses with fewer than 15 employees and A$495,000 or three times the underpayment for businesses with 15 or more employees. Businesses can also owe back pay, leave, superannuation guarantee charge, Part 7 penalties of up to 200 per cent and PAYG withholding penalties.
What is the sham contracting test?
There is no single test. Since 26 August 2024, section 15AA of the Fair Work Act requires the real substance, practical reality and true nature of the whole relationship to be considered. Key indicators include who controls how the work is done, set hours, hourly pay, who supplies tools, whether the worker can delegate, how integrated they are in the business and who carries the commercial risk.
Does having an ABN make someone a contractor?
No. An ABN, an invoice or a contract titled "contractor agreement" does not decide a worker's status. If the relationship operates like employment – set hours, direction, the business's tools, ongoing exclusive work – the worker can still be an employee and the business can be liable for sham contracting.
Does sham contracting apply to offshore workers?
It can. In Pascua v Doessel Group, a Philippines-based paralegal engaged under an independent contractor agreement was found by the Fair Work Commission to be an employee and the decision was upheld on appeal. The case is not a blanket rule for all offshore workers, but it shows that a contractor label does not protect a business that directs an offshore worker like an employee.
How do I report sham contracting?
Workers can call the Fair Work Ombudsman on 13 13 94, make a tip-off to the ATO, or seek independent legal advice. The Fair Work Ombudsman cannot tell individuals whether they are an employee or a contractor, but it can explain the rules and investigate where appropriate.
