Australian startups love contractors. They’re flexible, they don’t require leave entitlements, and they keep the headcount low on pitch decks. A founder can engage a developer on an ABN, pay them by invoice, and avoid the overhead of PAYG withholding, superannuation, workers’ compensation insurance, and the full suite of National Employment Standards entitlements.
The problem is that many of these arrangements aren’t genuine contractor relationships. They’re employment relationships dressed up in contractor clothing. And the legal term for that — sham contracting — now carries penalties that can reach $495,000 per contravention for larger businesses, with the potential for criminal prosecution following the Fair Work Legislation Amendment (Closing Loopholes No. 2) Act 2024.
In March 2026, the ATO and Fair Work Ombudsman announced a joint crackdown on sham contracting, signalling that enforcement in this area is intensifying. Startups — particularly those in tech, where contractor engagement is endemic — should be paying close attention.
What Makes a Worker an Employee?
There is no single statutory definition that draws a bright line between an employee and an independent contractor. Instead, Australian courts apply a multi-factor test that examines the totality of the working relationship. Following the High Court’s decisions in CFMMEU v Personnel Contracting (2022) and ZG Operations v Jamsek (2022), the primary focus is on the terms of the written contract — but only where those terms genuinely reflect the relationship.
The key factors are:
- Control. Does the business control how, when, and where the work is done? Employees work under direction; genuine contractors control their own methods and processes.
- Integration. Is the worker an integral part of the business, or are they operating their own independent enterprise?
- Basis of payment. Is the worker paid a fixed hourly or daily rate (suggesting employment), or per project or result (suggesting contracting)?
- Tools and equipment. Does the business provide the tools, or does the worker supply their own?
- Risk. Does the worker bear genuine commercial risk — the chance of profit and risk of loss — or are they guaranteed payment for their time?
- Delegation. Can the worker subcontract the work or send a substitute, or must they personally perform the services?
- Exclusivity. Does the worker serve multiple clients, or work exclusively for one business?
No single factor is determinative. The overall picture matters. But if several of these indicators point to employment, calling the worker a “contractor” in the agreement won’t change the legal outcome.
Where Startups Typically Get It Wrong
The pattern is remarkably consistent across early-stage companies. A startup engages a developer, designer, or operations person as a contractor. The worker gets an ABN — sometimes at the startup’s request. They invoice fortnightly. The contract says “independent contractor” on the first page.
But the reality looks like employment:
- The worker uses the company’s Slack, attends daily standups, and is assigned tasks through the company’s project management system.
- They work set hours — typically aligned with the rest of the team — and are expected to be available during those hours.
- They use the company’s codebase, development environment, and cloud infrastructure. They don’t supply their own tools.
- They can’t send a substitute. The startup hired them specifically for their skills.
- They work exclusively for the startup, or close to it.
- They’re paid a fixed daily or weekly rate regardless of output.
This is the textbook sham contracting scenario. The contract says contractor. Everything else says employee.
The Consequences Are Severe
Sham contracting is prohibited under sections 357–359 of the Fair Work Act 2009. The consequences operate at multiple levels:
Civil penalties. The maximum penalties per contravention are $19,800 for individuals (including founders personally), $99,000 for businesses with fewer than 15 employees, and $495,000 for larger businesses. Critically, each pay period during which the sham arrangement continues can constitute a separate contravention. A 12-month arrangement with fortnightly invoicing could theoretically generate 26 separate contraventions.
Back-payment of entitlements. If a worker is found to be an employee, the company owes them every entitlement they should have received for the entire period of the relationship: annual leave, personal leave, notice of termination, redundancy pay (if applicable), superannuation at the prevailing SG rate, and any applicable award or enterprise agreement entitlements.
Tax penalties. The ATO will assess unpaid PAYG withholding for the entire period, plus the superannuation guarantee charge (which includes the unpaid SG amounts, an interest component, and an administration fee). Failure to comply with SG obligations can also result in director penalties under Division 269 of Schedule 1 to the Taxation Administration Act 1953, making directors personally liable for unpaid super.
Criminal liability. Following the Closing Loopholes amendments, intentional wage theft — which can include deliberate sham contracting to avoid paying employee entitlements — carries criminal penalties of up to 10 years’ imprisonment and fines of up to $7.8 million for corporations. These criminal provisions commenced on 1 January 2025.
Workers’ compensation exposure. If a worker is injured and is found to be an employee rather than a contractor, the business faces uninsured liability for the workers’ compensation claim — a potentially catastrophic exposure for an early-stage company.
The Defence Has Narrowed
Under the original provisions of the Fair Work Act, an employer could defend a sham contracting claim by showing they did not know the worker was an employee — effectively, a test of recklessness. The Closing Loopholes amendments changed this to a “reasonableness” test: the employer must now show they reasonably believed the worker was a genuine contractor.
This is a harder standard to meet. A founder who engaged a full-time, exclusive, direction-taking worker as a contractor will struggle to establish that their belief was reasonable — particularly given the volume of publicly available guidance from the Fair Work Ombudsman and ATO on the distinction between employees and contractors.
Ignorance of the law is not a defence. And in 2026, with the ATO and FWO actively publicising the distinction, it will be very difficult for any business to credibly claim they didn’t understand the difference.
The Superannuation Trap
Even where a contractor arrangement is genuine for Fair Work purposes, the super obligations can still apply. Under section 12(3) of the Superannuation Guarantee (Administration) Act 1992, a person who works under a contract that is wholly or principally for their labour is treated as an employee for superannuation purposes — regardless of their ABN, GST registration, or the label on the contract.
This catches a wide range of startup contractor relationships. A developer engaged on a daily rate to write code is working principally for their labour. Unless they’re operating a genuine business — quoting for projects, supplying their own materials, bearing commercial risk, and working for multiple clients — they’re likely entitled to employer-paid super at the current SG rate of 12%.
The two tests — Fair Work employee status and SG employee status — operate independently. A worker can be a genuine contractor for employment law purposes but still be entitled to super. Many startups miss this entirely.
What Founders Should Do
Audit your existing arrangements. Review every contractor relationship against the multi-factor test. If the relationship looks like employment — exclusive, directed, paid by time, using your tools — it probably is employment.
Structure genuine contractor relationships properly. If you want a genuine contractor relationship, the engagement needs to reflect that in substance, not just on paper. The contractor should work for multiple clients, control their own methods and hours, supply their own tools, bear commercial risk, and have the ability to delegate or subcontract.
Pay super where required. Even if the contractor relationship is genuine, check whether the SG obligations apply. If the contract is principally for the worker’s labour, pay the super. The cost of compliance is 12%. The cost of non-compliance is significantly higher.
Get advice before, not after. If you’re unsure whether a worker is an employee or a contractor, get advice from an employment lawyer or seek a private ruling from the ATO. Rectifying a misclassification proactively — by converting the worker to employment and paying the back-entitlements — is vastly cheaper than defending a Fair Work claim or an ATO audit.
Don’t rely on the contract alone. The High Court has confirmed that the terms of the contract are the starting point, but a contract that does not reflect the true nature of the relationship will not protect you. If your “contractor” agreement says the worker can subcontract, but in practice they can’t, the contractual term is a fiction — and regulators know it.
The Bottom Line
Engaging workers as contractors is not inherently wrong. Genuine contractor relationships are a legitimate and valuable part of the Australian labour market. But labelling an employee as a contractor to save on entitlements is illegal, and the enforcement environment in 2026 makes it riskier than ever.
For startups, the cost of getting this wrong extends beyond penalties and back-payments. A sham contracting finding during due diligence can delay or derail a funding round. Investors conducting legal due diligence will flag contractor misclassification as a material risk — and they’ll want it resolved before they write a cheque.
The practical advice is straightforward: if someone works like an employee, employ them. The additional cost of doing it properly is almost always less than the cost of doing it wrong.
