Worker misclassification: How to know if you’re at risk—and what to do about it
Many of us have heard about governments pursuing gig economy giants for misclassifying their workers. As part of Australia’s crackdown on the misclassification of workers, courts have ordered companies to pay steep fines in back taxes and penalties. For instance, a judge issued $238,920 in fines to Happy Cabby, an airport shuttle service, for treating employees as contractors in 2013. It's important to note that companies of all sizes—including small businesses—can be held liable for violating labour laws.
How to know if you’re at risk of misclassification
In Australia, worker classification is governed by a combination of federal and state regulations, managed by bodies such as the Fair Work Ombudsman and the Australian Taxation Office (ATO). These agencies are responsible for enforcing labour laws and regulations that address worker classification, and the landscape for these regulations is continuously evolving.
Classifying workers in Australia as either employees or independent contractors is critical, and the consequences of misclassification can be significant. Australia uses a set of common principles across the country to determine worker status. However, the interpretation and application of these principles can still vary depending on the circumstances.
One key concept in Australia is that simply labelling a worker as an independent contractor or having a contract stating such does not make it so. Australian courts and regulatory bodies apply various tests to examine the true nature of the relationship. This typically includes examining:
- The level of control over how work is performed (behavioural control)
- The worker's ability to control the business aspects of their job (financial control)
- The permanency of the relationship
- Whether the work performed is an integral part of the business
Despite these common federal principles, specific details can vary by state, especially regarding entitlements like workers' compensation, which are typically regulated at the state level.
In sum, while the basic framework for assessing independent contractor status in Australia is consistent, careful consideration of the relationship and the contractual terms is essential to ensure proper classification. Misclassification can lead to legal repercussions, including penalties and back-payment of entitlements. Recognisng the signs of misclassification is key to maintaining compliance and protecting your business.
The risks of misclassification
Misclassification is when a business considers a worker to be an independent contractor when they should have considered them an employee. Whether your contractors are in Australia or overseas, misclassifying a worker can incur huge penalties. Consequences can vary depending on the severity of the violation and the laws in the company's jurisdiction.
Different countries have different rules for what distinguishes a contractor from an employee, making the risk even higher for companies that hire global workers. Without HR admins experienced in the nuances of each country’s classification regulations, you may find that you inadvertently run afoul of the regulations applicable to your situation. Remember that a regulator, court, or arbitrator applying the rules of the jurisdiction, may conclude that a worker is misclassified even when both the company and the worker want an independent contractor arrangement and have a contract that says so.
Below are some of the potential outcomes that can occur when a company is found to be misclassifying its workers.
Are you misclassifying your global contractors? Find out in 90 seconds.
Government or regulatory investigation
When workers are misclassified as independent contractors instead of employees, employers can potentially face significant risks of government or regulatory investigation. This is because misclassification can result in non-compliance with labour laws and regulations, which can attract the attention of government agencies such as the Fair Work Ombudsman and ATO. In some cases, an investigation into misclassification can lead to a full-scale audit of the employer's operations, which can be time-consuming and costly.
Furthermore, misclassification can create a ripple effect, as other government agencies may become involved. For example, if workers are misclassified, they may not be properly covered by workers' compensation insurance, which can result in claims against the employer's general liability insurance. This can lead to higher insurance premiums and even the loss of coverage.
Fines, penalties, and other legal action
If a government agency concludes that an employer has misclassified workers, the consequences can be severe. For example, the hiring entity may be required to pay back wages, including overtime pay, payroll tax assessments and penalties, workers’ compensation premiums and penalties, and claims for benefits, leave entitlements, and related penalties worked as employees.
A relevant example is the case involving Happy Cabby, a shuttle bus company, in 2013. The Fair Work Ombudsman took action against Happy Cabby after an investigation concluded that the company had misclassified its drivers as independent contractors rather than employees. This misclassification led to the drivers not receiving their rightful entitlements, such as minimum wages, paid leave, and other benefits typically afforded to employees.
As a result of this misclassification, the Fair Work Ombudsman sought to recover unpaid wages and other entitlements on behalf of the drivers, costing Happy Cabby $238,920 in fines. The case highlighted the significant implications of misclassifying workers in Australia, regarding legal repercussions for the business and financial and personal impacts on the workers involved.
The incident serves as a cautionary tale and emphasises the importance of correctly classifying workers to comply with Australian labour laws. The case has also had broader implications for the gig economy and worker classification practices, as many companies have faced increased scrutiny and legal challenges since the ruling.
Lawsuits from misclassified workforce
In addition to legal action from regulators, workers who believe they have been misclassified may file their own lawsuits seeking back pay, overtime, benefits, and other damages, which can be costly and time-consuming for employers. Additionally, misclassification audits from state workforce agencies are often triggered when a worker applies for unemployment benefits, and the agency discovers that the worker was paid as an independent contractor.
In recent years, a number of high-profile lawsuits have been filed by misclassified workers against companies in the gig economy, such as Uber, Lyft, and DoorDash. But lawsuits happen outside the gig economy, too. For example, Shine Lawyers initiated a class action lawsuit against ISG Management Pty. Ltd. (now known as Tandem), alleging the misclassification of telecommunications workers as independent contractors since 2011. The lawsuit was valued at AUD$400 million and involved over 4,700 workers, highlighting significant issues in worker classification. On 1 July 2021, Tandem Corporation and several related companies entered voluntary administration.
Reputational damage
Finally, even if a company isn't fined or sued, it may suffer reputational damage if it's found to have misclassified workers. If a company is seen as exploiting workers or violating labour laws, it can damage its brand, image, and relationships with customers, investors, and other stakeholders.
Reputational damage can have significant financial consequences for a company, including lost revenue, reduced market share, and decreased investor confidence. It can also lead to negative media coverage, boycotts, and other forms of public backlash, which can further harm the company's reputation and bottom line.
Reputational damage can lead to legal and regulatory consequences in addition to potential financial consequences. Companies perceived as violating labour laws may face increased scrutiny from government agencies and other stakeholders, which can result in new or further legal and financial consequences.
Misclassifying people is easier than you think
Misclassification can happen over time—many of the warning signs are small and innocuous on their own, but when many of them are present, it becomes a slippery slope that can catch employers off guard.
Here's an example:
Fictional Enterprises (FE) hires John, a graphic designer, as an independent contractor to work on a specific project. John works remotely, sets his own hours, and uses his own equipment. FE pays John a flat fee for the project and does not provide him with any benefits.
After the project is complete, FE is impressed with John's work and decides to hire him for another project. This time, FE provides John with more detailed instructions on how to complete the project and sets a deadline for completion. John still works remotely and uses his own equipment, but he now feels like FE more closely supervises him.
Over time, FE continues to hire John for additional projects. The work becomes more regular and ongoing, and FE begins to rely on John's work to run its business. John continues to work remotely and use his own equipment, but he now works exclusively for FE and doesn't have any other clients or customers.
At some point, John realises that he has been working for FE for several years and has never been classified as an employee. He starts to question whether he should be receiving benefits such as health insurance and annual leave.
In this example, FE may have accidentally misclassified John as an independent contractor. While John may have initially met the criteria for independent contractor status, over time his work became more regular and ongoing, and he became more closely supervised by FE, and he became economically dependent on FE as his sole client. If John were to challenge his classification, a court might determine that he should have been classified as an employee and was entitled to benefits such as health insurance and annual leave.
And in such a case, FE would be at risk of many potential consequences. They might owe John back pay, back benefits, and other remuneration. They might be audited, fined, or sued by government agencies for violating labour laws. And government regulators may even take a closer look at all the other contractors at FE and layer on additional fines and penalties if they conclude that other workers were misclassified. And their company reputation could take a hit, making it harder to attract talented workers like John.
Misclassification can happen accidentally, unintentionally, and, as illustrated here, gradually over time. One first step you can take to protect yourself and your company is to use Rippling's worker classification analyser, which can help you understand whether there are potential issues with your workforce classifications. Take the quiz.
You can also learn to identify some of the warning signs of misclassification in our guide.
Rippling and its affiliates do not provide tax, legal, or accounting advice. This material has been prepared for informational purposes only, and is not intended to provide, and should not be relied on for tax, legal, or accounting advice. You should consult your own tax, legal, and accounting advisors before engaging in any related activities or transactions.
