Service Agreements & the long arm of the ATO

A service agreement is entered into when one party supplies a ‘service’ to another, as an alternative to employment.

Common examples of typical service agreements situations are:

law firms and their administrative consultants;
Owners of medical centres and their medical practitioners; and
Principal real estate agents and their selling agents.

Entering into a services agreement can have benefits for both parties, however, taxation and compliance issues may develop if you are not careful.

Who bears responsibility for any ATO liabilities and for any breaches for non-payment is dictated by who enters into the service agreement.

To illustrate, let’s look at a case study.

Mario owns a Dental Surgery and has a spare room from which he wants another dentist, Phyllis, to operate. He does not wish to employ Phyllis, so instead they enter into a services agreement. Rather than contracting in her own name, Phyllis decides to enter into the services agreement via the trustee company of her family trust (Clean Shine Pty Ltd). Phyllis and her husband Jim are directors of the trustee company who receives the income from the services agreement and distributes only to Phyllis.

Phyllis has forgotten to pay GST and now the ATO are seeking payment. Phyllis is unsure who is liable for the GST and whether her husband Jim can be held liable as a director of Clean Shine Pty Ltd. The answer depends on who entered into the services agreement.

If Clean Shine Pty Ltd properly entered into the service agreement with Mario, liability to pay GST rests with Clean Shine Pty Ltd. This does not make Phyllis or Jim liable to pay GST, but failure to comply with GST law puts Phyllis and Jim in breach of their directors’ duties and therefore leaves them open to prosecution, with a likely outcome being an order that they pay the GST plus penalties. The fact that it was Phyllis performing the services and receiving payment through Clean Shine Pty Ltd does not absolve Jim of his responsibilities as a director. Jim has a duty to be aware of what the company is doing and that it is complying with law.

If however the services agreement with Mario is unwritten and it is not clear who entered into that agreement, then the ATO may examine the arrangement and determine that Phyllis personally entered into the services agreement, leaving Phyllis personally liable for the GST. Indeed the ATO may also consider that Phyllis’ relationship with Mario is an employment contract, not a services agreement, which removes any liability but creates an obligation for Mario to pay superannuation and leave entitlements.