The Federal Court’s recent decision in JMC Pty Ltd v Commissioner of Taxation  FCA 750, should be sounding the alarm on the risk of potential ATO audit activity for any business engaging contractors as sole traders.
JMC has now appealed the Federal Court’s decision, but the lessons continue to be valuable by highlighting the types of arrangements that are at risk.
Why is this an issue now?
In March 2022, the High Court delivered two judgments that clarified the legal position on determining whether an employment or independent contractor relationship exists: CFMMEU v Personnel Contracting Pty Ltd  HCA 1 and ZG Operations v Jamsek  HCA 2 (Jamsek).
Prior to the High Court decisions, the legal test for determining whether an individual was an independent contractor or an employee required consideration of several factors, including both the contract between the parties and the actual conduct of the parties.
The High Court decisions made it clear that the terms of the contract are relevant above all else when determining whether an individual is an independent contractor or an employee, not the actual conduct between the parties.
The effect is that businesses need to be very careful of particular clauses in their contracts with sole trader contractors.
What happened in JMC?
JMC Pty Limited runs a business providing higher education courses in creative industries. JMC engaged Mr Nichollas Harrison, a qualified sound engineer, to provide teaching services under a number of written agreements between 1 April 2013 to 30 June 2016 and 1 July 2017 to 31 March 2018 (Contracts). JMC and Mr Harrison also signed a number of memoranda of agreement, including a memorandum dated 16 October 2012 (Memorandum). The terms in that Memorandum formed parts of the terms of the later Contracts and was largely the same as later memoranda of agreement.
The terms of the Contracts included that:
- JMC would pay Mr Harrison an hourly rate
- Mr Harrison was required to submit invoices to JMC specifying the teaching services he provided, including time sheets and written lesson plans
- JMC had multiple means to supervise Mr Harrison’s teaching services and also had control over how, when and where Mr Harrison was required to provide teaching services
- either party had the right to terminate on short notice
- Mr Harrison had the right, subject to JMC’s approval, to subcontract his services.
The Memorandum also included a term that attempted to define the relationship between JMC and Mr Harrison as a contractor relationship:
- In relation to the teaching services to which this Agreement relates, the Services provider agrees and acknowledges that her/his relationship with the Academy is that of a contractor and indemnifies the Academy in relation to any and all claims, including expenses reasonably and necessarily incurred in relation to such claims, which may be made in relation to any and all entitlements which accrue to an employee under the Fair Work Act 2009 and/or the Superannuation Guarantee (Administration) Act 1992 and any legislation replacing those Acts.
JMC paid invoices submitted by Mr Harrison for his teaching services but did not make superannuation contributions on his behalf.
The ATO audited JMC and determined that Mr Harrison was an employee for the purposes of sections 12(1) and (3) of the Superannuation Guarantee (Administration) Act 1992 (Cth). The effect was that JMC should have been making superannuation contributions on Mr Harrison’s behalf.
What did the Court decide?
Applying the High Court decisions, the Court found that Mr Harrison was an employee in the ordinary meaning of the word (the test under section 12(1) of the Act) and the extended definition of an employee under section 12(3) of the Act. In coming to its decision, the Court analysed the rights and obligations accruing to JMC and Mr Harrison under the Contracts. Evidence of the actual conduct of the parties was not considered.
Notably, the Court concluded that clause 10 of the Memorandum was of little weight to determining the nature of the relationship:
Little, if any, weight is to be given to Mr Harrison’s agreement and acknowledgment as to the status of his relationship with JMC. It is, at best, no more than an expression of opinion by the parties – though, in reality, really only an expression of opinion by JMC, the party with the greater bargaining power and the party that drafted the Memoranda – about the legal character of the relationship.
Is my business at risk now?
The ATO is active in this space. It is engaging in reviews of businesses that engage contractors.
Businesses that have agreements with contractors that include terms that suggest an employment relationship are at a much higher risk. These include terms, for example, where:
- payment is calculated by hours worked rather than achieving a result
- the business retains the ability to control the contractor in how the work is performed
- delegation is permitted only with the consent of the business.
It is important to note that the whole of the terms of the contract need to be considered, not individual terms in isolation.
There is no time limit to the ATO auditing your business for superannuation obligations. If the ATO does review agreements with your contractors and determines that they are employees for superannuation guarantee purposes, the consequences can be severe and include:
- superannuation guarantee charge equal to the unpaid superannuation
- ‘nominal interest’ of 10% on the unpaid superannuation
- penalties, which may be equal to or greater than the superannuation guarantee liability
- an administrative component.
I engage sole traders as independent contractors. What should I do?
You should review your service agreements with those contractors. This is to identify whether there are any historical risks, but also to consider, in light of the High Court decisions, whether those agreements contain clauses that unnecessarily increase the superannuation guarantee risk.
Please contact a member of our team if you would like us to assist.
 JMC Pty Ltd v Commissioner of Taxation  FCA 750 at  per Wigney J.