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Employees’ tax considerations when using the services of contractors

In an ever evolving business world with labour related issues becoming increasingly complex, many businesses are considering alternatives to obtain the resources and skills required. Examples of such alternatives include the use of independent contractors, labour brokers and personal service providers, among others. In many instances these provide simplified solutions to meet the immediate business need, but more often than not, these could lead to increased tax complexities, especially in relation to employees’ tax.

The legislation of the Fourth Schedule of the Income Tax Act dealing with employees’ tax is unfortunately rather complex, especially in relation to the inclusions or exclusions from the definitions of “remuneration” and “employees” often leaving accountants and payroll departments unsure of how to deal with payments made to contractors and other third parties. In most instances the third party will issue an invoice for services rendered and there is an inherent risk that businesses will merely opt to pay the invoice as a supplier payment without considering the legal requirement to withhold employees’ tax to be paid to SARS.

An employer that has failed to deduct employees’ tax or failed to deduct the correct amount of employees’ tax could be held liable by SARS for the amount of tax that should have been deducted, as well as additional penalties and interest. The amount of employees’ tax to be withheld is to be determined using the tables published in the Fourth Schedule, unless the employment falls out of the definition of “standard employment” (this is discussed later in this article). The employer does have the right to recover the tax from the employee, however this is a situation most businesses would prefer to avoid.

In this article we will point out some of the most common scenarios that we encounter and what the likely employees’ tax consequences of each are. The intention is not to provide a detailed explanation of the legislation set out in the Fourth Schedule of the Income Tax Act. To assist with the interpretation of the legislation, SARS has issued Interpretation Notes 17 (dealing with independent contractors) and 35 (dealing with personal service providers and labour brokers) that can be consulted if further detail or clarification is required.

Independent contractors

Income earned by an independent contractor (from an independent trade) is specifically excluded from the definition of remuneration in paragraph 1 of the Fourth Schedule (thus no requirement to withhold employees’ tax). In establishing whether an independent trade exists, two sets of tools are available, being the statutory tests and the common law tests. In practice, the statutory tests are considered first and the common law tests are applied only if the statutory tests are not applicable.

The statutory tests consist of two tests which are as follows:

  • The first test has two parts. If both of these are met, an independent trade is deemed to not exist:
    1. Services are required to be performed mainly at the premises of the client; and
    2. Services are performed under the control or supervision of the client (this includes the hours of work being prescribed).
  • The second test (which takes precedence over the first test) is that if the contractor has three or more full time employees who are not connected persons to him or her, an independent trade is deemed to exist.

The common law tests are more complex and do not follow a simple “checklist” approach. An “overall” or “dominant impression” of the employment relationship must be considered. Annexure C to SARS Interpretation Note 17 provides a test grid that can be consulted for further guidance.

In summary, employees’ tax needs to be deducted if the services are required to be performed mainly at the premises of the client, and under the control and supervision of the client, provided that the contractor does not have three or more full time employees who are not connected persons to him or her. If that contractor does have three or more full time employees who are not connected persons to him or her, an independent trade would exist and no employees’ tax would need to be withheld, regardless of the outcome of the first part of the first test.

Labour brokers

A labour broker is a natural person who, for reward, provides and remunerates workers for a client.

Labour brokers are specifically included in the definition of “employees” in paragraph 1 of the Fourth Schedule (thus employees’ tax is required to be withheld).

The Fourth Schedule does make provision for an exemption certificate (IRP30) to be issued by SARS which will absolve employers from having to deduct employees’ tax from any payments made to such labour brokers.

The deduction of employees’ tax from payments made to labour brokers would therefore depend on the broker being in possession of a valid exemption certificate. An employer who does not deduct employees’ tax from a payment to a labour broker must be in possession of a certified copy of the exemption certificate and this must be retained for inspection purposes.

The definition of labour brokers specifically refers to natural persons. Therefore, in the instances where labour broking services are provided by companies or other legal entities, they would fall outside the definition of labour brokers and payments to such entities would not be subject to employees’ tax.

Personal service providers

The taxation of personal service providers was introduced to eliminate tax schemes whereby employees would resign from employment and then form a company, close corporation or a trust which would then offer their services to their former employers.

A personal service provider exists in a company, close corporation or trust where all of the following requirements are met:

  • Receipts meet the definition of “remuneration” as defined in paragraph 1 of the Fourth Schedule.
  • The services are rendered personally or by a person who is a connected person.
  • The company, close corporation or trust does NOT employ three or more full time employees who are not connected persons.
  • If any one of the following applies:
    1. The person would be regarded as an employee by the client if the service was rendered directly to the client; or
    2. The duties are performed mainly at the premises of the client and that person is subject to the control and supervision of the client; or
    3. More than 80% of the income of the company, corporation or trust consists out of amounts received from services rendered to the client. In respect to this requirement, the employer is entitled to rely on an affidavit attesting that this is not the case.

Personal service providers are specifically included in the definition of “employees” in paragraph 1 of the Fourth Schedule (thus employees’ tax is required to be withheld).

Employees’ tax on payments made to service providers must be withheld at 45% for trusts and 28% for companies and close corporations.

Non-standard employment

Standard employment is defined in paragraphs 1 and 9(1) of the Fourth Schedule. Non-standard employment is any employment which cannot be classified as Standard or Deemed Standard employment.

In most cases where an employee is required to work for less than 22 hours per week, it would be considered non-standard employment. Common examples of non-standard employment are:
• Casual commissions paid;
• Casual payments to casual workers for irregular services or occasional services;
• Fees paid to part-time lecturers;
• Honoraria paid to office bearers of organisations, clubs, etc.

Employees’ tax deducted from remuneration paid for non-standard employment is calculated at either 0% or 25% depending on the number of hours worked (more or less than 5 hours per day) and the amount of remuneration paid (being less or more than R300 for that day).

Conclusion

The employees’ tax consequences of using third parties to render services should be carefully considered and can often be complex. Our aim with this article was to draw attention to the most common scenarios encountered by our clients, and briefly provide an overview of the key considerations. It is worth consulting a qualified tax expert that can provide reliable advice when in doubt as the financial consequences of not deducting employees’ tax or deducting an incorrect amount of employees’ tax can often be significant.

 
 
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