More people are finding themselves outside the permanent labour force and are conducting their work removed from the traditional employer-employee relationship.
The employment landscape increasingly includes freelancers, independent contractors, personal service providers and part-timers, bringing with it a whole range of complex tax rules that can make life quite difficult if not applied correctly.
Essentially, employers should deduct employees’ tax (PAYE) when remuneration is paid to employees. However, where a person trades ‘independently’, their earnings are not regarded as remuneration and should not be subject to PAYE.
Elle-Sarah Rossato, head of dispute resolution and tax controversy at PwC, says the concept of independent trade is complex and can easily be misunderstood.
“The basic principle is that in order to qualify as being independent, the person must be independent of both the person paying them and the person to whom the services are provided.”
The employer is not absolved from the potential labour and tax laws that may be applicable simply because someone calls themselves an independent contractor, says Beatrie Gouws, head of stakeholder management and strategic development at the South African Institute of Tax Professionals.
When dealing with either an entity or a natural person in a non-permanent labour environment, the employer should apply the available tests to determine the exact status of the individual or entity to ensure the labour and tax obligations are clear, Gouws advises.
Negotiating this new landscape is made more complicated by the fact that the rules are not contained in one single section of the Income Tax Act, says Anthea Scholtz, tax director at Deloitte.
Personal service providers
The water has been muddied even more with the introduction of personal service provider (PSP) companies in the legislation. This was done to put a stop to a so-called popular tax-saving method.
Employees used to establish companies, closed corporations (no longer available under the Companies Act) or trusts and offer their services through this entity back to the employer.
In this way they used the tax arbitrage opportunity to pay 28% tax as a company instead of anything between 30% and 45% as an employee. If an entity is regarded as a PSP it will be subjected to tax of 28% on its income and the deduction of business expenses is limited.
There is a carve-out in the legislation. When a company employs three or more people on a full-time basis, who are directly involved in the business activities and not connected to the company or the owner, it will not be classified as a PSP.
There are broad categories under which workers can be classified, namely unincorporated entities and incorporated entities.
This is usually individuals who trade in their own name as sole traders. Unless the individual is classified as independent, they will be subject to employees' tax at a flat rate of 25%.
The premises test (that determines whether work is done mainly at the premises of the client) and the control or supervision test (the client determines how and when the work is done) generally determine independence.
Both tests must be satisfied before one can state that the person is not independent. “The onus to make the correct classification is on the person who is making the payment. We have found in practice that employers err on the side of conservatism and many simply withhold employees’ tax at 25%,” says Scholtz.
Nicci Courtney-Clarke, financial manager and head of tax at TaxTim, says when employment tax has been deducted, it is mandatory to issue a tax certificate to the contractor. If it is disclosed under the basic salary code, the contractor or freelancer may not be able to claim normal business expenses.
Scholtz advises contractors to request in writing that all their clients voluntarily deduct employees’ tax.
The most common incorporated entity has been PSPs, but there has been a sharp decline since the change in the legislation.
The decision to incorporate as a company rests on business principles, but there are some tax considerations
to keep in mind. Rossato says although the corporate tax rate is 28%, dividends paid by the company is subject to a20% dividend withholding tax rate. If all profits are distributed to shareholders, the effective tax rate can be as high as 44%.