Compliance with International Auditing Standards 

International Auditing Standards require that auditors plan and perform audits to obtain reasonable assurance that the financial statements are free of material misstatement. 

Salaries and salary-related costs often comprise a significant percentage of the total expenditure of an enterprise, therefore it is easy to envisage that incorrect employees’ tax payments could result in material misstatements, even in the first year of occurrence. However, the audit procedures of many auditors do not adequately address the risks associated with employees’ tax issues, partially because of the approach followed does not mirror that of the South African Revenue Service (SARS) to any extent. Many audit clerks involved in auditing salary accounts also do not have sufficient understanding of employees’ tax to recognise serious problems even if these are highlighted during certain audit procedures or client enquiries. 

Other risks 

Apart from the non-compliance with International Auditing Standards, employees’ tax risks pose a serious problem to audit firms, given the ever increasingly litigious audit environment. Negligent audit firms may also be liable to their clients for additional taxes, penalties and interest levied by SARS on underpaid employees’ tax. 

Compliance Testing 

While compliance testing can potentially go far in addressing employees’ tax risks, audit firms frequently reach a favourable conclusion regarding employees’ tax based on insufficient compliance testing. For example, the practice of checking that the correct version of the payroll package is installed and that there is segregation of duties within the payroll function, although being a useful start, is in itself insufficient. Auditors should review the remuneration policies and employees’ tax treatment of the non-cash components of remuneration packages to ensure that the client is complying with its employees’ tax obligations regarding fringe benefits and allowances. 

Substantive testing 

With regard to the more substantive-based approach followed largely by smaller firms, important risk areas are overlooked. For example, if the payroll audit programme addresses employees’ tax risks in the following audit steps: 

  • Reconcile gross salaries, deductions and fringe benefits to IRP5s – Procedure 3 (presumably from the financial records of the company – no mention is made of the employment contracts).
  • For selected employees for a typical period, agree statutory deductions to relevant manuals – Procedure 4.2.2.
  • Test to ensure deductions are paid over timeously – Procedure 4.5. 

While these audit steps would pick up certain blatant errors, the following types of transactions frequently result in substantial employees’ tax underpayments, and are not covered by the above payroll audit programme. 

  • Fixed and excessing subsistence allowances.
  • Excessive travel allowances, a recent favourite target area of SARS.
  • Fund rules (provident/medical/etc) not correctly specifying contribution rates.
  • Improperly structured salary sacrifices.
  • Cash book items, not going through the payroll, e.g. cellphone payments, entertainment bills paid, various other benefits paid for by the company as ‘business’ expenses. 

SARS risk area: Fixed and excessive subsistence allowances 

Employers sometimes pay fixed subsistence allowances, tax free. This is not permissible as per the Guideline for Employers (EMP10) published by SARS, read with Interpretation Note 14. The reason is that subsistence allowances are supposed to compensate an employee for the cost of meals, refreshments and other incidental costs while away from his or her normal place of business in abnormal circumstances, therefore the subsistence allowance cannot form part of the normal salary package of the employee. 

Subsistence allowances paid in excess of the permissible standard amounts may not be untaxed. Subsistence allowances paid based on permissible standard amounts but where the employer does not envisage that the employee will incur similar amounts of expenditure are also not in actual fact intended to compensate the employee for business costs, and are therefore not subsistence allowances, but rather ordinary remuneration which is fully taxable. 

SARS risk area: Excessive travel allowance 

A problem arises when an employee is paid an excessive travel allowance. In this regard, it is important to take note of the fact that travelling to and from work is not business travel for tax purposes. If the amount of the allowance or advance is more than the employee would realistically expend on business travel, SARS may apply a ‘substance over form’ approach, in other words tax the amount based on the actual substance of the transaction rather than the form in which it appears. In this case, a substance of the transaction rather than the form in which it appears. In this case, a substance approach over form approach would result in the excessive portion being deemed to be part of the ordinary salary of the employee and subject to employees’ tax in full. The employer would be liable for penalties and interest on the excessive portion of the travel allowance, and the employee would be restricted in his or her personal capacity to a travel claim up to the actual non-excessive part of the allowance. 

There is no set way in which SARS attacks excessive travel allowances. However, where a company keeps records of actual business travel (for example, where both a fixed travel allowance and a reimbursive travel allowance is paid, or where actual business travel is documented in order to recover travel costs from clients), a common approach by SARS is to compare the actual business travel claimed from or documented by the employer to the fixed allowance paid, per employee for a specific tax year. 

Employers are therefore at risk whenever they pay travel allowances based on arbitrary considerations, for example up to 25% of the salary package, without taking into consideration the position of the employee, the likely actual business travel during the year, the likely actual total travel during the year, and the cost of the vehicle used. 

SARS risk area: Fund rules 

One of the most common and effective methods of salary structuring is to include an employer contribution to a provident fund. If the employer is liable to make these contributions according to the fund rules, it is not a debt of the employee settled by the employer, and the employee also does not derive any benefit in that year of assessment, therefore it comprises a benefit with no tax value. The employer contribution can therefore be paid without any employees’ tax consequences.

In order for these salary structuring options to be effective, however, the fun rules must provide that the employer is liable. If the fund rules state that the employee is liable, any amount paid by the employer to settle this liability of the employee is a fully taxable fringe benefit. Checking that the fund rules are in line with the intention of the employer is therefore a very important audit step, both for SARS and for the independent auditor. 

SARS risk area: Improperly structure salary sacrifices 

It is important to note that remuneration does not become tax-free simply because it is not paid in cash. Most fringe benefits have a tax value equal to their market value. One can then exchange cash for another benefit, but frequently the benefit which one will then enjoy will still be subject to equal employees’ tax. Salaries can only be structured in a tax effective manner if the benefit for which cash is exchanged has no tax value. 

When structuring salaries in a tax effective manner, employees can only validly forego remuneration which is going to accrue to them, and not remuneration which has already accrued to them. For example, if an employee becomes entitled to a bonus, the employer instructs the employee that he has earned his bonus and offers him the option of receiving it in cash or receiving an alternative benefit, this bonus has already accrued and must be taxed in full, regardless of the form in which the employee elects to take the money. 

Employers should also be very wary of offering a cash option, because unless it is subject to some form of condition which is unfulfilled, a cash option implies that there is an amount which has accrued to the employee, which must then be taxed. 

SARS risk area: Cashbook items 

Many employers pay certain amounts to employees through the cashbook. This is perfectly acceptable, provided that this information is also entered into the payroll system and properly taxed. However, this step is often omitted. 

Reimbursements to employees are only tax-free when the expense is a valid business expense. Common practices which do not meet this requirement are the practice of allowing employees to claim ‘entertainment bills’ without offering proof of the client entertained and the purpose of the entertainment, and the practice of paying the full cellphone bills of employees without taxing the private usage of the cellphone. There are several other practices which are unacceptable for employees’ tax purposes, such as allowing employees to reclaim grocery bills, stationery bills for their children’s school items, private internet bills, and so on. 


Auditors should not go overboard in attempting to duplicate a tax audit, or address every employee’s tax risk. One should always bear in mind that there are numerous risks faced in an annual audit, of which underpaid tax is only one. However, it is important that the audit clerks involved in auditing salaries have a solid understanding of the basics of employees’ tax and the most common problem areas identified by SARS. In addition, as a minimum, either compliance or substantive tests should be applied to ensure that the standard salary components offered by the company in an environment of structured salaries, and cashbook payments made, are being correctly taxed. 


Accountancy SA