INDEPENDANT CONTRACTORS DEEMED TO BE EMPLOYEES

INDEPENDANT CONTRACTORS DEEMED TO BE EMPLOYEES

You have received a letter of intent to audit from the South African Revenue Services (SARS). The scope of the audit engagement indicates that SARS will conduct an employees’ tax audit (PAYE) and the SARS has requested a copy of your vendor database. What is the SARS looking for in this PAYE audit? The absence of an employment contract does not imply that a consultant or service provider should not be recognised as an employee for tax purposes. If classified as an employee, a natural person is subject to taxation in accordance with the tax tables applicable to individuals. If classified as an employee, a personal service company is subject to taxation at the corporate tax rate on its net of VAT invoice.

Individuals

There are two sets of rules to consider in relation to the classification of independent contractors for employees tax purposes. The common law rules and the statutory (tax) rules.

The common law rules also known as the “dominant impression test” (the Test), as provided in SARS interpretation note 17 (available on the SARS website www.sars.gov.za), must be applied to determine whether a person is independent or an employee for common law purposes. The Test makes use of several indicators, of differing significance or weight, which have to be applied in the relevant context. No single indicator is conclusive. The Test is more of an analytical tool that is designed to establish the independence of a person. For the payroll administrator the absence of an employment contract, short-term contract or fixed-term contract with the consultant or independent contractor is often enough that the payroll administrator would assume that the person is independent for common law purposes.

The statutory rules operate independently from the common law rules. The statutory rules provide for a deeming provision that a person who carries on his or her trade independently (that is, a person deemed to be an independent contractor in terms of common law rules) shall be deemed not be carrying on a trade independently if he or she meets any of the statutory rules provisions. The payroll administrator’s focus is on the statutory (tax) rules provisions to decide whether or not employees’ tax should be withheld from payments to a common law independent contractor.

The statutory (tax) rules are found in the exclusionary proviso at subparagraph (ii) of the definition of “remuneration” in paragraph 1 of the Fourth Schedule to the Income Tax Act. This paragraph states that any amount paid or payable in respect of services rendered or to be rendered by any person (excluding non-residents) in the course of any trade carried on by him or her independently of the person by whom such amount is paid or payable or of the person to whom the services have been or are to be rendered (that is, amount payable to a common law independent contractor) is excluded from the definition of “remuneration” (the amount is not subject to employees’ tax but however forms part of the gross income of that person). This paragraph further provides that such a person (common independent contractor) will be deemed not to carry on a trade independently for the purposes of the Fourth Schedule to the Act

– If the services are required to be performed mainly at the premises of the client, and

– The person who rendered or will render the services is subject to the control or supervision of any other person as to the manner in which his or her duties are performed or are to be performed or to his or her hours of work.

This paragraph provides further that a person (common law independent contractor) will be deemed to be carrying on an independent trade if he or she throughout the year of assessment employs three or more employees who are on a full-time basis engaged in the business of such person of rendering any such service (excluding any employee who is a connected person in relation to such person).

When determining whether or not a person is subject to control or supervision, it is important to make sure that office hour requirements are not confused to be control or supervision. For example, if the independent contractor is told to be at the client’s premises at a specified time to facilitate staff attendance of a meeting or during the core hours of 9:00 to 15:00 to accommodate interfaces with staff that does not amount to control or supervision. However, if during the time that the independent contractor is at your premises he/she is given instructions on how to do the work this will amount to control or supervision.

In determining whether or not the statutory test applies to the consultant or service provider who is an independent contractor in terms of common law rules, the following step must be followed:

– Determine whether an independent contractor employs throughout the tax year of assessment three or more employees who are on a full-time basis engaged in the business of the independent contractor of rendering services and who are not connected persons in relation to the independent contractor. If this is not the case, proceed to the next step. If this is the case, the independent contractor is deemed to be carrying on a trade independently and accordingly the amounts payable to him or her are not subject to employees’ tax.

– Determine whether the services are required to be performed mainly at the premises of the client. If this is the case, proceed to the next step. If this is not the case, the independent contractor is carrying on a trade independently and accordingly the amount payable to him or her is not subject to employees’ tax.

– Determine whether one of the following is true:

– The person who rendered or will render the services is subject to the control of the client as to the manner in which his or her duties are performed or to be performed or as to his or her hours of work, or

– The person who rendered or will render the services is subject to the supervision of the client as to the manner in which his or her duties are performed or to be performed or as to his or her hours of work.

If any of the above two tests apply (that is, control or supervision), the independent contractor is deemed not to be independent for the purposes of the Fourth Schedule to the Act. Accordingly, the amounts payable to him or her are subject to employees’ tax. The consultant or service provider is subject to taxation in accordance with the tax tables applicable to individuals. Since this is a common law independent contractor deemed not to be carrying on a trade independently for the purposes of the Fourth Schedule to the Income Tax Act only, the remuneration must be coded 3616 on the IRPS certificate.

Companies and Trusts.

Where the consultant or service provider contracts through the medium of a legal entity (that is, company, close corporation or trust) the common law and statutory rules will not apply.

The payroll administrator will, therefore, have to determine whether the provisions relating to the “personal service provider” apply. A “personal service provider” is defined in paragraph 1 of the Fourth Schedule to the Act.

A “personal service provider” means any company or trust, where the owner(s) of the business or his/her relatives personally render the service, and –

  1. If it were not for the disguise of contracting through the company or trust, the person rendering the service would be recognised as an employee, or
  2. The service is rendered mainly at the clients premises and the manner of work of the person rendering the service is subject to the control or supervision of the client, or
  3. 80% or more of the company or trust’s income is derived directly or indirectly from one client.

This definition of “personal service provider” states further that a company or trust will be deemed not to be “personal service provider” if throughout the year of assessment it employs three or more employees (who are not the owner(s) or relatives of the owner(s)) who are on a full-time basis engaged in rendering the business’ service to its clients.

SARS interpretation note 35, available on the SARS website www.sars.gov.za can offer further detail with respect to classification of a personal service provider. Where the provisions relating to “personal service provider” apply, the company or close corporation or trust will be subject to employees’ tax deduction. The companies and close corporations are subject to tax at a rate of 28% (of their net of VAT invoice) while trust are subject to tax at a rate of 40% (of their net of VAT invoice). The remuneration paid to a personal service provider must be coded 3601 on the IRP5 certificate.

Skills Development Levies

In terms of the Skills Development Levy Act, 1999, every employer must pay a skills development levy at a rate of 1% of the “leviable amount”, namely “remuneration” as defined in paragraph I of the Fourth Schedule to the Income Tax Act. An amount payable to a common law independent contractor deemed not be independent for the purposes of the Fourth Schedule to the Income Tax Act or an amount payable to a “personal service provider”, is not excluded from the definition of “leviable amount” and accordingly subject to skills development levy.

Unemployment Insurance Fund

The Unemployment Insurance Contributions Act, 2002 (the UIF Act) requires all employers and employees (excluding employers and employees which are exempt in terms of section 4 of the UIF Act) to make UIF contributions. In terms of the UIF Act, employee means – “any natural person who receives any remuneration or to whom any remuneration accrues in respect of services rendered or to be rendered by that person, but excludes an independent contractor”. The term “independent contractor” above refers to a common law independent contractor. As stated in paragraph 4 above, common law independent contractors deemed not to be independent for the purposes of the Fourth Schedule to the Act, retain their common law independent contractor status even though they are treated as if they are employees for PAYE purposes. Accordingly, such independent contractors will not be required to make UIF contributions even though they are deemed not to be independent for PAYE purposes.

In practise

The payroll administrator is only aware of contracts with common law employees and does not have sight of contracts with consultants and service providers who are engaged through a procurement process. It is therefore recommended that employers should integrate a questionnaire as part of their procurement process to evaluate the employees’ tax consequence (if any) of engaging consultants and service providers for the business. This will give the employer some assurance that it has discharged its obligation to identify remuneration paid all of its employees (including independent contractors recognised as employees/ personal service providers) and has deducted employees tax (where applicable).

Referance: Alison Futter