The possible employees’ tax implications of payments to independent contractors and personal service providers is a relatively complex part of tax law. Persons making payment to these persons should exercise care and ensure that they have the proper relevant material to support their interpretation of the law in this respect.
Taxpayers often have to determine whether employees’ tax must be withheld from amounts payable to individuals or other persons who rendered services to them. This issue typically arises where the services are rendered by a person who is not employed by the person making, or having to make, the payment. In this respect, the nature of the person rendering the services is relevant and it is particularly relevant where these services are rendered by individuals on behalf of a company or a trust to the clients of the company or the trust
In the Basic Conditions of Employment Act 1997, unless the context indicates otherwise, ‘employee’ means −
‘(a) any person, excluding an independent contractor, who works for another person or for the State and who receives, or is entitled to receive, any remuneration, and
(b) any other person who in any manner assists in carrying on or conducting the business of an employer’
and ‘employed’ and ‘employment’ have a corresponding meaning.
Section 82 of the same Act gives a specific meaning to the word ‘employee’ and is relevant to temporary employment services. It reads as follows:
‘(1) For the purposes of this Act, a person whose services have been procured for, or provided to, a client by a temporary employment service is the employee of that temporary employment service, and the temporary employment service is that person’s employer.
(2) Despite subsection (1), a person who is an independent contractor is not an employee of a temporary employment service, nor is the temporary employment service the employer of that person.’
With respect to services rendered by an individual, from a labour law point of view, it is clear that the individual will either be an employee or an independent contractor.
For employees’ tax purposes, ‘employee’ means –
‘(a) any person (other than a company) who receives any remuneration or to whom any remuneration accrues;
(b) any person who receives any remuneration or to whom any remuneration accrues by reason of any services rendered by such person to or on behalf of a labour broker; (c) any labour broker;
(d) any person or class or category of person whom the Minister of Finance by notice in the Gazette declares to be an employee for the purposes of this definition;
(e) any personal service provider’
and ‘employer’ means ‘any person … who pays or is liable to pay to any person any amount by way of remuneration’. This is in terms of paragraph 1 of the Fourth Schedule to the Income Tax Act.
Apart from the last three mentioned above, the common thread is remuneration. So, if the amount involved is remuneration (for employees’ tax purposes), the party to whom the remuneration accrues will be the employee and the other party the employer. No reference is made here to an independent contractor.
In this article, it is not intended to deal with labour brokers, persons rendering services to them, or persons declared to be an employee in a Gazette.
Employees’ tax considerations
Let’s start with services rendered by an individual (as an independent contractor).
Generally speaking, a person deriving an amount (in respect of services rendered) by way of a fee (or commission) would be in receipt of remuneration. This is in terms of the definition of remuneration in paragraph 1 of the Fourth Schedule. However, the amount paid would not constitute ‘remuneration’ if it is paid or payable in respect of services rendered or to be rendered by a person in the course of any trade carried on by him or her independently of the person by whom such amount is paid or payable and of the person to whom such services have been or are to be rendered. This is in terms of proviso (ii) to the definition of remuneration.
The issue, for the person making payment and for purposes of employees’ tax, is whether the services are rendered by the individual in the capacity as a person carrying on a trade independently. This is what is colloquially referred to as an independent contractor.
The Income Tax Act doesn’t define the term ‘independent contractor’. The legal relationship between the parties must be gathered from the terms of the agreement between them. The general principle in this regard was explained as follows by Judge Streicher in Niselow v Liberty Life Association of Africa Ltd:
‘An independent contractor undertakes the performance of certain specified work or the production of a certain specified result. An employee in terms of the common law, on the other hand, undertakes to render personal services to an employer. In the former case, it is the product or the result of the labour which is the object of the contract and in the latter case the labour as such is the object …
… an employee is a person who makes over his or her capacity to produce to another; an independent contractor, by contrast, is a person whose commitment is to the production of a given result by his or her labour …’
With respect to Niselow, the judge concluded by saying that the relationship between the parties remained one in terms of which Niselow (the person doing the work) undertook to produce a certain result and not to render personal services to Liberty, the person paying for it. The judge held that Niselow was not an employee but was an independent contractor and was carrying on and conducting his own business. He was not assisting in the carrying on or conducting of the business of Liberty.
The Fourth Schedule, however, modifies this common law principle. It provides that, for purposes of employees’ tax, a person ‘shall not be deemed to carry on a trade independently …
- ‘if the services are required to be performed mainly at the premises of the person by whom such amount is paid or payable or of the person to whom such services were or are to be rendered
- 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 to be performed or as to his hours of work’.
This is in terms of the proviso to paragraph (ii) of the definition of ‘remuneration’ in paragraph 1 of the Fourth Schedule to the Act. This is referred to as the statutory test and it ignores, in a sense, the form of the contract between the parties and essentially deems the person rendering the services not to be an independent contractor but an employee.
In practice, it may not always be clear if the relationship between the parties is one of independent contractor and principal. The practice generally prevailing refers to the so-called ‘dominant impression test’ that must be applied to determine whether a worker is an independent contractor or an employee. For this article, it is not necessary to deal with that.
What is relevant, and very important, is that it ‘is the responsibility of the employer to determine whether the provisions of exclusionary subparagraph (ii) of the definition of “remuneration” are applicable and whether payments are subject to employees’ tax’. This is in terms of the current practice generally prevailing (Interpretation Note 17, issue 5), and it is SARS’s view that the employer ‘is in the best position to evaluate the facts and the actual situation’. The ‘employer’ in this instance would be the person paying the ‘contractors’. It is suggested that person paying the independent contractors must retain some supporting documents to be able to prove this if it is queried by SARS.
It must be remembered that, in terms of section 80(1)(viii) of the Tax Administration Act, SARS may reject an ‘application’ for an ‘advance ruling’ if the ‘application’ requests or requires the rendering of an opinion, conclusion or determination regarding whether a person is an independent contractor, labour broker or personal service provider.
It must be remembered that, in terms of binding general ruling 40, directors’ fees received by a non-executive director of a company for services rendered as a non-executive director on a company’s board is not ‘remuneration’ and is not subject to the deduction of employees’ tax. Such an individual would not be an employee and essentially is treated as an independent contractor.
If the recipient, of the fee or commission, rendered the services in the course of a trade carried on independently by him or her, the amount payable will not be subject to the withholding of any amount by way of employees’ tax. Incidentally, no IT3(a) is also required to be issued here either.
On the other hand, if the recipient of the amount is not someone who carries on a trade independently, or who is deemed not to do so (the statutory exclusion), the amount would be remuneration and the person paying would be an employer. The person paying then has an obligation to withhold employees’ tax.
The guide for employers in respect of employees’ tax, issued by SARS in respect of the 2020 year of assessment, states that the ‘employees’ tax for an independent contractor’ must be ‘calculated according to the deduction tables or a tax directive’. This implies that an ‘independent contractor’ (who is not independent because of the statutory exclusion) may apply for a directive to not have the employees’ tax withheld according to the deduction tables.
In terms of paragraph 11 of the Fourth Schedule to the Income Tax Act, SARS ‘may, having regard to the circumstances of the case, issue a directive to an employer authorising that employer … to deduct or withhold by way of employees’ tax from any remuneration … a specified amount or an amount to be determined in accordance with a specified rate or scale’. SARS can, however, only issue a directive:
- ‘in order to alleviate hardship to that employee due to circumstances outside the control of the employee
- or to correct any error in regard to the calculation of employees’ tax,
- or in the case of remuneration constituting commission …’
It makes no reference to an independent contractor – so, effectively a directive can only be applied for if there is hardship (unlikely). It is not sure why SARS say that they will issue a directive in this instance, but it appears that they will entertain an application from the individual.
The personal service provider
It was alluded to earlier in this article that services are often rendered by individuals on behalf of a company or a trust to the clients of the company or the trust. As defined, a personal service provider is an employee (for purposes of employees’ tax) – see earlier in this article.
For the purposes of the Fourth Schedule, ‘personal service provider’ means
‘any company or trust, where any service rendered on behalf of such company or trust to a client of such company or trust is rendered personally by any person who is a connected person in relation to such company or trust, and
(a) such person would be regarded as an employee of such client if such service was rendered by such person directly to such client, other than on behalf of such company or trust; or … ’
The part before the (a) gives the general principle, but one of any of the next three requirements in that definition must be present before the company or trust will be a personal service provider. The basic principle then is that the entity will be a personal service provider if a person who is a connected person in relation to the entity, personally renders the services.
Judge Kirk-Cohen, in CSARS v Professional Contract Administration CC, said, where ’the substance of a contract (as opposed to its form) demonstrates that the contract concluded between a body corporate and a third party is one where the member of the body corporate, and not the body corporate itself, in fact rendered the services’, proviso (ii) in paragraph (c) of the definition of gross income in section 1(1) of the Income Tax Act would apply.
Paragraph (c)(ii) of the definition of gross income deems the amount to have been received by the individual (and not by the company or trust). Paragraph (a) of the definition of personal provider does much the same, although it doesn’t deem the fee to have accrued to the individual. It really ignores the form of the agreement and looks to the substance thereof.
Paragraph (b) of the definition of personal service provider adds something similar to the statutory test for individuals. It reads as follows:
‘(b) where those duties must be performed mainly at the premises of the client, such person or such company or trust is subject to the control or supervision of such client as to the manner in which the duties are performed or are to be performed in rendering such service … ’
So, where the connected person (the individual) performs the duties mainly (more than 50%) at the premises of a client of the company or trust, and is subject to the control or supervision of the client as to the manner in which the duties are performed or are to be performed in rendering such service, the company or trust will be a personal service provider.
Under paragraph (c) of the definition, where ‘any service rendered on behalf of such company … to a client of such company or trust is rendered personally by any person who is a connected person in relation to such company trust, and … where more than 80 per cent of the income of such company … during the year of assessment, from services rendered, consists of or is likely to consist of amounts received directly or indirectly from any one client of such company …, in relation to such client …’, the entity will be a personal service provider.
There is a safe harbour here. The entity would not be a ‘personal service provider’ (see the proviso to the definition of personal service provider in paragraph 1 of the Fourth Schedule to the Act) if the entity ‘throughout the year of assessment employs three or more full-time employees who are on a full-time basis engaged in the business of such company or trust of rendering any such service’. The employees must be persons ‘other than any employee who is a holder of a share in the company … or is a connected person in relation to such person …’.
Employees’ tax considerations
The rate of tax that applies in respect of a personal service provider that is a company is 28% and for a trust it is 45%.
Furthermore, the personal service provider is limited, under section 23(k) of the Income Tax Act, in the expenses it may deduct, it is forced to channel the amounts received, as a payment for the services rendered by the connected person (and other employees). It would therefore never be finally taxed on its gross accruals.
SARS is again able to issue a directive here and can issue a directive where the remuneration is paid or payable to a personal service provider. This recognises that the gross amount will not remain in or be taxed in the hands of the personal service provider.
This article was originally published in ASA.