Why your client deducts PAYE from the fee your one-man company charges for services rendered
22 August 2014
Posted by: Author: Lesedi Seforo
Lesedi Seforo (SAIT Technical)
You’ve had it with the corporate world: the gossip, the office
politics and bureaucracy. You’ve always wanted to start your own business and
have the independence that comes from being your own boss: waking up whenever
you feel like it, flexible working hours, etcetera. Plus the government is
always going on and on about how the country needs more entrepreneurs in order
for us to make a serious dent on that persistently high unemployment rate. You’ve
been very good with your savings over the years and have enough tucked away to
act as a cushion should you not be able to make enough money during those
initial months. To top it all off, the kids are still under ten years old so
education is not as expensive as it could be. In case your business venture
fails, you can always go back to work.
I’m sure these thoughts have crossed the minds of most middle
class professionals at some point or another. It’s actually quite common for
those who have spent some time in the corporate world to go into business for
themselves, many times acting as external consultants to their former
employers. In most cases, such people are able to charge their ex-employers
fees much higher than the salaries they were earning during their employment. That’s
the power of maintaining good relationships in the workplace and not burning
your bridges when you resign: you do not necessarily have to start from scratch
when you’re looking for clients for your new consulting business.
So the business begins and you’re doing fairly well. So far
you’re the only employee of your company and you have one client from which your
company earns income. But at least it’s one big client. You have noticed,
however, that your ex-employer client keeps withholding an amount of tax from
the payment made to settle your fee for services rendered; just like they used
to do when you were their employee. "Surely that’s a mistake. Companies don’t
pay PAYE, do they?” you wonder.
Can a company ever be
an employee for tax purposes?
The answer to that question lies in the meaning of
‘employee’. What is ironic in the abovementioned case is that though the person
took all the steps necessary to no longer be classified as an employee (by
starting his own company), his company has now replaced him as the employee…for
Which leads us to the question: what is an employee…for tax
purposes? Aside from the ordinary meaning of ‘employee’ which the layman can
understand, the term also includes what the Income Tax Act calls a ‘personal
services provider’ (or PSP). This is:
- a company
- where the service rendered on behalf of such a company
to a client is rendered personally
- by any person who is a connected person in
relation to such company; and
- More than 80% of the income of such company during
the tax year from services rendered is from any one client.
These requirements also apply to a trust and a close
corporation (CC). Aside from this "80% income requirement”, there are other
instances where a company or trust could be classified as a personal services
provider. The focus for this article, however, is the "80% income requirement”
as that applies specifically to the abovementioned example.
A connected person in relation to a company is anyone who
holds more than 20% of the shares in that company. In the case of a CC, it essentially
includes any member of the CC, the member’s spouse or relative of the member.
In the example above, we have a company, the service
rendered on behalf of that company to a client is rendered by the owner of the
company, who owns more than 20% of the shares in that company. That ownership
percentage makes him a connected person in relation to the company. Finally, more
than 80% of the company’s income is from one client. All the requirements of a
PSP are thus met. Qualification as a PSP makes the company an ‘employee’ for
income tax purposes.
Employees and PAYE
The ex-employer client is, ironically, now the employer of
the PSP and must deduct PAYE when it pays the PSP for services rendered. This
may cause some cash flow problems for an already cash-strapped company trying
its best to grow as fast as possible. On the plus side, the PAYE deducted by
the client represents tax paid in advance. When the company submits an income
tax return and is assessed by SARS, it may have either:
- overpaid its income tax for the year and be due
a refund; or
- have to make only a very small final payment to
settle its tax owing to SARS as the majority of the tax was already paid in the
form of PAYE.
Classification as a PSP fortunately does not continue
indefinitely; it is something that must be determined every tax year. A company
may therefore qualify as a PSP in year 1, not be a PSP in year 2 and again meet
the PSP requirements in year 3. For instance, in the second year of operations,
the abovementioned company may experience significant growth and find that 80%
of its income is not attributable to any one client. This would put it outside the scope of the PSP
definition, assuming all the other requirements for a PSP are not met. As such,
clients paying the company would not be required by the tax law to deduct PAYE
from payments made to the company as it is not a PSP during that tax year.
You may consult your SAIT-registered tax advisor for more
information about personal service providers.