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Independence Days

24 July 2017   (0 Comments)
Posted by: Author: Diane Seccombe
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Author: Diane Seccombe (diane.seccombe@mazars.co.za)

One does not simply qualify as an independent contractor for tax purposes. One can also be an independent contractor and still have PAYE withheld. Diane Seccombe walks us through the various tests and potential consequences.

 

Although being an independent contractor can have specific consequences for your tax situation, the term “independent contractor” is not specially defined in the Income Tax Act. Instead, to determine whether a taxpayer is an independent contractor for normal tax purposes, both the Fourth Schedule of the Income Tax Act and the common law status of the taxpayer is considered.

 

This article will specifically focus on individuals who are South African tax residents as neither a company nor a non-resident can be regarded as an independent contractor. Labour brokers will also not be discussed here.

 

May the Fourth Schedule be with you

 

The definition of “remuneration” is found in paragraph 1 of the Fourth Schedule of the Income Tax Act.

 

The Fourth Schedule does not dictate the common law substance of transactions between parties, it merely dictates the PAYE consequences. The receipt of remuneration alone does not make the recipient a common law employee. Instead, the purpose of the definition is to ensure that, when remuneration is paid for services rendered, the person paying bears the obligation of withholding employees’ tax (PAYE) and will be subject to penalties and interest should the correct PAYE not be withheld. The person receiving the remuneration is regarded as an “employee” for PAYE purposes.

 

Services rendered independently

The remuneration definition contains a proviso (ii) and payments falling within the proviso are excluded from the definition. Thus, the payments will not be subject to PAYE. The recipient remains liable for any normal tax that is payable.

 

In terms of the proviso, an amount paid or payable for services rendered will be excluded from the definition if the services are rendered “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”.

 

Statutory tests – what is independent anyway?

To determine whether services are rendered independently in terms of the proviso, the statutory tests must be applied. However, these tests are worded in the negative. In other words, an individual that passes the tests is seen as having not rendered services independently and the amounts paid for such services will count as remuneration and be subject to PAYE.

 

The tests will only be satisfied when the services rendered are to be performed mainly at the premises of the person paying for the service or to whom the services are rendered and:

  • The person rendering the service is subject to the control of any other person as to the manner in which the person’s duties are or will be performed or as to the hours of work; or
  • The person rendering the service is subject to the supervision of any other person as to the manner in which the person’s duties are or will be performed or as to the hours of work.

If the services rendered are not required to be performed mainly (more than 50%) at the premises of a so-called client, then the statutory tests will not apply and the elements of control and supervision need not be addressed.

 

In the application of the tests, if either the element of control or supervision is met, the services are deemed not to be rendered independently and amounts received for such services will be subject to PAYE. If a taxpayer does not meet the requirements of the statutory tests, it is still not sufficient to regard the individual as an independent contractor. The individual must also be regarded as an independent contractor in terms of the common law.

 

Common law: the dominant impression test

 

A second and entirely separate investigation must be undertaken to determine the independent contractor status of an individual in terms of the common law. All individuals, including those not meeting the statutory tests, must still consider their independent contractor status in terms of the common law dominant impression test.

 

This test looks to the substance (and not merely the contractual form) of the manner in which the services are rendered. The dominant impression test uses several indicators to determine whether the actual productive capacity (for example skills, labour power and power to work) of the individual has been acquired by the party paying for the services. If the productive capacity of the individual has been acquired, then the person who provides the services will be regarded as a common law employee who renders employment services and not as an independent contractor.

 

The acquisition of productive capacity involves a great deal more than merely being able to control the output or product which the individual delivers. It also involves being able to control and dictate the individual’s actual manner of working. SARS’ Interpretation Note 17 (Issue 3 dated 31 March 2010) contains a thorough explanation of all the indicators to be considered and a “common law dominant impression grid” to illustrate the application of the test.

 

Two is company, three is a contractor

 

When an individual employs at least three employees who are not “connected persons” to that individual on a full-time basis, the statutory tests need not be applied to that individual as the individual will be automatically regarded as rendering services independently and thus as being an independent contractor. For example, a sole trader with three or more qualifying employees will be regarded as an independent contractor.

 

Common law employee vs Fourth Schedule “employee”

 

The distinction between an individual being regarded as an “employee” (in terms of the Fourth Schedule by way of meeting the statutory tests) and a common law employee (in terms of the dominant impression test) is important.

 

When an individual is not a common law employee, but is a Fourth Schedule “employee”, remuneration for services rendered is subject to PAYE. As the services are not regarded as employment services in terms of the common law, the amount paid must be coded under the 3616 code on the IRP5 certificate.

 

An individual who renders services as a common law employee will be paid remuneration and be subject to PAYE. The amount paid for the employment services rendered must be coded under the 3601 code on the IRP5 certificate.

 

What sort of expenses may be claimed?

 

Section 23(m) of the Income Tax Act limits the deduction of expenses which relate to any employment or office held in respect of which remuneration is earned. The employment referred to in this section is that of a common law employee. The section lists the expenses that may be claimed against employment income and expenses not listed in section 23(m) are thus disallowed.

 

Also, remuneration coded under 3601 on the IRP5 will be regarded as employment income and only the expenses listed in section 23(m) may be claimed. Remuneration coded under 3616 on the IRP5 is not regarded as remuneration from employment income and the expenses which may be claimed against the remuneration are not limited to those listed in section 23(m).

 

As the onus of proof rests on the taxpayer in respect of expenses incurred, the taxpayer must ensure that expenses are accurately calculated and proof of the expenses must be maintained. Further care must be taken in respect of the expenses incurred that relate to both income earned from services rendered and private use of assets, for example home office and travel expenses. The portion of any expense that is not incurred for trade purposes will not be deductible.

 

Provisional tax and VAT issues

 

From the above, it is clear that an individual can render services and receive remuneration subject to PAYE because they meet the statutory tests, but still be regarded as an independent contractor due to the fact that they are not a common law employee.

 

An independent contractor who earns taxable income (whether or not the remuneration is subject to PAYE) will be required to register as a provisional taxpayer and submit provisional tax returns. The cash flow consequences of this must be carefully considered. PAYE withheld during the relevant tax period must be taken into account when calculating provisional tax payments, thereby reducing the payment to be made. Taxpayers also need to be aware of instances when the rate of PAYE withheld is 25%, yet this is lower than the rate of normal tax payable by the independent contractor. In such cases, the independent contractor must ensure that he or she has the cash available to pay the balance of the required provisional tax payments as and when they fall due at the end of August and February each year. If no PAYE has been withheld, the independent contractor must ensure that sufficient funds are available to meet the full tax obligation of the provisional tax payments.

 

As remuneration received by an independent contractor is not from employment services, the remuneration must be considered as turnover for VAT purposes. If the individual makes taxable supplies in terms of the VAT Act and the turnover from those supplies exceeds the R1 million threshold, then the individual must register as a VAT vendor. When the individual issues a tax invoice for services rendered and the consideration charged includes VAT, the VAT will be excluded before any PAYE is withheld.

 

Independent contractors and ITR12

 

An independent contractor will have to disclose service income and expenses separately in their ITR12 and be able to prove to SARS that all income earned has been fully disclosed and expenses claimed qualify as tax deductible and were in fact incurred.

 

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This article first appeared on the July/August 2017 edition on Tax Talk. 


 

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