Independent Contractors’ Tax Status About To Change
04 March 2009
Posted by: Author: Annette Thomson
Independent Contractors’ Tax Status About To Change
If you are a contractor in the engineering and environmental sectors, take note if you find yourself working under conditions similar to the following:
•You are truly an independent contractor.
•You are not subject to the control or supervision of your client as to the manner in which your duties are performed or your hours of work.
•You often invoice monthly but the amounts of the invoices differ, with the periodicity of invoicing often agreed with the client. For short-term projects invoicing may be linked to the completion of certain milestones; for longer term projects, billing might be monthly but the bill is only for the actual time spent on the project. When the project ends, the ‘remuneration’ from that client ends. If no work is done, no payment is due.
•The projects on which you work may often be complex and take time to complete (the duration may extend to a year) and there are periods where you essentially work on one project for one client even though there is no employment contract with the client or anyone else.You work for clients on a project by project basis.
•You often work from your own office or from home.
If you are an independent contractor, PAYE does not have to be deducted from payments to you unless you receive remuneration as defined in tax legislation. If you do receive remuneration, you will be treated as an employee for PAYE purposes, even though you are not, in fact, an employee.When does an independent contractor run the risk of having PAYE deducted from his fees?Remuneration is widely defined in the Income Tax Act and includes salary, leave pay, wages, overtime pay, bonuses, gratuities, commissions and fees.
Typically, independent contractors receive fees, and fees fall within the definition of remuneration. However, amounts paid to contractors in the course of any trade carried on independently are not treated as remuneration and PAYE is not deducted.Unfortunately, SARS has written into the law that a contractor will not be regarded as carrying on a trade independently if:
•The services have to be performed mainly at the premises of the person who pays the remuneration or of the person to whom such services are rendered.
•The manner in which the contractor works and his/her hours of work are subject to the control or supervision of any other person.
If an independent contractor employs three or more full time employees (not including connected persons), the independent contractor will not be subject to PAYE.Whether or not PAYE is deducted from an independent contractor’s fees depends on whether they comply with the definition of a personal service company.Currently a personal service company (PSC) is defined as any company (except a labour broker) where:
•The service it renders to its client is rendered personally by any person connected to the PSC.
•The person rendering the service would be regarded as an employee of the client if the service was rendered directly by the person to the client (that is, if the work was not being rendered through a company, the person rendering the service would be regarded as an employee).
•Where duties must be performed mainly at the premises of the client, and the person performing the duties, or the PSC, is subject to the control or supervision of the client as to the manner in which the duties are to be performed.
•Where more than 80% of the PSC’s income during a year of assessment, from services rendered, consists of or is likely to consist of amounts received directly or indirectly from any one of the PSC’s clients, except where the PSC, for the duration of the year of assessment, employs three or more full time employees, other than employees who are shareholders or members of the company or
are PSC-connected persons.
SARS proposes to change the law through The Revenue Laws Amendment Bill 2008, which incorporates labour broker, personal service company and personal service trust under the same personal service provider (PSP) definition.The criteria earlier defined as determining who is and who is not a PSP still apply under the proposed new legislation.Employee’s withholding tax will not have to be deducted where a PSP has provided the client with an affidavit or solemn declaration that the PSP derives less than 80% of its income from that particular client, and the client relies on the affidavit or declaration in good faith.
Effect of Proposed Amendment : Remuneration and Deductions
In terms of the explanatory memorandum to the bill, SARS aims to avoid practices breaking the employment link between an employer and employee to avoid the obligation on the employer to withhold tax.For this reason, payments to PSPs will be deemed to be remuneration.The Income Tax Act also limits PSCs’ tax deductible expenses to prevent individuals from using an entity in order to claim deductions to which they would not otherwise be entitled.A further difficulty here is that PSPs’ expenses are often high because they lack the infrastructure that an employer would otherwise provide.Bear in mind that they are required to cover all their own expenses for the running of their businesses.By taking away the ability to deduct these bona fide expenses, SARS may be crippling small business entrepreneurs.
For those falling under the PSP definition, it would be advisable to provide a standard declaration form to each client as a precautionary measure against the client deeming payments on its invoices to be remuneration.The declaration should be worded in compliance with the Income Tax Act requirements for the percentage of the PSP’s income from a single client.However, where a project accounts for more than 80% of a PSP’s income, it will be deemed to be remuneration and thus subject to the withholding tax of PAYE.Even so, it is possible to obtain a tax directive from SARS providing that having regard to the circumstances of the case, the client will not need to withhold the employee’s tax.For such a directive to be binding, application will have to be made to SARS in the prescribed form.
Source: By Annette Thomson (TaxTALK)