3 August 2009

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In terms of paragraph 2(1) of the Fourth Schedule ("the Fourth Schedule") to the Income Tax Act 58 of 1962 ("the Act"), every employer, who is a resident, and every representative employer in the case of any employer who is not a resident, who pays or is liable to pay an employee remuneration shall deduct or withhold the amount of employees’ tax due in terms of the relevant provisions of the Act, and must pay this amount to the Commissioner for the South African Revenue Service ("SARS") within seven days after the end of the month during which the amount was deducted or withheld.

In terms of paragraph (c) of the definition of "employee" contained in paragraph 1 of the Fourth Schedule, a labour broker is specifically deemed to be an employee. Consequently, clients of a labour broker are required to withhold employees' tax at a rate of 33% in respect of fees paid to the labour broker, unless the labour broker has an exemption certificate (IRP30).

If an employer fails to pay this employees’ tax to SARS on time, it will be liable for a 10% penalty (paragraph 6(1) of the Fourth Schedule) and interest at the prescribed rate (section 89bis(2) of the Act).

Therefore, there is a large compliance burden imposed on South African entities to ascertain whether or not a service provider is a labour broker, and whether or not such labour broker is in possession of an IRP30 certificate. The imposition of this burden is acknowledged in the Explanatory Memorandum on the Revenue Laws Amendment Bill 2008, and is stated to be the reason that the Legislature has amended the definition of a labour broker contained in paragraph 1 of the Fourth Schedule.

This article considers the impact of this recent amendment, and the extent to which relief is granted to "labour brokers" and their South African clients.

Changes to the labour broker definition

Previously a labour broker was defined in paragraph 1 of the Fourth Schedule for the purposes of the employees’ tax withholding obligation, as follows:

"any person who conducts or carries on any business whereby such person for reward provides a client of such business with other persons to render a service or perform work for such client, or procures such other persons for the client, for which services or work such other persons are remunerated by such person".

Despite the wide language of this definition, its scope is reduced in that, in order for a person to be regarded as a labour broker, the services must be rendered or the work performed by the employee for the client and not on behalf of or for the benefit of the employer.

The South African Revenue Service ("SARS") Tax Guide for Independent Contractors and Labour Brokers (issued in December 1992) states that it is the provision or procurement of workers (i.e. persons) and not the provision of services that is the distinguishing factor between what a labour broker does and a business that provides goods or services (at 3.3). The Guide states further that a labour broker either makes available his own employees to perform work for the client or he obtains workers for the client, but he does not himself provide the services required by the client. Therefore, where a client requires the specialist services of a business and the services are performed by the employees of the business for or on behalf of the business, the business is not a labour broker but an independent contractor.

Earlier this year, an amendment was enacted which restricts the above labour broker definition to natural persons only, i.e. individuals. Therefore, a company is no longer regarded as a labour broker as defined for purposes of the Act, and specifically for purposes of the employees’ tax withholding obligation.

Effective date of amendment

The amendment to the definition of a labour broker applies in respect of a year of assessment commencing on or after 1 March 2009, in terms of section 66(2) of the Revenue Laws Amendment Act, 2008.

However, the effective date of the amendment and its impact for companies who are labour brokers is not entirely clear. The issue for a company is that, if it has a financial year that ends on 31 December, the amendment to the definition of a labour broker set out above may only apply to its financial year commencing on 1 January 2010. This would lead to an exposure for the company for the current financial year running from 1 January 2009 to 31 December 2009.

We therefore approached SARS to obtain clarification on the effective date of the amendment in respect of companies. SARS has indicated that a company will from 1 March 2009 not be regarded as a labour broker and will only fall within the definition of personal service provider if the person providing the services (the contracted individual) is a connected party to the company. SARS has also indicated that, where a company was not registered with SARS by 1 March 2009, the amendment to the labour broker definition will apply.

This view is confirmed in a letter issued by SARS on its website (www.sars.gov.za) which states that from 1 March 2009, a company, close corporation and trust is no longer defined as a labour broker and is therefore no longer eligible for an exemption certificate.

Therefore, it appears as if companies will not be regarded as labour brokers as defined in the Act with effect from 1 March 2009 in terms of the amended definition, even if their financial year ends on 31 December 2009.

Offshore labour brokers

The amendment to the definition of a labour broker is especially beneficial for foreign labour brokers. If a foreign entity carries on labour broking activities, there is an argument that the source of its labour broking fees it receives from South African entities could be regarded as being sourced in the country of residence of the labour broker. Because the foreign labour broker is a non-resident and therefore only subject to tax on income sourced in South Africa, these labour broking fees would not subject to income tax in South Africa.

However, if the foreign labour broker qualified as a labour broker in terms of previous definition of the Act, this would have had the effect that the labour broking fees payable to the foreign labour broker would be subject to the withholding of employees' tax at 33%, regardless of the source of this income. It is unlikely that a non-resident labour broker would have qualified for an IRP30 exemption certificate, and foreign labour brokers would therefore have been liable to have 33% employees’ tax withheld from payments made to them by South African clients.

In light of the new amendments to the definition of a labour broker, offshore companies that carry on labour broking activities will no longer qualify as labour brokers in terms of the Act. These entities will therefore not automatically be subject to tax in South Africa on payments made to them by South African entities for labour broking services, and South African clients of these labour brokers will no longer have an employees’ tax withholding obligation in respect of these payments.



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