Employees and commission-earners

Sometimes I think that tax law is a bit schizophrenic.  First you find a section that allows you to deduct something, then you find another that says you can't!

The rules around employment seem a little bit like that. The definition of "trade" as contained in Section 1 of the Income Tax Act includes "every profession, trade, business, employment, calling, occupation or venture ...", and then along comes Sections 23(a) and 23(b) that states that private or domestic expenditure, as well as that relating to the maintenance of any taxpayer or their household, is not deductible.

Now we add to that Section 23(m), which effectively wipes out any deductions under Section 11(a) if the trade concerned happens to be employment or the holding of any office, from which "remuneration" as defined in the Fourth Schedule to the Income Tax is derived.

It's however quite interesting to note that this section refers specifically to those employees or holders of office who derive remuneration, so technically if one could be employed or hold an office whereby the compensation paid falls outside the remuneration definition, the deductions covered by Section 11(a) would be available.

In this final part of our series on instances where expenses that otherwise fall within the ambit of Section 11(a) cannot be deducted (Don't deduct these expenses and  Stuff you can't deduct) 


Commission earnings do not fall within Section 23(m)
Although the receipt of commission falls within the definition of remuneration, Section 23(m) specifically does not apply to those who earn commission "based on his or her sales or the turnover attributable to him or her".  Technically it could therefore be argued that Section 23(m) would still apply to those who derive commission based on something other than sales (eg, gross or net profit), but I'm not aware of the South African Revenue Service (Sars) making such a distinction in practice.

However, one argument that tax practitioners constantly have with Sars is around the word "mainly", since this term is not defined in the Income Tax Act.  Sars has therefore historically applied its own criteria, regarding "mainly" as being "in excess of 50% of total remuneration".  While this is fine in theory, in practice a commission-earner who also receives a basic salary and/or travel allowance could well fall foul of the 50% threshold in a bad year.  The result is that Section 23(m) would end up applying in some years and not in others, notwithstanding the fact that, over time, commission makes up the lion's share of the taxpayer's earnings.

Another problem identified by The South African Institute of Chartered Accountants (Saica) in a discussion document dated July 23 2004, is the use of incorrect IRP5 codes by employers.  Many employers disclose all earnings (commission or otherwise) under Code 3601, which relates to normal remuneration, instead of disclosing the commission portion separately under Code 3606.  As soon as Sars sees Code 3601, Section 23(m) is applied automatically, regardless of the fact that the underlying income represents commission.

Sars would naturally not be aware of that, since the IRP5 certificate must be taken at face value, and therefore the onus rests upon employers to ensure that the correct earnings code is used.

Saica has also identified instances where an employee earns commission for part of a tax year, and salary for another part of the same tax year.  In this case, Section 23(m) should be applied only to that part of the tax year in which a salary was earned, and not to the entire tax year.

Other earnings not subject to Section 23(m)
Since Section 23(m) only applies to earnings falling within the definition of "remuneration", deductions may still be claimed against income falling outside of this definition.  This means that, for example, if a taxpayer who earns remuneration also receives income from a rental property, any expenses relating to such rental income that falls within the ambit of Section 11(a) can still be deducted.