1125. Independent contractors
October, 2003
The question of when a person is an employee for tax purposes as opposed to an independent contractor is one that continues to cause difficulties and conflict for taxpayers and especially employers. The reason, of course, is that employees’ tax is deductible from remuneration whereas payments to independent contractors are not subject to the deduction. It therefore suits both parties to treat a relationship as being that between independent provider and recipient respectively of a service.
SARS has issued several papers on the subject over the past decade, and has recently issued Interpretation Note No 17 which sets out its position and, after discussing the various tests at some length, provides a useful decision tree to guide taxpayers in determining the true nature of a relationship, as well as a test grid for use in arriving at a dominant impression. These are reproduced below with thanks to SARS.
The note identifies two tools that are available in determining whether a person is an independent contractor for employees’ tax purposes. The first tool is the statutory tests. These are conclusive in that, if a person is not an independent contractor in terms of their application, then that is the end of the matter. The second tool is the common law tests available for arriving at the conclusion. In respect of the latter there are no hard and fast rules in determining whether or not a person is an independent contractor. An "overall" or "dominant impression" of the employment relationship must be formed.
A constant theme of the note is that it is the responsibility of the employer to determine whether or not the payments are subject to employees’ tax. Save for the instance mentioned in the following paragraph, the decision is in the hands of the employer and not SARS, and in this regard it should be borne in mind that a wrong decision can be costly in terms of interest and penalties, not to mention the practical difficulty of recovering employees’ tax from an employee from whose remuneration employees’ tax ought to have been deducted.
SARS is statutorily required to determine status in this context only where a labour broker applies for an exemption certificate, and SARS must make a decision in terms of paragraph 2(5) of the Fourth Schedule (see paragraph (c) of "The Decision Process" below).
DefinitionsThree definitions in the Fourth Schedule to the Income Tax Act 58 of 1962 ("the Act") are central to this process: "employee", "remuneration" and "employer". The decision tree begins with the first of these and then uses the second in order to determine whether the third applies. If it does, employees’ tax is payable.
"employee" means, to the extent here relevant –
a) any person (other than a company) who receives any remuneration or to whom any remuneration accrues; b) any person who receives any remuneration or to who any remuneration accrues by reason of any services rendered by such person to or on behalf of a labour broker; c) any labour broker; d) [not relevant]; e) any personal service company; f) any personal service trust."remuneration" means, to the extent here relevant, any amount of income which is paid or is payable to any person by way of any salary, leave pay, allowance, wage, overtime pay, bonus, gratuity, commission, fee, emolument, pension, superannuation allowance, retiring allowance or stipend, whether in cash or otherwise and whether or not in respect of services rendered, including
a) any amount referred to in paragraph (a), (c), (cA), (d), (e), (eA) or (f) of the definition of "gross income" in section 1 of this Act [annuities; amounts for services rendered or to be rendered; restraint payments; termination payments; lump sums from funds; commutations of amounts due under contracts of employment]; b) any amount required to be included in such person’s gross income under paragraph (i) of that definition [fringe benefits]; bA) ………………………… c)but not including –
i) …………. ii) any amount paid or payable in respect of services rendered or to be rendered by any person (other than a person who is not a resident or an employee contemplated in paragraph (b), (c), (d), (e) or (f) of the definition of "employee") in the course of any trade carried on by him 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: Provided that for the purposes of this paragraph a person shall not be deemed to carry on a trade independently as aforesaid – aa) if he is subject to the control or supervision of any other person as to the manner in which his duties are performed or to be performed or as to his hours of work; or bb) if the amounts paid or payable for his services consist of or include earnings of any description which are payable at regular daily, weekly, monthly or other intervals; iii) …………. iv) any amount paid or payable to any employee wholly in reimbursement of expenditure actually incurred by such employee in the course of his employment;"employer" means, to the extent here relevant, any person (excluding any person not acting as a principal, but including any person acting in fiduciary capacity or in his capacity as a trustee in an insolvent estate, and executor or an administrator of a benefit fund, pension fund, provident fund, retirement annuity fund or any other fund) who pays or is liable to pay to any person any amount by way of remuneration.
The decision processThe first step in the process is to determine under which paragraph of the definition of "employee" the person falls. Then certain questions follow, depending on which paragraph applies. This process is graphically illustrated in the attached decision tree.
a) Is the person, other than a company, in receipt of any remuneration? If so, is the person a resident of South Africa for tax purposes? If no, employees’ tax is deductible. If yes, is the person under control or supervision (see below under "concepts") as envisaged by paragraph (ii)(aa) of the definition of "remuneration"? If yes, employees’ tax is deductible. If no, is the person in receipt of regular payments (see below under "concepts") as envisaged by paragraph (ii)(bb) of the definition of "remuneration"? If yes, employees’ tax is deductible. If no, apply the "dominant impression" test (see below under "concepts"). Is the dominant impression that of an independent contractor? If yes, no employees’ tax deductible. If no, employees’ tax is deductible. b) Is the person in receipt of any remuneration by reason of services rendered to or on behalf of a labour broker? If yes, employees’ tax is deductible. c) Is the person a labour broker? (See below under "concepts") If yes, is the person registered as such for employees’ tax purposes and are all returns up to date? If no, employees’ tax is deductible. If yes, are any of the following present: · more than 80% of gross income from one client or associated institution; · provides the services of any other labour broker; · contractually obliged to provide the services of a specified employee? If yes, employees’ tax is deductible. If no, apply the dominant impression test. Is the dominant impression that of an independent broker? If yes, employees’ tax is not deductible. If no, employees’ tax is deductible.e) & f) Is the person a personal service company or trust? (See below under "concepts")
If yes, is the person a labour broker as defined? If yes, apply the test in (c) above. If no, employees’ tax is deductible. ConceptsCommon law dominant impression test grid
The attached "Common Law Dominant Impression Test Grid" divides the categories of factors to be considered into three main groups in descending order of importance:
Near conclusive:
these factors indicate the extent to which the employer is able to control the manner in which the person carries out the service, and the extent to which the employer enjoys exclusive acquisition of the services of the person.
Persuasive:
these factors indicate the extent of control in respect of issuing instructions, demanding reports, carrying out training, and determining productive time.
Relevant:
these are factors whose presence is resonant of control and supervision.
Control or supervision
There are numerous factors that may indicate whether or not a control or supervision situation is present. They comprise most of the Grid, but it must be remembered that none is definitive.
Near conclusive:
· employer may instruct as to tools, staff, raw materials, routines; · a particular person must render the service; · the person must be present, whether or not there is work to do; · the person is bound to an exclusive relationship with the employer; · the person bears no risk for poor workmanship, price increases, time over-runs.Persuasive
· employer may instruct as to location, order of work, which work when; · the person must submit reports; · the person undergoes training by or at the behest of the employer; · employer sets the work hours, which may be full time.Relevant
· employer provides materials; · employer provides office, secretarial or administrative support; · the person normally uses the premises of the employer; · the person’s services are integral to the business operations; · the person has a job description in the hierarchy of the business; · the duration is open-ended; · employer may dismiss on notice; · employer invests in the activities of the person; · the person enjoys any employment benefits, especially loyalty rewards; · employer bears overheads.It is evident that there is no simple solution to the question of whether or not the employer exercises control and supervision over the person. Each of the indicators mentioned above contributes to establishing the overall impression, and the weight of any particular indicator will depend on the circumstances.
Regular paymentsThis concept has caused considerable confusion and uncertainty, because there are many situations where an independent contractor receives regular payments and yet can by no means be described as an employee. Examples such as auditors keeping the books of small enterprises, gardening services, and legal retainers come to mind. When the person receives regular payments, the onus of showing independence increases, and the control and supervision criteria obviously become very important; but regular payments do not of themselves condemn a relationship to the status of employer and employee. At the same time, the absence of regular payments does not of itself determine that the relationship is not one of employment.
It is significant that regular payment is found on the grid only in the "near conclusive" category, indicating its importance. If the payments are made at regular intervals or by a rate per time period and regardless of output or result, this is a strong indicator of employment status. On the other hand, if they are made with reference to results, or output, during the period, there is more chance of showing an independent relationship. This reflects again the difference between providing time and providing results. An employer cannot withhold remuneration in response to poor performance, but must instead have recourse to increased control or dismissal. In an independent situation, the employer can withhold payment or refuse to accept the results of the work done.
Labour brokerThis term is defined in the Fourth Schedule as being any person who carries on the business, for reward, of providing clients with persons to render services or perform work. If a labour broker is in possession of an exemption certificate (IRP 30), it means that SARS is satisfied that the broker is carrying on an independent business. In general terms, this is an entrepreneurial enterprise with sufficient independence to survive the termination of a relationship with a client.
Personal service company or trustThis is a company (or trust as the case may be) that is not a labour broker, and whose services to clients are performed on its behalf by a connected person;
· and such person would be regarded as an employee of the client if the relationship was directly between the person and the client; or · the person fails the control and supervision test; or · the person fails the regular payments test; or · more than 80% of the income of the company/trust from services rendered is directly or indirectly from the client;except where the company/trust throughout the year employs more than three full-time employees who are:
· engaged full-time in rendering the services; and · are not shareholders or members in the case of a company; and · who are not connected persons in relation to the entity or its members or shareholders as the case may be. ConclusionIn this area of uncertainty and confusion in tax law, a systematic approach can assist in arriving at a reasoned decision, and for this reason alone the Interpretation Note is welcome, despite the fact that it still burdens the employer with an often difficult and always risky decision.
Deneys Reitz
IT Act:Interpretation Note 17 (28 March 2003)
