Distinguishing independent contractors from employees in South Africa – and why it matters Distinguishing independent contractors from employees in South Africa – and why it matters

Distinguishing independent contractors from employees in South Africa – and why it matters
21 Dec 2017

Whether someone is an independent contractor or an employee for payroll purposes is often a highly debated topic, especially in the course of audit work conducted by Revenue authorities around the globe. So why does it matter? How is this contentious issue dealt with in South Africa and what factors do payroll managers - and anyone else tasked with ensuring that payroll complies with legislation – need to consider here?

What is the difference between an employee and independent contractor?

In South Africa, someone who is deemed to be an employee has their earnings subjected to PAYE. According to Section 23 (m) of the Income Tax Act, employees can only claim very limited expenditure as a deduction from income earned.

But if workers are classified as independent contractors, there are no limitations on the deduction of expenses that can be made against income earned - as long as those expenses are incurred in producing income. PAYE does not necessarily need to be deducted. As a result, contractors generally prefer to be classified as “independent contractors” rather than employees.

Determining employment status is a responsibility placed on employers by the South African Revenue Services (SARS) in relation to the fourth schedule of the Income Tax Act. There are two sets of tests that they need to review in order to arrive at a decision on the question of whether someone is an employee or an independent contractor. These are the statutory test and the common law test.

Statutory test

Someone will not be viewed as an independent contractor if:

• their duties or the service they provide must be performed mainly at the client’s premises and
• they are subject to the control of any other person as to how their duties must be performed and/or the hours they must work or
• the person is subject to supervision by any other person as to how their duties must be performed and/or the hours they must work.

If the test is positive – that is, the worker is required to perform their duties at the client’s premises under the control or supervision of the client (or employee of the client) – they are deemed not to be an independent contractor for the purposes of the Fourth Schedule. This means that PAYE will be deducted from the amount paid to them.

But there is also an “escape clause”. The statutory test will be negative if an independent contractor employs three or more full-time employees who are not connected to him/her and who are engaged in his/her business.

What practical steps should an employer take to administer the test?

Step 1: Ask the question - Does the individual employ three or more full-time unconnected persons throughout the year of assessment?

Common law test

In South Africa, the common law test currently used for determining the status of workers is the “dominant impression test”. Forming the basis of the test, which is fundamentally an analytical tool, are several indicators, each with a different significance or weighting.

There are “near-conclusive indicators”, which are used to provide “insight into the quality of control, the nature of financial relations and the degree of exclusivity of the relationship” (SARS INTERPRETATION NOTE: NO. 17 (ISSUE 3). The indicators are dealt with in length in Interpretation Note 17).

A second category is referred to as “persuasive indicators”. This category examines the “degree or extent of behavioural control, as well as the purpose of acquiring control” (SARS INTERPRETATION NOTE: NO. 17 (ISSUE 3).

Near-conclusive indicators

These indicators include items such as reviewing who controls the manner of working; what the payment regime is; what the nature of the obligation to work is, and who bears the risk of profit or loss.

So in the case of the last indicator, because in most instances employers bear the risk of making a profit or loss, if the worker bears no such risk, they are likely to be an employee. But if they do bear the risk for time over-runs, price hikes or bad workmanship, it would suggest independent contractor status.

As an example, if you hire a decorator to paint your home, they are generally contracted at a flat fee to supply the paint and materials necessary to complete the job. If they spend more time on it or use more paint than expected, the cost is borne by them. This situation would suggest that, under the terms of this arrangement, the decorator is an independent contractor.

Persuasive indicators
The indicators used to evaluate how much control employers have over their workers include examining their productive time (work hours) and evaluating who controls how long they work. So if, for example, the hours are set and the individual needs to work certain hours, it would suggest employee status.

But if they have sole discretion as to when they work, it would suggest independent contractor status. Examining who the person reports to; whether training is provided as to the employer’s favoured means of completing a task, and whether instructions have been provided on the sequence of work to be carried out are all further examples of persuasive indicators (For more, Interpretation Note Number 17 is an excellent resource).

What can employers do to limit risk if SARS disagrees with their assessment?
Employers need to be able to prove to SARS that they have “applied their minds” to the decision reached. Therefore, it is highly recommended that employers devise some sort of flowchart or proof of the process followed to arrive at their chosen categorisation.

A further possible step is to get the worker concerned to sign a disclosure document certifying that they employ three or more full-time employees who are not connected but are engaged in their business. Doing so would mean the escape clause in the statutory test could be applied.

But most employers also elect to deduct PAYE and issue an IRP5 tax certificate, which identifies payment as “independent contractor earnings”. Remember that independent contractors do not need to have PAYE deducted from their earnings.

Deducting PAYE each month, however, reduces the potential financial impact that any decision by SARS to reclassify a worker as an employee rather than independent contactor could have. In this instance, SARS recovers any PAYE shortfall directly from the employer, while the employer is left attempting to recover the money owed by the contractor.

 

After graduating with a degree majoring in taxation, accounting and managerial accounts and finance, Sharon gained considerable experience in the fields of training, tax issues and financial ICT management, including mergers and acquisitions. She progressed to a position within South African Revenue Services before moving on to Anglo American Property Services, where she became group financial director with responsibility for ICT and payroll. Sharon joined Praxima Payroll Systems in 2001 and steered the company through the development of its own software. It is now a provider of payroll services to some of the largest legal practices in South Africa. She has since moved to Celergo to take up the role of head of operations UK. She has overseen the rightsizing of its operations and the refining of its payroll processes to improve productivity. Share was asked to take on the COO role at Praxima Holdings in 2013 and has helped the company extend its footprint into Africa and beyond. She is a registered tax practitioner and member of CIPP and GPA.

Whether someone is an independent contractor or an employee for payroll purposes is often a highly debated topic, especially in the course of audit work conducted by Revenue authorities around the globe. So why does it matter? How is this contentious issue dealt with in South Africa and what factors do payroll managers - and anyone else tasked with ensuring that payroll complies with legislation – need to consider here?

What is the difference between an employee and independent contractor?

In South Africa, someone who is deemed to be an employee has their earnings subjected to PAYE. According to Section 23 (m) of the Income Tax Act, employees can only claim very limited expenditure as a deduction from income earned.

But if workers are classified as independent contractors, there are no limitations on the deduction of expenses that can be made against income earned - as long as those expenses are incurred in producing income. PAYE does not necessarily need to be deducted. As a result, contractors generally prefer to be classified as “independent contractors” rather than employees.

Determining employment status is a responsibility placed on employers by the South African Revenue Services (SARS) in relation to the fourth schedule of the Income Tax Act. There are two sets of tests that they need to review in order to arrive at a decision on the question of whether someone is an employee or an independent contractor. These are the statutory test and the common law test.

Statutory test

Someone will not be viewed as an independent contractor if:

• their duties or the service they provide must be performed mainly at the client’s premises and
• they are subject to the control of any other person as to how their duties must be performed and/or the hours they must work or
• the person is subject to supervision by any other person as to how their duties must be performed and/or the hours they must work.

If the test is positive – that is, the worker is required to perform their duties at the client’s premises under the control or supervision of the client (or employee of the client) – they are deemed not to be an independent contractor for the purposes of the Fourth Schedule. This means that PAYE will be deducted from the amount paid to them.

But there is also an “escape clause”. The statutory test will be negative if an independent contractor employs three or more full-time employees who are not connected to him/her and who are engaged in his/her business.

What practical steps should an employer take to administer the test?

Step 1: Ask the question - Does the individual employ three or more full-time unconnected persons throughout the year of assessment?

Common law test

In South Africa, the common law test currently used for determining the status of workers is the “dominant impression test”. Forming the basis of the test, which is fundamentally an analytical tool, are several indicators, each with a different significance or weighting.

There are “near-conclusive indicators”, which are used to provide “insight into the quality of control, the nature of financial relations and the degree of exclusivity of the relationship” (SARS INTERPRETATION NOTE: NO. 17 (ISSUE 3). The indicators are dealt with in length in Interpretation Note 17).

A second category is referred to as “persuasive indicators”. This category examines the “degree or extent of behavioural control, as well as the purpose of acquiring control” (SARS INTERPRETATION NOTE: NO. 17 (ISSUE 3).

Near-conclusive indicators

These indicators include items such as reviewing who controls the manner of working; what the payment regime is; what the nature of the obligation to work is, and who bears the risk of profit or loss.

So in the case of the last indicator, because in most instances employers bear the risk of making a profit or loss, if the worker bears no such risk, they are likely to be an employee. But if they do bear the risk for time over-runs, price hikes or bad workmanship, it would suggest independent contractor status.

As an example, if you hire a decorator to paint your home, they are generally contracted at a flat fee to supply the paint and materials necessary to complete the job. If they spend more time on it or use more paint than expected, the cost is borne by them. This situation would suggest that, under the terms of this arrangement, the decorator is an independent contractor.

Persuasive indicators
The indicators used to evaluate how much control employers have over their workers include examining their productive time (work hours) and evaluating who controls how long they work. So if, for example, the hours are set and the individual needs to work certain hours, it would suggest employee status.

But if they have sole discretion as to when they work, it would suggest independent contractor status. Examining who the person reports to; whether training is provided as to the employer’s favoured means of completing a task, and whether instructions have been provided on the sequence of work to be carried out are all further examples of persuasive indicators (For more, Interpretation Note Number 17 is an excellent resource).

What can employers do to limit risk if SARS disagrees with their assessment?
Employers need to be able to prove to SARS that they have “applied their minds” to the decision reached. Therefore, it is highly recommended that employers devise some sort of flowchart or proof of the process followed to arrive at their chosen categorisation.

A further possible step is to get the worker concerned to sign a disclosure document certifying that they employ three or more full-time employees who are not connected but are engaged in their business. Doing so would mean the escape clause in the statutory test could be applied.

But most employers also elect to deduct PAYE and issue an IRP5 tax certificate, which identifies payment as “independent contractor earnings”. Remember that independent contractors do not need to have PAYE deducted from their earnings.

Deducting PAYE each month, however, reduces the potential financial impact that any decision by SARS to reclassify a worker as an employee rather than independent contactor could have. In this instance, SARS recovers any PAYE shortfall directly from the employer, while the employer is left attempting to recover the money owed by the contractor.

 

After graduating with a degree majoring in taxation, accounting and managerial accounts and finance, Sharon gained considerable experience in the fields of training, tax issues and financial ICT management, including mergers and acquisitions. She progressed to a position within South African Revenue Services before moving on to Anglo American Property Services, where she became group financial director with responsibility for ICT and payroll. Sharon joined Praxima Payroll Systems in 2001 and steered the company through the development of its own software. It is now a provider of payroll services to some of the largest legal practices in South Africa. She has since moved to Celergo to take up the role of head of operations UK. She has overseen the rightsizing of its operations and the refining of its payroll processes to improve productivity. Share was asked to take on the COO role at Praxima Holdings in 2013 and has helped the company extend its footprint into Africa and beyond. She is a registered tax practitioner and member of CIPP and GPA.

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