For payroll purposes, it is important to know whether an individual is classified as an independent contractor/self-employed or an employee. But getting it right can be a tricky and controversial topic, especially during the course of audit work by a revenue authority.
So why is making a distinction between these different employment categories so important, and what factors do payroll managers need to consider when trying to do so? Here we compare the differing approaches of South Africa and the UK in a bid to clarify the situation:
Definition of employee, independent contractor/self-employed worker
In most countries around the world, anyone who is defined as an employee will have their earnings subjected to Pay As You Earn (PAYE) or some other form of withholding tax at source.
In South Africa, according to Section 23(m) of the Income Tax Act, employees are only entitled to claim very limited expenditure as a deduction from the income they earn. This means that the categorisation assigned by their employer at the time of processing payroll is critical.
If an individual is classified as an independent contractor/self-employed, there are no limits on what level of expenses may be deducted from their income, as long as the expenses are incurred during the process of generating that income. PAYE does not necessarily need to be deducted. Therefore, contractors generally prefer to be classified as an “independent contractor (self-employed)” rather than an employee.
In the UK, on the other hand, Her Majesty’s Revenue and Customs (HMRC) may regard someone as self-employed for tax purposes regardless of their status in employment law.
But the obligation falls to employers to actually establish if a worker is self-employed in tax law, and if they are exempt from PAYE. Employers are also required to determine the worker’s status in employment law to see whether they are entitled to employment rights.
If employers get an individual’s employment status wrong, HMRC may call upon them to pay unpaid taxes and penalties.
In both countries, determining employment status is a responsibility that is placed on employers by the local tax authorities.
South Africa
In South Africa though, there are two sets of tests that can be used to assist you in deciding whether someone is an employee or independent contractor: A statutory test and a common law test.
- Statutory test
A person will not be viewed as an independent contractor if:
- Their service or duties must be performed mainly on their client’s premises; and
- They are subject to the control of another individual relating to how their duties must be performed and/or what hours are worked; or
- They are subject to the supervision of any other person relating to how their duties must be performed and/or what hours are worked.
If the test is positive – that is, if an individual is required to perform their duties at their client’s premises, under the control or supervision of that client (or one of their employees) - the worker is not considered to be an independent contractor for the purposes of the Fourth Schedule. As a result, PAYE will be deducted from their earnings.
But it is worth noting that there is an “escape clause” in relation to this statutory test. The test will prove negative if an independent contractor employs three or more full-time employees with whom they are not connected but who work for their business.
- Common law test
In South Africa, the common law test used for determining a worker’s status is the ‘dominant impression test’. The test, which is essentially an analytics tool, is based on several indicators, each of which have different significance or weightings.
‘Near-conclusive indicators’ are used to provide “insight into the quality of control, the nature of financial relations and the degree of exclusivity of the relationship”, according to the South African Revenue Authority’s (SARS) Interpretation Note: No 17 (Issue 3). Note No 17 deals at length with these indicators and is an excellent resource that provides examples to guide employers through the decision-making process.
A second grouping consists of ‘persuasive indicators’. According to SARS Interpretation Note: No 17 (Issue 3) again: “This category examines the degree or extent of behavioural control, as well as the purpose of acquiring control”.
UK
- Tax law: Employee status test
HMRC has provided employers with guidance on determining whether someone is self-employed and is not, therefore, subject to PAYE. Employers are required to consider the following questions and, if most of the answers are positive, the likelihood is that the worker concerned should be classified as self-employed:
- Is the individual in business for themselves? Are they responsible for the success or failure of their business? Do they ‘own’ the profit or loss made by the operation?
- Can they decide what work to do as well as when, where or how to do it?
- Can they hire someone else to do the work (substitution test)?
- Are they responsible for sorting out any unsatisfactory work in their own time?
- Does their employer agree a fixed price for their work irrespective of how long the job takes to finish?
- Do they use their own money to purchase business assets, cover running costs and provide tools and equipment for work?
- Are they in a position to work for more than one client?
HMRC provides an online employment status checker tool, which can be used to help you reach an appropriate decision.
2. Employment law: Employee status test
In the UK, an employee is defined as someone who works under an employment contract. In order to determine whether someone is self-employed and, therefore, is not entitled to employment rights, the questions below should be used as a guide.
If someone has already been classified as exempt from PAYE by using the Tax Law Employee status check above, and most of the following questions are answered in the affirmative, the individual is likely to be self-employed:
- Do they put in bids or provide quotes to obtain work?
- Are they under no direct supervision when working?
- Do they submit invoices for work once it has been completed?
- Are they responsible for paying their own National Insurance and tax?
- Do they receive no holiday or sick pay when not working?
- Do they operate under a contract (sometimes known as a ‘contract for services’ or ‘consultancy agreement’) that uses terms such as ‘self-employed’, ‘consultant’ or ‘independent contractor’?
What can be done to limit risk in both South Africa and the UK if your conclusions on employment status differ from those of the local revenue authorities?
Employers should ensure they can prove to the authorities that they have ‘applied their minds’ to the decision reached. Therefore, it is highly recommended that you create some sort of flowchart or proof of the process that was followed in order to decide on an appropriate worker categorisation.
In South Africa, it is also important to have individuals sign a disclosure form certifying that they employ three or more full-time employees who are not connected with them but who do work for their business. Doing so will enable you to apply the escape clause in the statutory test, if necessary.
Sharon Tayfield is a senior manager, with extensive experience in global outsourcing and a special interest in payroll. She has undertaken senior management roles at a range of multinational companies, including a wholly-owned subsidiary of Anglo America where she was financial director. Prior to her current role, Sharon was chief operating officer for a payroll service company specialising in outsourced services to Africa and the UK.
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For payroll purposes, it is important to know whether an individual is classified as an independent contractor/self-employed or an employee. But getting it right can be a tricky and controversial topic, especially during the course of audit work by a revenue authority.
So why is making a distinction between these different employment categories so important, and what factors do payroll managers need to consider when trying to do so? Here we compare the differing approaches of South Africa and the UK in a bid to clarify the situation:
Definition of employee, independent contractor/self-employed worker
In most countries around the world, anyone who is defined as an employee will have their earnings subjected to Pay As You Earn (PAYE) or some other form of withholding tax at source.
In South Africa, according to Section 23(m) of the Income Tax Act, employees are only entitled to claim very limited expenditure as a deduction from the income they earn. This means that the categorisation assigned by their employer at the time of processing payroll is critical.
If an individual is classified as an independent contractor/self-employed, there are no limits on what level of expenses may be deducted from their income, as long as the expenses are incurred during the process of generating that income. PAYE does not necessarily need to be deducted. Therefore, contractors generally prefer to be classified as an “independent contractor (self-employed)” rather than an employee.
In the UK, on the other hand, Her Majesty’s Revenue and Customs (HMRC) may regard someone as self-employed for tax purposes regardless of their status in employment law.
But the obligation falls to employers to actually establish if a worker is self-employed in tax law, and if they are exempt from PAYE. Employers are also required to determine the worker’s status in employment law to see whether they are entitled to employment rights.
If employers get an individual’s employment status wrong, HMRC may call upon them to pay unpaid taxes and penalties.
In both countries, determining employment status is a responsibility that is placed on employers by the local tax authorities.
South Africa
In South Africa though, there are two sets of tests that can be used to assist you in deciding whether someone is an employee or independent contractor: A statutory test and a common law test.
- Statutory test
A person will not be viewed as an independent contractor if:
- Their service or duties must be performed mainly on their client’s premises; and
- They are subject to the control of another individual relating to how their duties must be performed and/or what hours are worked; or
- They are subject to the supervision of any other person relating to how their duties must be performed and/or what hours are worked.
If the test is positive – that is, if an individual is required to perform their duties at their client’s premises, under the control or supervision of that client (or one of their employees) - the worker is not considered to be an independent contractor for the purposes of the Fourth Schedule. As a result, PAYE will be deducted from their earnings.
But it is worth noting that there is an “escape clause” in relation to this statutory test. The test will prove negative if an independent contractor employs three or more full-time employees with whom they are not connected but who work for their business.
- Common law test
In South Africa, the common law test used for determining a worker’s status is the ‘dominant impression test’. The test, which is essentially an analytics tool, is based on several indicators, each of which have different significance or weightings.
‘Near-conclusive indicators’ are used to provide “insight into the quality of control, the nature of financial relations and the degree of exclusivity of the relationship”, according to the South African Revenue Authority’s (SARS) Interpretation Note: No 17 (Issue 3). Note No 17 deals at length with these indicators and is an excellent resource that provides examples to guide employers through the decision-making process.
A second grouping consists of ‘persuasive indicators’. According to SARS Interpretation Note: No 17 (Issue 3) again: “This category examines the degree or extent of behavioural control, as well as the purpose of acquiring control”.
UK
- Tax law: Employee status test
HMRC has provided employers with guidance on determining whether someone is self-employed and is not, therefore, subject to PAYE. Employers are required to consider the following questions and, if most of the answers are positive, the likelihood is that the worker concerned should be classified as self-employed:
- Is the individual in business for themselves? Are they responsible for the success or failure of their business? Do they ‘own’ the profit or loss made by the operation?
- Can they decide what work to do as well as when, where or how to do it?
- Can they hire someone else to do the work (substitution test)?
- Are they responsible for sorting out any unsatisfactory work in their own time?
- Does their employer agree a fixed price for their work irrespective of how long the job takes to finish?
- Do they use their own money to purchase business assets, cover running costs and provide tools and equipment for work?
- Are they in a position to work for more than one client?
HMRC provides an online employment status checker tool, which can be used to help you reach an appropriate decision.
2. Employment law: Employee status test
In the UK, an employee is defined as someone who works under an employment contract. In order to determine whether someone is self-employed and, therefore, is not entitled to employment rights, the questions below should be used as a guide.
If someone has already been classified as exempt from PAYE by using the Tax Law Employee status check above, and most of the following questions are answered in the affirmative, the individual is likely to be self-employed:
- Do they put in bids or provide quotes to obtain work?
- Are they under no direct supervision when working?
- Do they submit invoices for work once it has been completed?
- Are they responsible for paying their own National Insurance and tax?
- Do they receive no holiday or sick pay when not working?
- Do they operate under a contract (sometimes known as a ‘contract for services’ or ‘consultancy agreement’) that uses terms such as ‘self-employed’, ‘consultant’ or ‘independent contractor’?
What can be done to limit risk in both South Africa and the UK if your conclusions on employment status differ from those of the local revenue authorities?
Employers should ensure they can prove to the authorities that they have ‘applied their minds’ to the decision reached. Therefore, it is highly recommended that you create some sort of flowchart or proof of the process that was followed in order to decide on an appropriate worker categorisation.
In South Africa, it is also important to have individuals sign a disclosure form certifying that they employ three or more full-time employees who are not connected with them but who do work for their business. Doing so will enable you to apply the escape clause in the statutory test, if necessary.
Sharon Tayfield is a senior manager, with extensive experience in global outsourcing and a special interest in payroll. She has undertaken senior management roles at a range of multinational companies, including a wholly-owned subsidiary of Anglo America where she was financial director. Prior to her current role, Sharon was chief operating officer for a payroll service company specialising in outsourced services to Africa and the UK.
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