In today's business environment companies often use the services of people on a contractual basis. Whether to tax these people and, if so, how much, is often a confusing question, and it is vital that you, as the employer, get it right.
If you don't get it right, you will have to pay a 10 percent penalty for the employees' tax you should have withheld and interest at 15 percent from the date it should have been paid to the SA Revenue Services (SARS). Because the interest is not deductible for tax purposes its real cost is higher than your business borrowing costs, as it represents, for a CC or company, the equivalent of a pre-tax rate of 23 percent of tax deductible interest.
These amounts are in addition to the tax that should have been paid and which you may not be able to recover from the contractor.
To establish whether you should be deducting employees' tax from the payments you are making to the contractor, you need not deduct any employees' tax and, unless the contractor is a labour broker, that is the end of your obligations, insofar as tax is concerned, to that person.
If the contractor is a labour broker, ie a person supplying you with staff to use as if they were your own, but you pay the labour broker rather than the staff then, unless they provide you with a labour broker exemption certificate issued by SARS, you will need to deduct tax in terms of the employees' tax tables or at 35 percent if the labour broker is a company or CC.
The income tax legislation contains special rules regarding whether a person is independent for employees' tax purposes. They state that workers will not be regarded as independent if they are subject to your supervision over how their duties are to be performed or hours of work, or if the amounts you pay to them comprise earnings paid at regular daily, weekly, monthly or any other intervals.
For this latter provision to apply, the contractor would be entitled to regular earnings. If no work is performed for a month or so, and no amount is payable even if you are normally billed on a monthly basis, then the contractor is probably independent.
Other signs of independence are the contractor is entitled to work for anyone else, and does not receive any of the normal employment benefits like medical or retirement benefits and leave pay.
If you are not sure whether contractors are independent you can ask them to give you a directive from SARS indicating that they are independent.
If contractors are not independent they will be classified as employees and you will be obliged to deduct employees' tax. The contractor may believe that, due to the various expenses incurred to earn the income from you, which may be tax deductible, the tax you must deduct will exceed the final amount of tax that they will be liable for. In this instance they can approach SARS for a directive instructing you to deduct the tax at a lower rate than the tables or 35 percent. With such a directive you are able to deduct tax at the rate set out in the directive without fear of being penalised. The directive must be renewed each tax year.
If the contractor is an individual, and you must tax him as an employee, you may be able to structure the amount you pay him as a package, ie partly as cash, partly as fringe benefits. This might result in the contractor's overall tax burden being reduced. I will cover this aspect in next week's article.