Tax treatment of labour brokers and personal service companies

Labour brokers and personal service providers are regarded as deemed employees.

The use of labels such as “independent contractor” and “service company” and the perception that they are acceptable means of avoiding the deduction of employees’ tax and compliance with labour legislation, necessitated the development of stronger anti-avoidance measures for employees’ tax purposes.

For years of assessment commencing on or after 1 March 2009:
• A labour broker means any natural person who conducts or carries on any business  whereby such person for reward provides a client of such business with other persons to  render a service or perform work for such client, or procures such other persons for the client,  for which services or work such other persons are remunerated by such person;
• A personal service provider is a company, close corporation or trust where any service rendered on behalf of the entity to its client is rendered personally by any person who is a connected person in relation to such entity, and one of the following provisions apply:
– the person would have been regarded as an employee of the client, if the service was not rendered through an entity; or
– the person or entity rendering the service must perform such service mainly at the premises of the client and such person or entity is subject to the control or supervision of such client as to the manner in which the duties are performed; or
– more than 80% of the income derived from services rendered is received from one client or associated person in relation to the client
• The entity will, however, not be regarded as a personal service provider where such entity employs three or more unconnected full-time employees for core operations throughout the year of assessment.

Tax Implications
• A labour broker not in possession of an exemption certificate is subject to PAYE on income received at the rates applicable to individual taxpayers. Deductible expenditure is limited to remuneration paid to employees
• A personal service provider is subject to PAYE at the rate of 28% (2012 : 33%) in the case of a company and 40% in the case of a trust
• No PAYE is required to be deducted where the entity provides an affidavit confirming that it does not receive more than 80% of its income from one source
• The deemed employee may apply to SARS for a tax directive for a lower rate of tax to be applied
• Deductions available to personal service providers are limited to remuneration to employees, contributions to pension, provident and benefit funds, legal expenses, bad debts, expenses in respect of premises, finance charges, insurance, repairs, fuel and maintenance in respect of assets used wholly and exclusively for trade and any
amount previously included in taxable income and subsequently refunded by the recipient.

Interpretation of the law
The deduction of employees’ tax is dependent on three elements, namely, an employer, an employee and the payment of remuneration. All three elements are defined in the Fourth Schedule. Employees’ tax cannot be charged where one or more of these three elements are not present. If, for example, an “employee” is removed from the equation, the person paying the remuneration has no responsibility to deduct employees’ tax. Similarly, if the term “remuneration” is removed from the equation, no employees’ tax liability arises. If remuneration is therefore paid to somebody who is not an “employee” as defined in the Fourth Schedule, or if something other than “remuneration” is paid to somebody, no employees’ tax needs to be deducted.

Previously it was a popular tax-saving method for employees to offer their services to their employers through the medium of private companies, close corporations or trusts. In order to discourage the use of corporate entities or trusts as intermediaries to provide personal services to a client which are, in essence, services provided in
terms of a contract of employment, legislation was introduced that required remuneration payable to such a company, close corporation or trust by the client be subject to employees’ tax and which limited the available deductions from income in the determination of taxable income for these entities.

Common misconceptions about the law
One of the areas that is typically misinterpreted is the relationship between the definition of an “employment company” in section 12E(4)(b) and the definition of a “personal service” in the section 12E(4)(d) on the one hand, and the definition of a “personal service provider” in the Fourth Schedule on the other. In this regard, it is
important to note that the definitions of “employment company” and “personal service” were not created for purposes of determining whether or not a company or trust is a “personal service provider”. For example, a company is not a “personal service provider” because it provides a “personal service”, but because it complies with the definition of a “personal service provider” in the Fourth Schedule.

The term “personal service provider” is only applicable to a “company” and “trust” as defined in section 1. This means that the term is not applicable to a natural person. The effect of the new legislation can therefore be eliminated by rendering the service through a natural person directly to the client. By rendering the services directly as a natural person, the normal rules relating to the status of an independent contractor or common law employee as explained in previous guidelines issued by SARS become relevant.

Not all companies are affected by the legislation relating to personal service providers. Only companies that fall within the definition of a “personal service provider” are affected by the definition, and also only when those that fall within the definition are in receipt of “remuneration”, as defined.

It is recommended that all users of services (employer/client) from potential labour brokers and personal service providers should have policies and systems in place to correctly identify and withhold tax from these entities and individuals. A possible solution would be a questionnaire or an affidavit (including an affidavit or solemn
declaration for a personal service provider indicating that not more than 80% of its income is derived or is likely to be derived from one client) that could be used by the service-user at the start of the engagement or contract and regularly thereafter. This will enable the client to determine whether employees’ tax should be deducted or not.

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Labour brokers and personal service providers.