Sage HR & Payroll Newsroom

Independent contractors versus employees: What are the tax implications?

29 September 2017

By Yolandi Esterhuizen, Compliance Manager at Sage

For many South African companies, the line between an employee and an independent contractor remains somewhat unclear. That is one of the impressions I got from the 2017 Tax Indaba, where I was part of a panel discussion titled: Independent Contractors Versus Employees: What's the Deal?

Use of independent contractors is on the rise in South Africa and the rest of world as companies seek to optimise workforce performance and as many employees seek more flexible working arrangements. In some cases, employers aim to reduce workforce costs such as paid leave and other benefits, or to gain more flexibility to dismiss workers when they're no longer needed.

In other instances, it's a way to exclude white male members of the workforce from the employee count for employment equity reports. And just as often, workers will ask to be employed as contractors so that they can better manage their tax affairs and enjoy the freedom of working for themselves.

However, companies that make extensive use of independent contractors need to be careful that they are abiding by South Africa's tax and labour laws. Employers need to distinguish between employees and independent contractors for tax and labour purposes. Non-compliance in the labour and/or tax law spheres has serious implications.

If an individual is seen as independent in terms of our labour laws, it means that he or she will not be entitled to the benefits and protection specified in labour legislation. If an individual is independent according to the income tax act, it means that the employer must not withhold PAYE (Pay-As-You-Earn) each month. In this article, I'll be focusing on the classification of an independent contractor for PAYE purposes and the related risk of incorrectly doing so.

Who pays the tax?

One major non-compliance risk lies in failing to withhold PAYE for individuals who are not independent workers. The responsibility of deducting and paying PAYE resides with the employer. So, how do you know if a contractor will be regarded as an employee? There are two sets of tools available - the statutory test and the common law dominant impression test.

The statutory test is conclusive and consists of the following questions:

  • Are the services or duties required to be performed mainly at the premises of the client?
  • Is the manner in which the duties are performed or the hours of work subject to supervision or control of the client?

If the answer to both these questions is yes, the individual will be seen as an employee for PAYE purposes (subject to certain exceptions) and the employer must withhold PAYE.

No simple checklist

If the statutory test does not apply, the employer must still apply the common law dominant impression test to determine whether PAYE needs to be withheld or not. This is not a simple checklist and consists of a range of questions that need to be asked to determine whether an employment relationship exists. Just a few examples of these questions are:

  • Is the person bound to an exclusive relationship with one employer?
  • Is he /she eligible for benefits?
  • Does the employee receive training from the company?
  • Is the person obliged to be present even if there is no work to be done?
  • Is the person obliged to render the service personally or can he/she subcontract? Are the working hours controlled or set by the client?

SARS confirms in interpretation note 17: "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". It is also important to note that only natural persons who are South African residents can be seen as independent contractors.

If you are unsure of the status of any member of your workforce, it is best to seek expert advice. However, the bottom line is that you cannot assume that SARS will not regard someone as an employee simply because he /she issues you with an invoice.

There are many good business reasons to use contractors, but they are not a simple way to escape tax and labour law compliance requirements, or to reduce the costs of employing someone. It's best to ensure that you are aligned with the law to avoid legal and financial risks down the line.