The move to a much greater level of remote working this year has reinforced the need for small businesses to ensure that they classify the people that work for them correctly. One of the biggest challenges for small businesses is to ensure that independent contractors, especially sole proprietors, do not drift into a position where the South African Revenue Service or the Department of Labour would classify such a person as an employee. The failure by a small company to manage the relationships with their independent contractors can lead to great costs for the company if the authorities find that the relationship with any of them is an employment relationship and the firm then needs to rectify the situation.
The prevalence of remote working since the start of the national lockdown in March has brought to the fore the need to distinguish between an employee and an independent contractor.
This topic has both labour and tax law implications.
Anli Bezuidenhout, a Cliffe Dekker Hofmeyr employment lawyer, said during an interview that a situation could arise where an independent contractor started working for a company, but ended up operating as an employee.
“It is important that both parties manage the relationship because the lines get blurred. Companies need to classify people correctly and manage the relationship properly,” she said.
Tertius Troost, a Mazars tax manager, said during an interview that small businesses could avoid an administrative burden if they dealt with an employee as an independent contractor.
“Small businesses battle with Pay-As-You-Earn (PAYE) tax, especially with complicated employee fringe benefits,” Troost added.
Having an employee defined as an independent contractor means that the employer would not need to pay the person either annual or sick leave or overtime pay, nor would the employer be required to make pension or medical aid scheme contributions.
In addition, an independent contractor cannot enforce a claim against the company for unfair dismissal, nor hold the employer to any of the many other employee rights provided by our labour laws.
The company would also not need to contribute on behalf of the contractor to the Skills Development Levy, Compensation Fund, and the Unemployment Insurance Fund.
Bezuidenhout said some companies like to have employees classified as independent contractors, because they then do not have to comply with the Labour Relations Act (LRA) and the Basic Conditions of Employment Act (BCEA).
Often employees agree (or pro-actively request) to be independent contractors in order to avoid PAYE and to make expense deductions against their business income.
Bezuidenhout said that individuals were often happy when companies classified them as independent contractors because that gave them flexibility.
However, the South African Revenue Service (SARS) and the Department of Labour look at the actual relationship between a company and those that work for it – it is a factual enquiry and an employer that incorrectly classified an employee as an independent contractor would be liable for the employee’s tax that the company should have deducted plus penalties and interest.
However, the employer could (at least in theory) recover the tax paid to SARS from the employee.
How tax law defines an employee versus an independent contractor
SARS requires a company to withhold employees’ tax when three elements are present, namely an employer, the payment of remuneration and an employee.
SARS also provides two tests to determine whether a person is to be regarded as an independent contractor for employees’ tax purposes.
If an employee meets both parts of the first test, then the person is an employee and any earnings paid to that employee will be subject to employees’ tax.
The first part of this test is that the employee performs over 50% of the services or duties at the client’s premises.
The second part of the test is whether any person controls the employee or his or her work hours.
The second test determines whether a contractor is trading independently.
Where an independent contractor rendered services to more than one client, then the contractor needed to apply these tests in respect of each client to assess whether the contractor was an employee at each engagement.
Another test is the common law “dominant impression test” that SARS applies to determine whether an employee is an independent contractor or an employee.
How to apply the common law “dominant impression” test
The “common law dominant impression grid” sets out 20 of the more common indicators.
These indicators take a detailed look at the relationship to determine if it is an employer and employee relationship or a client and independent contractor relationship.
There are three categories of these indicators, namely:
- Near-conclusive, which relate most directly to the acquisition of productive capacity;
- Persuasive, which relate to the control of the work environment;
- And resonant of either an employer-employee relationship or an independent contractor or client relationship, whichever is relevant.
SARS said in an Interpretation Note that it would use the dominant impression to classify the relationship as either an employee or an independent contractor relationship.
Personal service providers, labour brokers, and expatriate employees
SARS introduced anti-avoidance measures about personal service providers or labour brokers to clamp down on those trying to avoid employees’ tax.
SARS uses common law tests to determine whether a personal service provider or labour broker is carrying on an independent business.
Mazars’ Troost said that tax law required that when a company engaged a personal service provider or a labour broker, without a SARS certificate of exemption, that company had to withhold PAYE as SARS deemed such a person an employee.
SARS would only issue an exemption certificate if the labour broker or personal service provider conducted an independent business, according to a SARS Interpretation Note.
A personal services company has to have at least three employees who were not family members in order to be considered an independent contractor, Troost added.
Expatriate employees working in South Africa may need to pay employees’ tax on local income, subject to any double tax agreements which may be in place between South Africa and the expatriate employee’s home country.
In terms of the definition of remuneration in the Fourth Schedule of the Income Tax Act, a person who is not a resident cannot qualify as an independent contractor.
A quick comparison of employee versus independent contractor
Indicative factors in determining where a person is an employee or an independent contractor, according to the South African Guild of Editors.
|Works for only one employer at a time.||Provides services to more than one person or company at a time.|
|Works the hours set by the employer.||Sets his or her own hours.|
|Usually works at the employer’s place of business and uses their equipment.||Works out of his or her own office or home and uses his or her equipment.|
|Entitled to annual and sick leave.||Not entitled to any leave.|
|Often receives employment benefits, such as medical aid or bonuses.||Does not receive employment benefits from the employer.|
|Works under the control and direction of the employer.||Works relatively independently.|
|Receives a nett salary after the employer has deducted income tax and UIF.||A provisional taxpayer and responsible for paying his or her own taxes.|
How labour law handles the distinction between employees and independent contractors
The major pieces of employment legislation, the LRA, the BCEA and the Employment Equity Act (EEA), apply to employees and not independent contractors.
The law defines an employee to mean any person, excluding an independent contractor, who works for another person or the government, receives remuneration, and conducts the business of the employer.
There is no statutory definition of the term “independent contractor”.
As a result, several tests have evolved through case law, the presumption of employment provision in the LRA and BCEA, and the Code of Good Practice on “Who is an Employee”.
To ensure that employees do not lose their labour law protections, section 200A of the LRA and section 83A of the BCEA introduced a rebuttable presumption that everyone earning under the earnings threshold of R205,433.30 a year is an employee until proven otherwise and regardless of the contract concluded, according to an article on the EE Publishers website.
An employer who disputes that an independent contractor is an employee must provide evidence about the working relationship.