Is your service provider a personal service provider for employees’ tax purposes?

As early as 2000 certain provisions were inserted in the Income Tax Act to provide for amounts paid to a company, close corporation or trust to be subject to PAYE withholding where the company, close corporation or trust makes available the services of an individual that would normally have been rendered to the client in terms of a contract of employment. 

By interposing a company, for example, the amount paid for services rendered would be taxed at the lower company tax rate instead of the higher marginal tax rates for individual taxpayer and in addition the company would be able to claim deductions for expenses incurred in providing the service.  To discourage the use of an entity such as a company as intermediary to provide personal services to a client, which are, in essence, services provided in terms of a contract of employment, the concept of a  personal service company or trust (since changed to PSP) was introduced as well as the requirement to withhold PAYE from amounts paid or payable to such entities.

This model used by individuals for providing services to clients via an intermediate company, close corporation or trust poses significant risk for the client that engages the company, close corporation or trust, should it not be correctly classified as a PSP.

If the service provider is not correctly classified as PSP and PAYE is not withheld, the person or person engaging with the service provider company, close corporation or trust could face a substantial tax bill due plus penalties and interest.

When is a service provider considered to be a PSP for tax purposes

Any company, close corporation or trust that meets the definition of PSP is an “employee” and if in receipt of an amount for services rendered, such amount constitutes remuneration and is subject to the withholding of PAYE.

Remuneration excludes payments for serviced rendered by independent contractors, but not payments to a PSP.

It is therefore it is crucial to correctly determine whether the company, close corporation or trust that renders the services to you is a PSP or not to ensure that PAYE is withheld.

First test

A PSP is defined in the Income Tax and the first requirement is that the individual that is rendering the services on behalf of the company, close corporation or trust must be a “connected person” in relation to the company, close corporation or trust that is engaged to provide the service, for example a shareholder of the company.  If this is not the case the service provider is not a PSP and payments for services rendered is not subject to the withholding of PAYE.

Second test

The company, close corporation or trust that provides the service will not meet the definition of a PSP if it employs three or more full-time employees throughout the particular year of assessment who are, on a full-time basis, engaged in the business of rendering the service.  The employees must however not be connected persons in relation to the entity that is providing the service, for example must not hold shares in the company, be members of the close corporation, nor settlors or beneficiaries of the trust.

The employees must be directly involved in the service activities and auxiliary staff, such as cleaning staff are not regarded as qualifying employees. 

If the test is satisfied, then the service provider is not a PSP and payments for services rendered is not subject to the withholding of PAYE.

If the test is however not satisfied, it is necessary to apply the third test.

Third test

 Only one of the of the criteria needs to be met in order to be classified a PSP.

• Would you regard the person who is personally rendering the service on behalf of the company, close corporation or trust as an “employee” if the service was rendered directly to you and not through the company, close corporation or trust?
• Must the person who is personally rendering the service, or the company, close corporation or trust, perform the duties mainly at your premises, and if so, is that person subject to your control or supervision as to the manner in which the duties are performed or are to be performed?
• Does more than 80% of the income of the company, close corporation or trust from services rendered consist of amounts received from any one client, or from any “associated institution” in relation to the client?

If any of the above three criteria apply, the company, close corporation or trust will meet the definition of PSP and amounts paid for services rendered are subject to the withholding of PAYE.

PAYE must be withheld at a rate of 27% where the PSP is a company or close corporation and 45% where the PSP is a trust.

May i rely on an affidavit or solemn declaration from a service provider that states it does not meet the definition of a PSP?

The onus is placed on the person that makes the payment to the service provider for services rendered to determine whether the service provider is a PSP and whether the amounts payable must be subject to the withholding of PAYE.

Although a questionnaire that contains the relevant criteria to determine whether the service provider meets the definition of a PSP may assist you with determining whether the service provider is a PSP, an affidavit or solemn declaration signed by the service provider confirming that it does not meet the definition of PSP, does not absolve you from your obligations.

In instances where the first two criteria in the third test are not met and you have been provided with an affidavit or solemn declaration stating that the service provider will not derive more than 80% of its income from one client, you may however rely on the affidavit or solemn declaration to not withhold PAYE, provided you have relied on the affidavit or solemn declaration in good faith.

Risks and consequences for the employer should misclassification apply

Should SARS determine that your service provider is a PSP, and the PSP was incorrectly classified as an independent contractor you may face the following tax consequences:

• You may be liable for the unpaid payroll taxes and may face penalties, administrative non-compliance penalties, interest or even criminal prosecution.
• You remain liable to SARS for the PAYE but have a right of recovery from the PSP.

It is recommended that all users of services from potential PSP’s should have policies and systems in place to correctly classify a service provider and determine whether PAYE should be withheld, for example to use a PSP questionnaire, affidavit or solemn declaration confirming that not more than 80% of the service provider’s income is from one client. 

Should you determine that there has been a misclassification of PSP status and PAYE was not withheld, the error can be rectified and relief from penalties and criminal prosecution may be available under the Voluntary Disclosure Programme.

Consclusion

The use of a PSP must be approached with caution and users of services from potential PSPs must ensure that the tax status of service providers is determined at engagement. Misclassification can result in significant tax liabilities and penalties.

Contact our Private Client Tax team if you need assistance with any of your employees’ tax affairs.

Author:

Naomie Fourie, Assistant Manager