The tax landscape in South Africa can be complex. The term ‘Personal Service Provider’ refers to a specific category of taxpayer defined by the South African Revenue Service (SARS). Understanding the tax implications for PSPs is crucial for compliance and efficient financial planning.
Interpretation Note No. 35 states that ‘Personal Service Providers’ were previously a popular tax-saving method for employees to offer their services to their employers by using private companies, close corporations or trusts as a medium.
Legislation was therefore implemented to discourage the use of corporate entities/trusts as intermediaries to provide personal services to clients that are, in fact, services provided under an employment contract.
This resulted in remuneration that is payable by a client to such a company, close corporation or trust, being subject to employees’ tax.
Let’s delve into the key aspects that PSPs need to know.
Definition and Criteria for Personal Service Providers:
The definition of ‘employee’ in paragraph 1 of the 4th Schedule to the Income Tax Act includes a personal service provider. Any company, close corporation or trust that is a ‘personal service provider’ (as defined) and is in receipt of ‘remuneration’ (as defined) is subject to the withholding of employees’ tax.
The following should be considered in determining whether a company, close corporation, or trust is a “personal service provider” and whether employees’ tax must be deducted or withheld.
A personal service provider is any company or trust where any person, who is a connected person in relation to such company or trust, personally renders services on behalf of the company or trust to a client.
Apart from this, one of the following requirements must also be met:
- Such person would be regarded as an employee of the client if the service was rendered by such person directly or indirectly to such client, other than on behalf of such company or trust.
This would be met if the natural person receives ‘remuneration’ as defined if the services were not provided through an entity, or
- where the service or duties must be performed mainly at the premises of the client, such person or such company or trust is subject to the control or supervision of the client as to the manner in which the duties are to be performed or in rendering such service, or
- where more than 80% of the income of such company or trust from services rendered consists of amounts received from any one client or an associated institution. The reference to ‘income’ in the test is a reference to ‘income’ as defined in Section 1(1) of the Income Tax Act.
It is, therefore, necessary to isolate the income received for the services rendered from the income received for other activities of the company, close corporation, or trust to perform that calculation.
A client of a company or trust, which might be a personal service provider, will know whether requirement (a) or (b) is met. However, for requirement (c), the client will not necessarily know. Therefore, the company or trust might supply the client with an affidavit or solemn declaration stating that no more than 80% of the income was received from one client. The client may then bona fide trust the affidavit and, therefore, not withhold any employees’ tax.
There are, however, some exclusions available. A company or trust is excluded from the definition of ‘personal service provider’ where, throughout the year of assessment, three or more employees who are on a full-time basis engaged in the business of such company or trust are employed.
These employees may not be holders of shares in the company, members of the company or close corporation, a settlor or beneficiary of the trust, or be a connected person in relation to that person. Interpretation Note No. 35 clarifies that the employees referred to in this requirement must be directly involved in the service activities of the personal service provider. It further explains that auxiliary staff, such as cleaning staff, do not enable the service delivery business and do not qualify under the legislation. The facts and circumstances of each case must be evaluated to determine who would qualify as being engaged in the business on a full-time basis for purposes of the exclusion.
Tax Implications for Personal Service Providers:
Being classified as a PSP has specific tax implications.
Where the definition is met and remuneration is paid to a personal service provider, the client is obliged and is subject to the deduction of employees’ tax.
The employees’ tax withheld may be set off against the company or trust’s provisional tax payments.
A personal service provider does not qualify as a ‘small business corporation’.
Limitation on Deductions:
Section 23(k) of the Income Tax Act limits the deduction of expenses incurred by a personal service provider. This provision prohibits the deduction of any expenses incurred by these taxpayers other than any salaries paid to employees of the personal service provider and certain specific deductions. These are deductions for legal costs, bad debts, employer contributions to funds, repayment of employee benefits and repayment of restraint of trade payment.
Expenses in respect of premises, finance charges, insurances, repairs, fuel, and maintenance in respect of assets, if such premises or assets are used wholly and exclusively for purposes of trade, can also be deducted.
Tax Rate
The taxable income of a personal service provider that is a company will be taxed at 27%. If the personal service provider is a trust, the rate of tax is 45%. Employers making payments to personal service providers must also use these rates to deduct employees’ taxes. However, the employee may apply for a directive from SARS.
In addition, dividends tax will be payable on any dividends declared by personal service providers who are companies. If the personal service provider is a trust, the normal principles of Sections 7 and 25B will apply.
Conclusion:
Understanding the tax implications for Personal Service Providers is essential for managing compliance and financial obligations effectively. By staying informed about the criteria for PSP classification, tax rates, deduction limitations, and compliance requirements, individuals and companies can navigate the complexities of South African tax law with confidence. Seeking professional advice ensures that PSPs can make informed decisions that optimise their tax position while fulfilling their obligations to SARS. Navigating these regulations may seem daunting, but with proper guidance and proactive planning, PSPs can manage their tax affairs efficiently, ensuring both compliance and financial stability in the dynamic South African business environment.