Natural person taxpayers who earns a salary have very few items of expenditure available to them which they may deduct for income tax purposes (section 23(m) of the Income Tax Act, 58 of 1962). Generally, the deductions which salaried individuals may claim for income tax purposes are limited to amongst others contributions to retirement type funds, donations to approved public benefit organisations, medical aid contributions and expenditure linked to distances travelled which may be set off against a travel allowance earned.To escape this restraint, employee taxpayers would arrange with employers not to be directly employed, but that a company (which would typically be owned by the taxpayer) will be contracted to provide the services which the employee taxpayer otherwise would have provided directly in an employment capacity. The employee will now perform these services as employee of the contracted company to the employer indirectly. In this manner, many other expense items also become potentially deductible by the taxpayer’s company which would not be limited by the provisions of section 23(m) since the company does not stand in an employment relationship with its client which would otherwise have been the natural person’s employer. A further potential advantage to be achieved by interposing a company in an employment relationship is that the income tax payable by high income earners is effectively capped at the corporate income tax rate of 28%.
To counter these instances of avoidance, the “personal service provider” regime was created. The deductions available to “personal service providers” for income tax purposes are similarly restricted as is the case for salaried individuals (section 23(k)). A “personal service provider” is defined as a company or trust on which behalf services are rendered to a client of the company or trust personally by an individual who is a connected person in relation to the company or trust, and any one of the following three criteria are also met:
- The individual would be regarded as an employee of the client if the services were rendered by the individual directly to the client;
- The duties linked to the services are required to be performed mainly at the premises of the client, or the individual, company or trust is subject to the control or supervision of the client as to the manner in which the duties to be performed; or
- More than 80% of the income of the company or trust during the tax year from services rendered consists of amounts received directly or indirectly from any one client of the company or trust.
(See paragraph 1 of the Fourth Schedule to the Income Tax Act.)
Considering what would normally be required by an employment relationship of an employee, it would be difficult to escape the above anti-avoidance provisions. One exception which exists though is if the company or trust employs at least 3 employees on a full time basis (and other than employees which are connected persons in relation to that company or trust).
The above anti-avoidance provision is important to take note of for individuals attempting to make use of companies to gain access to increased income tax deductions, or to limited their margin tax rate. It is however similarly applicable to small companies which operate in the services industry, as it may very well be that these companies too are also inadvertently caught by these anti-avoidance provisions.
This article is a general information sheet and should not be used or relied upon as professional advice. No liability can be accepted for any errors or omissions nor for any loss or damage arising from reliance upon any information herein. Always contact your financial adviser for specific and detailed advice. Errors and omissions excepted (E&OE)