Comparison of classification criteria for independent contractors in South Africa to selected developed countries for tax purposes

Abstract

Complexities and uncertainties frequently arise when a decision has to be made by an employer to classify a worker as an employee or contractor for income tax purposes. This is especially true when the employer seeks to obtain a certain tax benefit from the classification or wishes to avoid carrying out certain administrative duties as an employer on behalf of the employee. The process of applying the classification criteria for employees and independent contractors is not straightforward or clear. This is because the criteria are open for interpretation and therefore subject to possible manipulation or misuse. The main objective of this study is to compare the classification criteria used in South Africa (in its current form) with those of Australia and Germany when determining the taxation status of an independent contractor in an attempt to establish if there is a more simplified and accurate classification method. The method currently used in this process in South Africa (that is, classification as an independent contractor or an employee) as envisaged by the South African Income Tax Act 58 of 1962 read with Interpretation Note17 of South African Revenue Services is explored. This is followed by an analysis of the classification criteria used by Australia and Germany in determining the taxation status of independent contractors and employees. From a South African income tax perspective, the definition of remuneration is a determining factor when establishing who does not qualify as an independent contractor. A person receiving remuneration as defined in the Act is not an independent contractor but an employee. The remuneration received is therefore subject to employees’ tax which is withheld by the employer and payable to SARS. In case of uncertainty of the employer-employee relationship, the application of statutory test and common law test is recommended in South Africa. In the cases of Australia and Germany, the relationships employers have with employees and contractors are tested by applying common law only. This process takes into consideration outcomes from existing court cases which dealt with differentiating employees from independent contractors. The study concludes that the system which applies both the statute and common law in South Africa seems to be more effective than the application of only the common law test in Australia and Germany. The statute in its current form in South Africa can be applied for common cases while the common law test is applied to more complex situations. The use of common law could be minimal if the terms ‘independent contractor’ and ‘carrying on a trade’ were clearly defined and incorporated in the Act.