Taxation of South African source income
In general a "resident", as defined in section 1 of the Income Tax Act (the Act), is taxed on his / her worldwide income, irrespective of where the income is earned. On the other hand, non-residents are only taxed on income from a South African source, subject to the application of a relevant agreement for the avoidance of double taxation (DTA).
The term 'source' is not separately defined in the Act, which is probably due to the fact that it would be impossible for the legislature to define the source of all types of income which a taxpayer may earn. Therefore, in determining the source of a receipt or accrual, it is necessary to consider court decisions on the subject, however, it is important to keep in mind that the determination of source is a factual question that must be determined in light of all the surrounding circumstances.
In the case of independent professional services rendered by individuals it is accepted that the source of income would generally be the place where the activity leading to the generation of income is physically being conducted (see CIR v Nell 24 SATC 261).
Limitation of taxing rights under a DTA
As stated before, South Africa's taxing rights may be limited under a relevant DTA, notwithstanding the fact that the non-resident independent contractor's income is from a local source. The basis on which South Africa's taxing rights are limited is however dependent on the wording and structure of the relevant DTA.
In the OECD Model Tax Convention (OECD MTC), before being deleted in 2000, provision was made in Article 14 for Independent Personal Services. Similar versions of Article 14 of the OECD MTC still exist in many of the DTA's South Africa has entered into and generally provides that income derived from those services will be taxable only in the State of residence, unless the individual has a fixed base regularly available to him in the other Contracting State where the services are being performed. Where such a fixed base is present, then only income attributable to that fixed base may be taxed in the other Contracting State.
In cases where a DTA does not provide for independent personal services (or a form thereof) then regard must be had to the relevant permanent establishment and business profits articles in determining whether any income is attributable to South Africa.
An example of a DTA that provides for independent personal services is that of the United States (the US Treaty). The wording of the US Treaty, dealing with independent personal services, is similar to that of the OECD MTC with the added proviso that a fixed base is deemed to be regularly available where that individual stays in the other Contracting State for a period exceeding 183 days in any twelve month period. On the other hand, the United Kingdom DTA (the UK Treaty) contains no article dealing with independent personal services, meaning the general provision dealing with permanent establishments and business profits will find application.
Obligation to withhold employee’s tax
It is clear from the above that a large compliance burden rests on a South African client engaging the services of a non-resident independent contractor. Once it has been determined that the nonresident independent contractor is subject to income tax in South Africa by virtue of the source rules, and the relevant DTA does not limit South Africa' taxing rights, then, a further enquiry is necessary to determine whether an employee's tax withholding obligation is present.
A number of amendments to the Act and the Fourth Schedule to the Act have been made to prevent employees from operating in the guise of independent contractors and in so doing avoid their employee's tax obligations.
The amendments have placed a significant compliance burden on employers, who are regarded by SARS to be in the best position to ascertain the tax status of a service provider. Proviso (ii) to the definition of "remuneration" in paragraph 1 of the Fourth Schedule provides for the so-called statutory tests to determine whether a person is an independent contractor for employees' tax purposes. The statutory tests are conclusive in nature, meaning that if they apply, the person is not deemed to be an independent contractor for employee's tax purposes only.
However, the statutory tests do not apply to non-resident independent contractors, meaning that they will fall within the employee's tax net, unless of course South Africa's taxing rights have been limited under a relevant DTA. This means that even though the nonresident would in normal circumstances have been regarded as a bona fide independent contractor, an employee's tax withholding obligation is placed on the person liable to pay remuneration for the services rendered. The person liable to withhold employee's tax will have the added responsibility of contributing towards skills development levies, but not the unemployment insurance fund.