The disclosure to the South African Revenue Service (SARS) of potential tax defaults can be addressed in various ways. However, the formal Voluntary Disclosure Programme (VDP), as contemplated in the Tax Administration Act, No 28 of 2011 (TAA), is the preferred and recommended option.
The VDP is a formal statutory process, regulated under Part B of Chapter 16 of the TAA, in terms of which a taxpayer can approach SARS voluntarily to regularise its tax affairs with the prospect of obtaining various forms of relief. It is important to note that upon a successful VDP application, the VDP process does provide relief in respect of understatement penalties (which could be up to 200% in severe cases), 100% relief from administrative non-compliance penalties and in addition thereto, SARS will not pursue criminal prosecution.
Recently there has been an increase in the number of employers defaulting on their pay-as-you-earn (PAYE) obligations to SARS. This is especially true where one is dealing with non-resident employees and the obligation on the employer to withhold PAYE.
In general, a ‘resident’, as defined in s1 of the Income Tax Act 58 of 1962 (Act), is taxed on their worldwide income, irrespective of where the income is earned. Non-residents are only taxed on income from a South African source, subject to the application of a relevant double tax agreement (DTA). Accordingly, where a DTA finds application, South Africa’s taxing rights may be limited, notwithstanding the fact that the expatriate employees’ income is from a local source.
Where, however, South Africa’s taxing rights are not limited by the application of a relevant DTA, the next step is to determine whether the employer concerned has an obligation to withhold PAYE. Paragraph 2(1) of the Fourth Schedule provides that an employer who is a resident or representative employer in the case of a non-resident and who pays or becomes liable to pay any amount by way of remuneration to any employee, will be required to deduct employee’s tax in respect of the normal tax liability of that employee.
The SARS External Reference Guide - Treatment of PAYE for VDP Purposes (Revision 1) (SARS Guide), specifically provides that where employers wish to regularise their employees’ tax affairs in terms of the VDP process, the employers must apply in the prescribed manner and in accordance with either one of the following options:
- the employer recovers the employees’ tax directly from the employees concerned; or
- the employer does not recover employees’ tax directly from the employees concerned but applies the ‘gross–up’ method.
In relation to the first option, it is important to note that one of the key requirements that must be present before an employer can rely on the first option in regularising its PAYE affairs is that the employer must have issued a valid IRP5 certificate to the relevant employee. By implication, this would mean that the employee, to whom the IRP5 certificate has been issued, must have a valid South African income tax reference number.
In circumstances where the employee does not have a valid income tax reference number and an IRP5 certificate has not been issued to the employee , the employer should automatically default to the second option in regularising its PAYE affairs. In other words, the employer would not be able to recover the employees’ tax from the employee concerned but would by default elect to pay the PAYE on behalf of the employee.
The consequence of the employer paying the PAYE on behalf of the employee is that such payment would constitute a ‘payment of the employee’s debt’ which triggers a taxable fringe benefit in the hands of the employee under the provisions of paragraph 2(h) of the Seventh Schedule to the Act.
The SARS Guide (at page 4) specifically states that the “…benefit due to the payment of the employees’ debt will result in another benefit on which tax again becomes payable…”. It is important to note that this ‘tax-on-tax’ benefit is calculated in accordance with the following prescribed formula:
‘Taxable amount’ x 100
100 — employee’s marginal tax rate
= ‘Taxable amount plus tax on tax benefit’
The ‘taxable amount’ represents the value of the remuneration in respect of which the employer wishes to regularize the PAYE. The full ‘taxable amount’ plus tax on tax benefit represents remuneration. The difference between the full ‘taxable amount’ plus tax on tax benefit and the ‘taxable amount’ represent the tax attributable to the tax-on-tax benefit (payment of employee’s debt).
It is further important to note that where the gross-up of the taxable remuneration results in an increase in the tax rate from one tax bracket to the next, the marginal tax rate in the above formula must be increased by 1%. For example, where the marginal tax rate of the independent contractors equal 40%, the increase by 1% will result in a marginal rate of 41%.
The SARS Guide concludes by stating that once the employer has determined the total PAYE amount payable to SARS, the employer must issue one global IRP5 certificate for the total employees’ tax not recovered from the employees (including the value of the tax attributable to the tax-on-tax calculation above). Accordingly, once the aforementioned is completed, the relevant EMP501 must be amended and reconciled and submitted together with the new VDP tax certificate to SARS.