During the course of a tax year many events occur outside the normal monthly payroll run requiring an employer to re-evaluate the position of certain payments with respect to employee's tax. These include, inter alia, the exercise of share options, retrenchment of employees or retirement.
The Fourth Schedule to the Income Tax Act, Act 58 of 1962 (the Act) governs the way in which employees’ tax needs to be withheld from remuneration paid to employees on a monthly basis. There are certain exceptions to the general rule, which place an obligation on the employer to approach SARS and obtain a tax deduction directive (directive) for certain classes of remuneration before it is paid to an employee.
The obligation to obtain directives in the aforementioned circumstances has also given SARS a foothold to recover unpaid taxes of employees. The process involves SARS either declining to issue a directive until such time that the employee's affairs are brought up to date, thereby delaying payment, or appointing the employer as an agent to deduct the outstanding tax from the payment due to the employee. This is certainly a worrying factor for employees who find themselves in arrears with their tax affairs and places the employer in a difficult position, as it is required to withhold the additional amounts if instructed to do so by SARS.
For purposes of this article a distinction has been made between directives which are compulsory, i.e. the employer has no choice but to apply, and those which are voluntary, and may be issued by SARS on application.
In practice, employers will deal mostly with the following payments which place an obligation under the provisions of the Fourth Schedule to obtain a directive:
Share options exercised by an employee;
Lump sum payments as a result of retrenchment; and
Lump sum payments as a result of retirement.
The obligation to request a directive from SARS in relation to share options exercised by an employee is contained in paragraph 11A(4) of the Fourth Schedule to the Act. The obligation under paragraph 11A(4) of the Fourth Schedule to obtain a directive, before making any payment to an employee, extends to gains made under sections 8A (right to acquire a marketable security), 8B (broad based share plans) or 8C (vesting of equity instruments) of the Act.
In many instances employers ignore the directive obligation in relation to share gains and merely subject the payment to tax at the employee's marginal tax rate. This approach is fraught with danger as it is regarded as an offence not to withhold the correct amount of employees’ tax. It is further an offence where an employer obtains a directive as required, but does not act in accordance with the instruction stipulated on that directive.
In relation to the accrual of lump sums as a result of retrenchment, an employer is obliged, under the provisions of paragraph 9(3) of the Fourth Schedule, to obtain a directive before making any payment to an employee.
Where benefits become due as a result of retirement, the obligation is also placed on the employer to obtain a directive. However, it must be understood that for purposes of the Fourth Schedule a fund administrator is also regarded as an employer. This means that the fund administrator is responsible for obtaining a directive only in relation to payments made from an employee's retirement fund.
Paragraph 11 of the Fourth Schedule provides SARS with a discretionary power to issue directives in certain circumstances. Directives under paragraph 11 of the Fourth Schedule can be issued in order to alleviate hardship of an employee relating to factors beyond the control of that employee or to correct employees’ tax calculation errors. Hardship directives are also available to directors of private companies, but are most commonly used by commission earners and personal services companies in order to reduce their effective tax rates by taking into account deductions allowable on assessment.
On issuing the directive under paragraph 11, SARS may either direct that no employees’ tax be withheld or that a specified amount or percentage be withheld.
Employers relying on directives issued by SARS must ensure that it is a valid document having regard to the period it was issued for. Many employers have found themselves on the wrong end of a SARS employees’ tax audit where reliance is placed on outdated and invalid directives provided by employees.
Cliffe Dekker Hofmeyr
IT Act:4th Schedule par 9(3), 11, 11A(4)