Written by: Jenny Klein
Source: www.persfin.co.za

Personal service companies were used as tax planning vehicles until a clampdown in 2000 left them without many of the benefits available to other small businesses. Now amendments to the law have helped balance the scales.

The concept of a personal service company was introduced in 2000 to combat a tax avoidance scheme whereby employees contracted to render services through a company in order to escape employees tax being deducted from their earnings.

For example, the scheme was used by information technology personnel. While employees are liable for PAYE, a person could do the same work and avoid PAYE by setting up a company or close corporation (CC) that would employ him or her to render services to the former employer. No employees tax was withheld from the fees paid to the company or CC in these circumstances.

• The person rendering the service would be regarded as an employee of the client if the service was rendered by that person directly to the client; or...
   
• The person or company is subject to the control or supervision of the client as to the manner in which, or hours during which, the services are to be performed; or...
   
• The amounts payable in respect of such service include earnings of any description that are payable at regular daily, weekly, monthly or other intervals; or...
   
• Where more than 80 percent of the company’s income during the tax year from services rendered consisted of amounts received from any one client...

However, a company was not a personal service company if throughout the tax year it employed more than three full-time employees who rendered such services on a full-time basis, other than shareholders, members or connected persons in relation to a shareholder or member.

Significant changes to the tax regime applicable to personal service companies are contained in the Revenue Laws Amendment Act of 2006. These changes are effective from the start of tax years ending on or after January 1, 2007.

The most important changes are:

• The payment of earnings at regular intervals to a company no longer triggers the application of the personal service company rules.
   
• The control/supervision criterion applies only if services are rendered mainly at the client’s premises.
   
• If a company has three full-time employees (as opposed to more than three) providing services, that company is not a personal service company.
   
• A client using the services of a small business can rely on an affidavit or solemn declaration issued by the entity that it is not a personal service company. Previously, the client bore the onus of identifying whether an entity was a personal service company. If the client relies on an affidavit or declaration in good faith, it cannot be held liable for a failure to withhold employees tax. This is a very welcome change for clients using the services of small businesses.
   
• Personal service companies are no longer restricted from claiming their business-related expenses as an income tax deduction. They can claim deductions for certain legal expenses, bad debts and contributions to pension, provident and benefit funds, as well as certain expenses relating to business premises and assets.