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Paye As You Earn (PAYE)

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ABOUT EMPLOYEES TAX

 

They say that there are two things in life you simply cannot duck – death and taxes. There’s not much you can do about the first, but with regards to the second, although you cannot duck it – you certainly can “soften the blow” a bit. As an employee or business owner it is your duty to yourself and your employees to know the basics of tax so that you can legally minimize your (and theirs!) tax burden, but more importantly to make sure that you, as an employer, keep in line with current legislative requirements when it comes to calculating what tax is due to the Receiver.

 

The penalties for non-conformance to current legislation are high and could easily sink a small business, so its not worth taking the risk.

 

Introduction …

 

This document is not designed to provide you with everything you need to know about employees tax as there are many other more detailed documents on this website that will do just that for you. Also, there is a suite of programs on this site namely PSIberTAX and PSIberPAY, which will do all appropriate tax calculations for you, so even if you don’t understand everything you read in this document, we will ensure that if you use any of these products you will automatically be kept in line with the most current tax rules and regulations.

 

What this document is however designed to do is to provide you with a simple and logical introduction to some basic principles of income tax as it applies to employees.

 

Some basics first …

 

South African legislation specifies what elements of an employee’s earnings are subject to tax and under what conditions a variance to the normal tax tables is permitted. It also deals with what deductions are allowed from these earnings prior to tax being calculated.

 

Assume then for a moment that everything you earn, be it in cash, be it in the form of a return of a favour that is worth something (i.e. has a value), or be it an item of value you are given instead of cash, is subject to some form of tax. However, the determining of the value and its associated tax liability in respect of any of these forms of payments will differ, and will generally fall into one of the following categories:

 

Zero Tax: This would apply where an amount of money is given to an employee which is over and above the employee’s Basic Salary / Package, that is deemed to be tax free. For example, where an employee is given a uniform allowance, with which the employee is expected to purchase a uniform that is to be worn every day whilst at work. As long as by wearing this uniform the employee is clearly distinguishable from other employees and that other employees that work with the employee in a similar role are also required to wear a similar uniform, the amount provided to the employee is tax free.

 

Fringe Benefit Tax: This tax will vary depending on the type of “Benefit” provided to the employee. For example, if an employee is given a low interest loan by his / her employer, the savings on interest payable between the percentage charged on the loan by the employer and the industry percentage (i.e. what a bank would typically charge as an interest rate) is taxable in the hands of the employee. All benefits currently allowed by the Receiver together with their tax implications are detailed in our document “Tax Rules made Simple”.

 

Normal Tax: This is probably the simplest form of tax. You simply take the employees earnings and look up the tax due on the Tax Tables as published by the Receiver of Revenue each year, taking into account the persons age and specified rebate entitlements. As the employee’s earnings increase so the percentage due (i.e. the tax due!) on portions of these earnings also increases.

 

Employees Marginal Tax Rate : The highest tax rate applicable on the employees earnings as determined in the Receivers Tax Tables is commonly known as the Employees Marginal Tax Rate. You may have heard a tax consultant say that the employee’s bonus should be taxed at his / her marginal rate. This simply means that the highest percentage paid by this employee when determining the tax due on his normal earnings must be used when taxing the employees bonus.

 

Marginal Tax: The official tax table operates on an escalating scale basis, (i.e. the higher your earnings the greater percentage tax you pay on each bracket of earnings). When your earnings reach a certain amount (R 400 000,00 P/A) the percentage stops increasing and a flat rate of tax becomes applicable for any earnings above this earnings level on the table – this is known as the Marginal Tax rate. The Marginal Tax rate for the current tax year (i.e. 2006/2007) is set at 40% which means that anything you earn above R400,000.00 per annum will be taxed at 40%.

 

Every year the Minister of Finance in his budget speech will review the rates of tax applicable to the various earnings levels as well as the instances under which zero tax or Fringe Benefit tax is due (and at what rates!).

 

For more detail about the recent Budget Speech CLICK HERE

 

Methods of Annualising employees earnings…

 

The earnings tables together with the associated tax due on these earnings are normally expressed in the Receivers handbook as Annual amounts, so the first thing you need to do is to establish whether or not the employee that you wish to calculate tax for is paid monthly, weekly or fortnightly etc. Then you need to apply the appropriate estimate (i.e. multiply by 12 for monthly or by 52/53 for weekly etc.) to arrive at the employee’s equivalent annual earnings. At this point you can now establish the annual tax due by the employee, which you then divide by 12 months or 52/53 weeks (whichever is appropriate) to arrive at the employee’s tax due for the period.

 

Now, to estimate the employee’s annual earnings you can use one of 3 methods – each one resulting in a different tax liability on a monthly / weekly basis, but all of them (in theory!) achieving the same tax result over a 12 month period).

 

The 3 methods are :

 

1- Non-Cumulative : this method assumes that the employee has had past earnings (i.e. from the beginning of the tax year) equal to what was earned in the current month and will continue to earn for the remaining period in the current tax year, the same amount as was earned in the current month. This is the simplest method and is the method used when SARS produces the Tax Tables each year (i.e. the one that is sent to employers each year).

 

For Example :

 

If the employee earns R8,000.00 per month, we assume he has earned this each month since the beginning of the current tax year and will earn this again for each month remaining in the current tax year. Therefore his annual earnings is calculated

at :

 

 

R8 000 x 12 = R96 000

So, using the 2005/2006 tax tables, the tax due would be

 

R1 085 giving Annual tax due of R13 020 pa

 

R13 020 divided by 12 = R1 085 pm

 

 

This method, as can be seen, does not take into account actual annual earnings or tax paid on a year to date basis. As such the total tax deducted for the year will not always be correct, unless of course the employee earns exactly R8,000 per month for the 12 months. A recalculation of tax deducted from each employee has to be done at tax year end anyway, so any over or under deduction will be highlighted and have to be corrected by the employer.

 

Employees who have underpaid during the year could become quite irritated when you put through a large recovery in the last month of the tax year. If you don’t they will have to pay it in anyway when their tax assessment is done.

 

The advantage to using this method of annualisation is that the amount of tax deducted each month from the employee will be exactly the same – so, hopefully no queries from your employees! In the last month of the year a final calculation will be done and in most cases a tax reduction for that month will be enjoyed by the employee. This is because this method normally results in a bit more tax being deducted each month than the other methods (as you will see further on). As such when the recalculation is done at tax year end, it would highlight an over payment of tax to date and hence a tax reduction for that month would occur.

 

2-Cumulative (based on current periods earnings): This method assumes that the employee will earn the same amount he received this month for the remaining months in the tax year. It also uses the ACTUAL amount earned in previous months to arrive at the employee’s estimated annual earnings.

 

For Example :

 

The employee earned R8,000 this month (say Aug) therefore it assumes his earnings for the remaining months will be R8,000 x 6 = R48,000 (i.e. September to February). It then looks at what was actually earned in prior months and adds it to the R48,000 as calculated above – Lets look at two scenarios :

 

Scenario 1:

(same monthly earnings – Mar to July)

Scenario 2:

(different monthly earnings – Mar to Jul)

Earnings for Aug

R  8 000

Earnings for Aug

R  10 000

Earnings for Sep – Feb

R48 000

Earnings for Sep – Feb

R  60 000

Actual Earnings (Mar – Jul)

R40 000

Actual Earnings (Mar – Jul)

R  40 000

Total for the year

R96 000

Total for the year

R 110 000

Annual Tax Due

R13 020

Annual Tax Due

R  15 600

Tax for 6 months worked

R  6 510

Tax for 6 months worked

R    7 800

Less Tax Paid

R  4 000

Less Tax Paid

R   4 000

Tax Due this month

R  2 510

Tax Due this month

R   3 800

 

 

 

 

N.B. If we had used the non-cumulative method as described in section 1 and scenario 2 was applicable to this particular employee – note that, had the earnings fluctuated a lot, we would have incorrectly taxed the employee (i.e. we would have estimated earnings as R120,000 and not R110,000) and as a result the employee could have had to have a greater tax deduction made in the last month of the tax year or had to “pay in” once his tax return had been assessed.

 

Also note however that this method of estimating the employee’s earnings (using the figures in scenario 1) would have yielded the same result as for the non-cumulative method. (only because the persons actual to date was equal to the theoretical amount as calculated by the non-cumulative method).

 

 

It is therefore more accurate than the non-cumulative method as it is self correcting from month to month (ie it always takes into account the actual earnings to date and only estimates future earnings). As each month goes by, the estimating of future earnings gets less and less significant in the calculation so in the last month of the tax year there is no estimating and a 100% accurate calculation is done  - as such it is not necessary in this instance to adjust under or over deductions of tax that may have taken place during the year – as by definition this could not have happened.

 

This method is most commonly used (as it is most suited!) for employees who earn relatively consistent amounts each month (i.e. the same basic, the same allowances and who maybe get an increase once a year).

 

The advantages of this method are:

 

-         The forecasted annual earnings are adjusted each month and as such become more accurate as each month goes by. Remember that the value of past earnings used in the forecast will be greater than the value of future earnings and,

 

-         Where employees have fixed earnings each month (i.e. the same!) the amount of tax deducted each month will be the same. The same will apply after that person gets an increase during the year.

 

On the other hand disadvantages could be:

 

-          The tax deducted each month could differ from the amounts due according to the official tax tables – this could cause endless queries from employees. Bear in mind though that at the end of the tax year or on termination of an employee the total tax deducted at that point will tally up with what the official tax tables determine, and,

-          If an employee’s earnings fluctuate each month as a result of commissions or overtime etc, forecast earnings as well as tax deducted for each month will fluctuate radically – hence lots of queries from the employee.

 

3-Cumulative (based on averaged year to date earnings): This method assumes that the employee will earn, on average, what he has earned in the past, again in the future (i.e. to the end of the tax year). So it, as with the previous method, it uses past earnings to determine the estimated annual earnings – the only difference however being, that this method forecasts future earnings based on averaged past earnings, whereas the previous method uses the current months earnings to forecast the future earnings.

 

For Example:

 

Scenario 1:

(same monthly earnings – Mar to Jul)

Scenario 2:

(same monthly earnings – Mar to Jul)

Earnings for Aug

R16 000

Earnings for Aug

R  16,000

Earnings for Mar – Jul

R40 000

Earnings for Mar – Jul

R  40 000

Forecasted Sept – Feb

R48 000

Forecasted Sept – Feb

R  56 000

Total for the year

R96 000

Total for the year

R112 000

Annual Tax Due

R13 020

Annual Tax Due

R  16 100

Tax for 6 months worked

R  6 510

Tax for 6 months worked

R    8 050

Less Tax Paid

R  4 000

Less Tax Paid

R    4 000

Tax Due this month

R  2 510

Tax Due this month

R    4 050

 

In scenario 1 the calculation produces the same result as in both previous examples – providing that the employees’ earnings remain the same for the remainder of the year.

 

In scenario 2 where the employee earns double his normal earnings in August (i.e. the R16,000), this method will assume that he will earn the R9 333.34 per month for the remainder of the year (i.e. ((R40 000 + R16,000) / 6)  x 12 = R112,000) even if the R16,000 was a “once off” anomaly – however the following month when his earnings revert back to R8,000 the tax payable will correct itself and will also cause his tax due to the following month to be a bit less because he would have been put into a higher tax bracket in the previous month (i.e. as a result of his earning the R16,000 and as such would have paid more tax than he should have).

 

 

So, this method is also a self correcting method as each month goes by. As with the previous method by the last month in the tax year the tax paid for the year will be 100% correct, due to, once again, no estimating involved as actuals will be used at this stage.

 

This method is useful for employees whose earnings fluctuate regularly (i.e. who earn varying amounts of commission or overtime etc.) because what this calculation in effect does is to average out past earnings each month before it does the tax calculation.

 

The main advantage of this method is that should the employees’ earnings fluctuate each month the forecast annual earnings as well as tax due will not fluctuate wildly at all. The other advantage being that the forecast annual earnings are adjusted each month and obviously become more accurate as each month goes by (same as the method previously described).

 

What to watch out for though is that should you have an employee who earns a fixed salary and then at a point gets an increase, the tax due each month will increase but will be a bit more (after the increase) than what the official tax tables stipulate. This could result in a confused and unhappy employee. In addition to this the tax due each month will differ from the official tax tables but like the previous method will be correct should the employee terminate his employment or at tax year end.

 

In Summary…

 

In all three of these methods the amount calculated as the employees Annual Earnings will vary. All three methods however, are correct, so it doesn’t really make a difference which method you use as far as the Receiver is concerned, you just need to decide which is the most appropriate (and convenient!) for the employee/s in question.

 

At tax year end, where an employee’s earnings fluctuate, the non-cumulative method will virtually always result in incorrect tax having been deducted and as such a refund or an additional deduction from the employee may have to be made. In contrast the cumulative methods will virtually always be correct as they are both self adjusting each month.

 

You will have noticed that we have kept the employees earnings, in all the examples we used, very simple (i.e. there are no bonus amounts, overtime etc) as we really just wanted to illustrate the different methods as simply as possible.

 

Pay periods vs calendar days…

 

In all of the above examples we used what is known as “the number of pay periods in the tax year” when we annualized the employees’ earnings (12 months in our examples). One can also use “the number of calendar days in the tax year” as well. All of the above calculations can also be done by using the number of calendar days in a year (e.g. 365). The results of the calculations will be slightly different but over a period of a full year will ultimately render the same result.  The down side being that if they earn the same income in 2 28 day month and a 31 day month their tax will be slightly different.

 

Both ways are correct and both are permissible by the Receiver, you just need to decide which is the most practical for your company and which yields the least amount of queries from employees.

 


About Employees Tax | Page 1 of 7 | About Provisional Tax
 TitleOwnerCategoryModified DateSize 
Labour Only Subcontractor Directive (March 2005)meagan kinsman 5/27/200556.00 KBDownload