How does SARS decide if someone is a contractor or employee?

SARS applies the dominant-impression test from the Fourth Schedule of the Income Tax Act, weighing factors like control over how and when work is done, integration into the business, exclusivity, ownership of tools, financial risk, and right to substitute. No single factor decides — the overall picture does. There are also two statutory employees: anyone working mainly at the client's premises under their control, and any person earning more than 80% of their income from a single client.

Does a contractor pay PAYE?

Genuine independent contractors don't have PAYE withheld — they receive gross payments and pay provisional tax (IRP6) twice a year on their net business income. Statutory employees (the 80% rule, or working under client control) have PAYE withheld at the standard tables, even though they may invoice rather than receive a payslip.

What happens if SARS reclassifies a contractor as an employee?

The hiring business becomes liable for the PAYE that should have been withheld, plus 10% penalty plus interest, plus UIF and SDL. The amount can go back several years. The 'contractor' is left having paid provisional tax and may have to claim a refund — not impossible but messy.

Can I deduct business expenses as a contractor?

Yes — genuine contractors are running a trade and can deduct expenses incurred in producing income: home-office costs (apportioned), professional fees, equipment depreciation, business travel, internet, etc. An employee can only deduct a narrow set (RA contributions, donations, certain home-office costs under tight rules).

Independent contractor vs employee

Why the distinction matters

An employee has PAYE withheld monthly, can't deduct most expenses, and gets UIF, SDL, and (often) leave and pension built into their employment. A contractor invoices gross, pays provisional tax (IRP6) twice a year, can deduct legitimate business expenses, and shoulders all their own retirement and risk cover. The numbers can differ by tens of thousands of rand a year.

SARS doesn't trust the labels people put on relationships. Two contractors with identical contracts can be treated differently if one looks like an employee in practice and the other looks like a genuine third-party service provider.

The dominant-impression test

This is the test from the Fourth Schedule of the Income Tax Act, and it's the one SARS and the courts apply. There's no scoring system; the test is qualitative. Among the factors that point to employment:

The "client" controls when, where, and how the work is done
Work is performed at the client's premises, with the client's tools / equipment / IT systems
Reporting lines exist (manager, performance reviews, HR processes)
Payment is a fixed monthly amount that doesn't change with output
The worker is integrated into the client's business — attends meetings, has a company email, is listed on the org chart
Exclusivity — the worker only works for this client and is contractually prevented from taking other work
The worker bears no real financial risk (gets paid whether the project succeeds or fails)
The worker can't substitute someone else — they personally must do the work

Factors pointing to genuine contracting: own tools, multiple clients, output-based pricing, ability to substitute, real financial risk, control over work hours and method.

The two statutory employees

On top of the dominant-impression test, the Fourth Schedule deems two specific cases to be employees regardless of the broader picture:

Anyone working mainly at the client's premises and subject to their control or supervision. If you're sitting in the client's open-plan office every day and reporting to their team lead, the contract on your laptop doesn't help you.
Anyone receiving more than 80% of their gross income from a single source. The "80% rule" — if one client makes up over four-fifths of your income for the tax year, you're treated as an employee for PAYE purposes (with one exception: if you employ three or more full-time non-relative employees yourself, you're treated as a true business and exempt from this rule).

Both rules trigger PAYE withholding by the client. They don't make the worker a common-law employee for labour-law purposes — but for tax, the result is the same as employment.

What each pays in tax

An employee on R600,000 a year:

PAYE deducted monthly using the SARS tax tables (about R10,500/month for under-65)
UIF: 1% from employee, 1% from employer, capped at R177.12 each per month
SDL: 1% from employer if total payroll > R500,000/year
Year-end ITR12 reconciles, usually generates a small refund or balance owing

A genuine contractor on R600,000 a year:

Receives R600,000 gross with no withholding
Files IRP6 provisional tax twice a year (end of August and end of February)
Deducts legitimate business expenses — home office, equipment, travel, professional fees, etc.
Files ITR12 with full income and expense schedule
Net tax is roughly comparable to PAYE, but timing and deductions differ
Must arrange own UIF, retirement, and disability cover

Consequences of getting it wrong

If SARS audits and reclassifies a contractor as an employee, the hiring business takes the hit:

PAYE that should have been withheld for the past several years (typically up to four years back)
10% late-payment penalty on each EMP201 period
Interest on each underpayment from the original due date
Possibly UIF and SDL too

The "contractor" who's been filing IRP6 needs to claim a refund of the provisional tax they paid. They get there eventually but it's a paperwork burden. The relationship usually doesn't survive.

How to set it up properly

If you want a relationship to genuinely be contracting, build it that way from day one:

Pay against invoices for completed deliverables, not flat monthly retainers
Don't require fixed working hours or attendance at internal meetings
Let the contractor work from their own premises with their own equipment
Don't include them in HR processes (performance reviews, leave forms, etc.)
Make sure they have, and can take, other clients
Use written agreements that reflect reality — but remember the contract is evidence, not the answer

If the work genuinely needs someone in your office every day reporting to your team lead, that's an employment relationship — pay PAYE and use a proper employment contract. Trying to dress it up as contracting is the most common audit trigger SARS sees in this space.