What happens when you have a second income?

The South African tax system is based on a progressive tax rate table, meaning that the more taxpayers earn, the higher the marginal tax rate and the more tax is payable on assessment.

Taxable income is calculated by taking into consideration all gross income, in cash or otherwise, received by or accrued to a resident taxpayer, after subtracting all allowable deductions, under the tax laws in the Republic.

An employer is liable under the provisions of the Fourth Schedule to the Income Tax Act to deduct employees’ tax (PAYE) on behalf of employees and must pay the amounts so deducted to SARS. Furthermore, the Act requires all registered employers to issue IRP5 certificates to their employees, for a relevant tax year, in which all income, allowable deductions, and tax paid are stated.

Individuals who earn only remuneration, or a salary, from an employer, are not allowed many deductions for tax purposes. An exception is if, for instance, the employee is granted a travel allowance. In that case, the employee must substantiate business travel to SARS with a logbook.

The Fourth Schedule also defines provisional taxpayers, which includes all taxpayers “who derive income by way of– (ii) any amount which does not constitute remuneration or an allowance or advance…”, as well as remuneration received from an employer who is not registered for employees’ tax.

Taxpayers who earn supplementary income such as consultancy, teaching, or other services income, in their own capacity as providers of the aforementioned services, are therefore by definition categorised as provisional taxpayers.

The perspective to be analysed is, therefore, the income tax implications for taxpayers who earn supplementary income in addition to remuneration.

SARS issued a publication on their website (http://www.sars.gov.za/TaxTypes/PIT/Pages/Income-from-two-sources.aspx), relating to income from two sources. In this publication, taxpayers are effortlessly guided on the tax consequences of receiving income from more than one source, as well as on options available to them to arrange for additional tax payments. The basis considered is an individual who receives both remuneration and pension incomes, where PAYE was deducted from both incomes.

We will, however, examine circumstances where a taxpayer receives a second income but no PAYE is deducted therefrom because the second income is not remuneration.

Additional income sources

If a taxpayer receives additional income such as consulting fees or other service fees, this is considered as income from a trade. Trade is defined in the Income Tax Act and “includes every profession, trade, business, employment, calling, occupation or venture…”. According to section 11, the Act allows the deduction of “expenditure and losses actually incurred in the production of the income, provided such expenditure and losses are not of a capital nature”. Taxpayers are therefore permitted to claim a deduction of their allowable expenses from their income from a trade.

Practical application

The practical application of this is that only expenses related to taxpayers’ additional income can be claimed as deductions in their income tax returns. These expenses would include, for instance, telephone and cell phone expenses if the taxpayer made calls to clients, travel costs, computer, printing and stationery, and internet costs and some home office expenses. The expenses must be typical to the nature of the taxpayer’s trade and incurred in the production of the freelance income. It is very important to highlight that the expenses must be proven by the taxpayer, as section 102 of the Tax Administration Act lays the burden of proof on the taxpayer to demonstrate that an amount is exempt, or non-taxable, or may be deducted or set off.

Another significant aspect to consider is that the taxpayer may claim the relative expenses only in proportion to the additional income. That is, for example, only cell phone calls made to the respective clients may be claimed, not the total cell phone bill for a billing period. The same would apply to other claimable deductions.

After considering the gross additional income received or accrued to them, less the allowable deductions, the person arrives at their taxable second income, which must be taken into account to calculate the person’s total tax liability.

The following example illustrates the practical application of the above:

 

R

R

Remuneration income

 

            250 000

Income from trade

75 000

             62 200

Less:

   

               Allowable deductions

-               12 800

 

               Computer expenses

-                  1 800

 

               Printing and stationery

-                  2 500

 

               Telephone costs

-                  3 500

 

               Travel expenses

-                  5 000

 

Total taxable income

 

            312 200

Normal tax payable

 

              53 130 *

Less: Tax paid (PAYE withheld by the employer)

 

              35  742*

Additional tax to be paid on assessment

 

17 387

* Income tax rates for 2018 tax year

In the said example the taxpayer, pursuant to receiving the additional income from trade, migrated to a higher income tax bracket. This results in additional tax to be paid on assessment, as the PAYE deducted by the employer is insufficient to cover the full tax liability of the taxpayer.

In the above case, SARS is entitled to raise penalties and interest on assessment with regard to the underpayment of income tax by the taxpayer.

How to avoid penalties and interest

To avoid a situation where penalties and interest are imposed by SARS, as discussed above, the person must register to become a provisional taxpayer and submit provisional tax returns in August and February each tax year, ensuring that adequate tax is paid. If income tax is overpaid, SARS will on assessment pay interest on the amount overpaid.

Paragraph 2 of the Fourth Schedule to the Income Tax Act allows a resident taxpayer to arrange with the respective employer to deduct additional PAYE. This option is, however, mostly suited to employees who earn a second income that is reflected on an IRP5 certificate. In other words, the person receives remuneration from two or more employers. In that case, the person is exposed to higher income tax rates, due to “moving up” in the progressive tax rate table.

If the taxpayer’s second income is income from trade and not from remuneration, then, he or she is a provisional taxpayer, as defined, and is obliged to be registered as such. They must then submit provisional tax returns twice a year and make two provisional tax payments for each year of assessment.

The Fourth Schedule to the Act also requires taxpayers to estimate their taxable income in a specific manner and provides for penalties for underpayment on provisional tax as a result of underestimation. It is thus vital that taxpayers with a second income, such as consultancy, or professional services rendered, not only register as provisional taxpayers but also accurately estimate their total taxable income in their provisional tax returns. This will enable them to avoid unnecessary penalties and interest imposed by SARS.

Last points

Taxpayers are advised to precisely complete the first page of their personal income tax returns (ITR12) on SARS’ eFiling platform, and to provide the required information accurately, as this will determine the relevant sections which will be generated on the income tax return. Typically, under the heading “Local Business, Trade and Professional Income” the question whether income was derived from local business, trade, or profession, other than rental income from letting of fixed property, should be answered “Yes”.

It is always recommended that taxpayers use the services of qualified and registered tax practitioners, who will be able to provide quality tax services and advise on all tax-related matters. Tax practitioners’ fees are also expense-deductible for income tax purposes in respect of taxpayers who earn income from trade.

This article was published first in TaxTalk Issue 71 July/August 2018