A Personal Service Provider (PSP) is a type of company or entity that provides services to clients, where the nature of the services is primarily based on the skills and labor of the individual providing them. The South African Revenue Service (SARS) defines a Personal Service Provider to be a business where the primary income derives from services provided by an individual who is personally engaged in the work.
Key Characteristics of a Personal Service Provider (PSP):
A business may be considered a Personal Service Provider if it meets certain conditions under South African tax law, particularly the Income Tax Act. These conditions generally focus on how the business operates and the nature of the services provided.
1. The Nature of the Services:
- The PSP offers services based on the personal skills or expertise of one or more individuals. These services typically require the individual to work directly with the client.
- It is often associated with professional services like consulting, accounting, legal services, IT development, engineering, or other personal services where the client’s need is specific to the individual’s expertise.
2. Relationships with Clients:
- The person providing the service is usually not independent but is dependent on the client for their work (e.g., the client specifies what needs to be done).
- The individual providing the services often works directly for a client in a capacity similar to an employee, even if they operate through their own company or other entity.
3. Employment-Like Relationship:
- If the service provider works under conditions where they are subject to control and their work is mainly performed for one client or within a structured environment (e.g., working under the direction or supervision of the client), the service provider may be considered a PSP.
- This is different from a regular independent contractor, who has a more flexible working arrangement, with multiple clients and the ability to delegate work.
4. Characteristics of a PSP Company:
If a company (Pty) Ltd, close corporation (CC), or other entity is formed to provide personal services and the only income earned is from those services, it may be classified as a Personal Service Provider. The following factors will make the company a PSP:
- The services are provided mainly by one or more connected persons (usually the directors or shareholders).
- The work performed is based on the personal skills of the connected person(s).
- The entity is set up in such a way that it doesn’t have substantial independent resources or assets beyond the skills of the individuals working in the business.
5. Legal and Tax Implications:
A business that qualifies as a Personal Service Provider faces specific tax rules under tax law, particularly regarding the employment tax and how the business income is treated for tax purposes. The business may be taxed more like an individual than a corporation. The tax implications for a PSP include:
- PSP companies are taxed on their profits in the same way as normal companies, but there are restrictions on claiming certain expenses or deductions.
- If a company is deemed to be a PSP, it cannot deduct certain expenses that would normally be deductible for a regular business.
- Salaries paid to individuals providing services may be treated similarly to employment income for tax purposes.
6. Specific Legislation for PSPs:
The Income Tax Act defines a PSP in section 69 of the tax legislation, which sets out the rules for taxing companies or close corporations that are considered Personal Service Providers.
A PSP is generally subject to a special tax regime where:
- The business may not be able to claim certain business deductions.
- The income of the PSP may be taxed as if the individual (or connected person) were employed by the client.
- The tax treatment may be harsher than for a regular independent contractor, as PSPs are seen as operating more like employees than independent businesses.
When is a Business Considered a Personal Service Provider?
A business may be considered a Personal Service Provider by SARS if:
- Majority of services are rendered by a connected person (like a director or shareholder).
- The services are rendered to a single client or a few clients under conditions where they are controlled or directed.
- The services are mainly dependent on the individual’s personal skills and labor, rather than capital or other resources.
If the business meets these criteria, it will be considered a PSP and taxed accordingly.
Consequences of Being Classified as a PSP:
- Employment Taxes: PSPs may be subject to PAYE (Pay As You Earn) tax, similar to regular employees. This means that personal service income may be taxed at higher rates compared to regular business profits.
- Limited Deductions: PSPs are restricted in claiming deductions related to business expenses. They may not claim certain business-related expenses as freely as other types of businesses.
- Potential Reclassification: If a company is operating as a PSP, it may need to reconsider its structure, as SARS may apply stricter tax rules on personal service income.
Summary:
A Personal Service Provider (PSP) is a business entity that primarily offers services based on the personal skills of individuals and is often seen in industries such as consulting, IT services, and professional services. The key characteristic of a PSP is the dependence on the personal services of the individual(s) providing the work, often leading to an employment-like relationship with the client. Businesses that qualify as PSPs are subject to special tax regulations, which may limit their ability to deduct expenses and subject their income to higher tax rates.
If you’re running a business that fits the definition of a Personal Service Provider, it’s important to be aware of these tax implications and consult with a tax advisor to ensure compliance with SARS regulations.