ETI Penalties – A Minefield
ETI Penalties – A Minefield
By Esther van Schalkwyk, Associate Director
The Employment Tax Incentive (“ETI”) is in theory a wonderful initiative. It was introduced on 1 January 2014 in response to the high rate of youth unemployment in South Africa. The incentive would reduce the cost of hiring young people between the ages of 18 and 29 through a cost-sharing mechanism with government while leaving wages unaffected, or so the Explanatory Memorandum went.
Eligible employers may claim the ETI in respect of qualifying employees by reducing their monthly employees’ tax (“PAYE”) otherwise payable to SARS, subject to the requirements and limitations contained in the ETI Act of 2013. The quantum of an ETI claim is determined by a formula driven by a qualifying employee’s level of monthly remuneration and whether it is their first or second year of employment.
The ETI Act previously defined an employee as a natural person, not being an independent contractor, who works for another person and who receives or is entitled to receive remuneration from that other person. In response to certain arrangements which have become the subject of court proceedings, from 1 March 2022 employees, for ETI purposes, also need to assist in carrying on or conducting their employers’ business and be documented in their employment records. While this amendment only came into operation for years of assessment commencing on or after 1 March 2022, SARS regards the amendment as merely clarifying the pre-existing legislation.
Employers who reduce their monthly PAYE in contravention of the ETI Act are subject to late payment penalties of 10% on the amount of PAYE underpaid (because of the setting off against their PAYE liability of invalid ETI claims), in addition to interest at the prescribed rate. For employers with large payrolls, the late payment penalties and interest alone can potentially run into millions since ETI audits may only uncover issues many months after an employer started claiming ETI. But wait, there’s more.
Since its promulgation, penalties under the ETI Act included:
The 2022 amendment to the Tax Administration Act goes beyond the intended target and seems to expose all ETI claims to understatement penalties, albeit reduced by penalties imposed under section 4(2) of the ETI Act (where the same ETI amount is subject to the 100% penalty discussed above).
Yet another harsh penalty was introduced into the ETI Act for years of assessment commencing on or after 1 March 2025 where an employer fails to disregard amounts not payable in cash to an employee in determining that employee’s “monthly remuneration” for ETI purposes.
The term “monthly remuneration” is defined in section 1(1) of the ETI Act as the monthly amount paid or payable to a qualifying employee who works for at least 160 hours in a month (apportioned for employees who work less than 160 hours in a month), provided that amounts not payable in cash to the employee, after adding back permitted deductions in terms of section 34(1)(b) of the Basic Conditions of Employment Act of 1997, must be disregarded.
Going forward, employers who receive the ETI without disregarding amounts not payable in cash to a qualifying employee in determining their monthly remuneration, will be subject to a penalty of 100% of the ETI received per month in respect of amounts that should have been disregarded. It is unclear whether the new penalty will apply in conjunction with any understatement penalty that may apply (ranging between 10% - 200% of the shortfall in “tax”), not to mention the 10% late payment penalty and interest for the underpayment of PAYE.
The importance of taking professional tax advice prior to entering the minefield of potential ETI penalties, cannot be overstated. While ETI is a wonderful initiative full of good intentions, it is one regime of which employers should not fall foul. Where an employer’s employees’ tax returns have been understated due to incorrect ETI claims, it may be possible to rectify the situation by means of the Voluntary Disclosure Programme contained in the Tax Administration Act. If successful, this would provide relief from, among other things, penalties for understatement and late payment.
The Employment Tax Incentive (“ETI”) is in theory a wonderful initiative. It was introduced on 1 January 2014 in response to the high rate of youth unemployment in South Africa. The incentive would reduce the cost of hiring young people between the ages of 18 and 29 through a cost-sharing mechanism with government while leaving wages unaffected, or so the Explanatory Memorandum went.
Eligible employers may claim the ETI in respect of qualifying employees by reducing their monthly employees’ tax (“PAYE”) otherwise payable to SARS, subject to the requirements and limitations contained in the ETI Act of 2013. The quantum of an ETI claim is determined by a formula driven by a qualifying employee’s level of monthly remuneration and whether it is their first or second year of employment.
The ETI Act previously defined an employee as a natural person, not being an independent contractor, who works for another person and who receives or is entitled to receive remuneration from that other person. In response to certain arrangements which have become the subject of court proceedings, from 1 March 2022 employees, for ETI purposes, also need to assist in carrying on or conducting their employers’ business and be documented in their employment records. While this amendment only came into operation for years of assessment commencing on or after 1 March 2022, SARS regards the amendment as merely clarifying the pre-existing legislation.
Employers who reduce their monthly PAYE in contravention of the ETI Act are subject to late payment penalties of 10% on the amount of PAYE underpaid (because of the setting off against their PAYE liability of invalid ETI claims), in addition to interest at the prescribed rate. For employers with large payrolls, the late payment penalties and interest alone can potentially run into millions since ETI audits may only uncover issues many months after an employer started claiming ETI. But wait, there’s more.
Since its promulgation, penalties under the ETI Act included:
- Section 5(1): A penalty of R30 000 for each displacement of an existing employee who was replaced by a qualifying employee for ETI purposes; and
- Section 4(2): A penalty of 100% of the ETI received per month in respect of an employee who received less than the applicable wage regulating measure or, if the wage was not subject to a wage regulating measure, R2 000 per month (assuming that the employee was paid remuneration for at least 160 hours in a month).
The 2022 amendment to the Tax Administration Act goes beyond the intended target and seems to expose all ETI claims to understatement penalties, albeit reduced by penalties imposed under section 4(2) of the ETI Act (where the same ETI amount is subject to the 100% penalty discussed above).
Yet another harsh penalty was introduced into the ETI Act for years of assessment commencing on or after 1 March 2025 where an employer fails to disregard amounts not payable in cash to an employee in determining that employee’s “monthly remuneration” for ETI purposes.
The term “monthly remuneration” is defined in section 1(1) of the ETI Act as the monthly amount paid or payable to a qualifying employee who works for at least 160 hours in a month (apportioned for employees who work less than 160 hours in a month), provided that amounts not payable in cash to the employee, after adding back permitted deductions in terms of section 34(1)(b) of the Basic Conditions of Employment Act of 1997, must be disregarded.
Going forward, employers who receive the ETI without disregarding amounts not payable in cash to a qualifying employee in determining their monthly remuneration, will be subject to a penalty of 100% of the ETI received per month in respect of amounts that should have been disregarded. It is unclear whether the new penalty will apply in conjunction with any understatement penalty that may apply (ranging between 10% - 200% of the shortfall in “tax”), not to mention the 10% late payment penalty and interest for the underpayment of PAYE.
The importance of taking professional tax advice prior to entering the minefield of potential ETI penalties, cannot be overstated. While ETI is a wonderful initiative full of good intentions, it is one regime of which employers should not fall foul. Where an employer’s employees’ tax returns have been understated due to incorrect ETI claims, it may be possible to rectify the situation by means of the Voluntary Disclosure Programme contained in the Tax Administration Act. If successful, this would provide relief from, among other things, penalties for understatement and late payment.