EMPLOYEES' TAX and material misstatement

Accountancy SA,  Nov/Dec 2004  by Williams, Patricia

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Compliance with South African Auditing Standards

South African Auditing Standards require that auditors plan and perform audits to obtain reasonable assurance that the financial statements are free of material misstatement.

Salaries and salary-related costs often comprise a significant percentage of the total expenditure of an enterprise, therefore it is easy to envisage that incorrect employees' tax payments could result in material misstatements, even in the first year of occurrence. However, the audit procedures of many auditors do not adequately address the risks associated with employees' tax issues, partially because the approach followed does not mirror that of the South African Revenue Service (SARS) to any extent. Many audit clerks involved in auditing salary accounts also do not have sufficient understanding of employees' tax to recognise serious problems even if these are highlighted during certain audit procedures or client enquiries.

Other risks

Apart from the non-compliance with South African Auditing Standards, employees' tax risks pose a serious problem to audit firms, given the ever increasingly litigious audit environment. Negligent audit firms may also be liable to their clients for additional taxes, penalties and interest levied by SARS on underpaid employees' tax.

Compliance testing

While compliance testing can potentially go far in addressing employees' tax risks, audit firms frequently reach a favourable conclusion regarding employees' tax based on insufficient compliance testing. For example, the practice of checking that the correct version of the payroll package is installed and that there is segregation of duties within the payroll function, although being a useful start, is in itself insufficient. Auditors should review the remuneration policies and employees'tax treatment of the non-cash components of remuneration packages to ensure that the client is complying with its employees' tax obligations regarding fringe benefits and allowances.

Substantive testing

With regard to the more substantive-based approach followed largely by smaller firms, important risk areas are overlooked. For example, the Probe payroll audit programme addresses employees' tax risks in the following audit steps:

* Reconcile gross salaries, deductions and fringe benefits to IRP5S - Procedure 3 (presumably from the financial records of the company - no mention is made of employment contracts).

* For selected employees for a typical period, agree statutory deductions to relevant manuals - Procedure 4.2.2.

* Test to ensure deductions are paid over timeously - Procedure 4.5.

While these audit steps would pick up certain blatant errors, the following types of transactions frequently result in substantial employees' tax underpayments, and are not covered by the above payroll audit programme:

* Fixed and excessive subsistence allowances.

* Excessive travel allowances, a recent favourite target area of SARS.

* Fund rules (provident / medical / etc) not correctly specifying contribution rates.

* Improperly structured salary sacrifices.

* Cash book items, not going through the payroll, e.g. cellphone payments, entertainment bills paid, various other benefits paid for by the company as 'business' expenses.

SARS risk area: Fixed and excessive subsistence allowances

Employers sometimes pay fixed subsistence allowances, tax free. This is not permissible as per the Guideline for Employers (EMP10) published by SARS, read with Interpretation Note 14. The reason is that subsistence allowances are supposed to compensate an employee for the cost of meals, refreshments and other incidental costs while away from his or her normal place of business in abnormal circumstances, therefore the subsistence allowance cannot form part of the normal salary package of the employee.

Subsistence allowances paid in excess of the permissible standard amounts may not be untaxed. Subsistence allowances paid based on the permissible standard amounts but where the employer does not envisage that the employee will incur similar amounts of expenditure are also not in actual fact intended to compensate the employee for business costs, and are therefore not subsistence allowances, but rather ordinary remuneration which is fully taxable.

SARS risk area: Excessive travel allowance

A problem arises when an employee is paid an excessive travel allowance. In this regard, it is important to take note of the fact that travelling to and from work is not business travel for tax purposes. If the amount of the allowance or advance is more than the employee would realistically expend on business travel, SARS may apply a 'substance over form' approach, in other words tax the amount based on the actual substance of the transaction rather than the form in which it appears. In this case, a substance over form approach would result in the excessive portion being deemed to be part of the ordinary salary of the employee and subject to employees' tax in full. The employer would be liable for penalties and interest on the excessive portion of the travel allowance, and the employee would be restricted in his or her personal capacity to a travel claim up to the actual non-excessive part of the allowance.