Distinguish between "Employment" and "Individual Independent Service Provider (ISP)" in Sri Lankan Context

The Inland Revenue Department ("IRD") of Sri Lanka released Circular SEC/2023/02 on July 18, 2023. This circular provides clarity on defining employment income and service fee payments made to individual taxpayers, addressing practical issues related to taxation in Sri Lanka.

1.?Why IRD issue this circular?

For Employment:

• If you're an employee, your employer deducts taxes (Advance Personal Income Tax - APIT) from your monthly salary.
• You don't have to worry about paying taxes separately because your employer takes care of it.

For Independent Service Providers (ISPs):

• ISPs, on the other hand, have a different tax setup.
• When they get paid, there's a 5% withholding tax deducted right away.
• However, ISPs need to calculate and pay the remaining tax themselves, typically on a quarterly basis.

It's crucial to follow these tax rules correctly because if you don't, you could face penalties and interest charges. So, employees have taxes automatically deducted by their employers, while ISPs have to handle more of their tax responsibilities independently.

2.?What is employment in accordance with the Income Tax Law?

An employee is an individual engaged in employment.

Employment means, a position of an individual in the employment of another.

• A position of an individual as a manager of an entity
• A position of an individual entitling the individual to a fixed or ascertainable remuneration in respect to services performed;
• A public office held by an individual;
• A position for an individual to whom a payment is made or due by or from an employer or who receives any other benefit as an employee or in a similar capacity;
• A position as a corporation or company director;
• include a past, present or prospective employment.

3.?Who is an Independent Service provider (ISP) in accordance with the Income tax law?

This is not defined in the Income Tax Act in Sri Lanka, however, when determining whether someone is an independent contractor or an employee, many jurisdictions, including the United States, consider the level of control the payer has over the work.

In the United States, the general rule is that an individual is considered an independent contractor if the payer can control or direct the result of the work but not the specific details of how the work is done. This distinction is crucial because it affects how taxes and employment laws apply to the individual.

4.?As per the Circular issued the General Criteria’s to clarify the difference between employment and ISP are;

• Applicability of usual rights set out in the labor laws
• Employment related by-laws
• Degree of control
• The permanence of the relationship
• Independence
• Ability to subcontract the assigned task.

5.?Factors to consider classifying Employment vs ISP as per the Circular issued by IRD Sri Lanka

Employment

• Are told what is required and how it should be done
• Equipment and materials are provided
• Has no power to delegate their duties to 3rd party
• Remunerated by fixed and determinable amounts for the time worked. Zero risk
• Bound by entity rules, regulations, circulars, terms, and conditions of the contracts

Independent Service Provider (ISP)

• Are told what is required but not how they are to do it
• Use of own equipment and materials
• Has the power to delegate their duties to 3rd party
• Take risks and derive varying returns and may even incur losses
• No limitation by entity rules and regulations

6.????? Is visiting lecturer ISP ?

Lecturer with Multiple Roles:

• If a lecturer has two roles, like teaching postgraduate students and performing other faculty duties, it's considered one employment contract.
• This means they're subject to Advance Personal Income Tax (APIT) for their regular duties, including during sabbatical leave.
• The lecturer should give their primary employment details to their employer.

Subject Matter Experts Giving Special Lectures:

• Subject matter experts who give special lectures are seen as Independent Service Providers (ISPs).
• They're subject to withholding tax when they get paid for their services.

Rejoining After Retirement or Resignation:

• If an employee comes back to work after retirement or resignation and doesn't have certain employment benefits like EPF, ETF, pension, health insurance, or gratuity etc., they're still considered an employee.
• They remain subject to APIT for their income.

In simple terms, if a lecturer has multiple roles, it's one employment contract subject to APIT. Subject matter experts giving special lectures are treated as independent service providers and taxed accordingly. Even if someone returns to work after retirement or resignation without certain benefits, they're still considered employees and pay APIT.

7.?Is the director a council, board, commission, Authority, or committee or entities considered as ISP?

Yes, As an individual is involved in making senior management decisions for a company, whether alone or with others, it's considered employment within that company.

The employee should provide a primary employment declaration.

??Point to take!

It's important to note that the classification of workers can vary from one jurisdiction to another, and specific criteria may be used to determine someone's status as an independent contractor or an employee. Therefore, it's essential for individuals and businesses to be aware of and comply with the relevant legal definitions and circulars issued by IRD to avoid legal and tax issues.