The recent High Court judgment in CSARS v HR Focus CC fundamentally clarifies when payroll administrators become liable for skills development levies (SDL) and value-added tax (VAT). More importantly, it demonstrates how courts will pierce through contractual labels to examine the commercial reality of employment relationships - a principle with far-reaching implications for the hundreds of businesses using outsourced payroll services.
The substance over form principle
HR Focus operated payroll services for approximately 4,500 employees of retailers. The South African Revenue Service (SARS) assessed the company for SDL and VAT, treating it as a labour broker that employed these workers. HR Focus argued it merely provided payroll services as an agent, while the retailers remained the true employers.
The court's analysis turned on a fundamental question: was HR Focus acting as principal or agent? This distinction matters because only employers fall within the Fourth Schedule definition that triggers SDL liability under the Skills Development Levies Act.
Three factors proved decisive. First, HR Focus had deliberately shifted its business model around 2010 from labour broking toward pure payroll administration, a strategic response to rumoured legislative changes. This historical context established clear intent to operate as an agent.
Second, the financial structure revealed agency. Clients deposited the full payroll amount into a dedicated account before HR Focus released any payments. HR Focus bore no financial risk; it was merely a conduit for client funds.
Third, operational control rested entirely with the retailers. The retailers recruited, interviewed, appointed, supervised, disciplined and terminated staff. They set wages, hours and bonuses. Employees wore uniforms of the retailers and were integrated into the operations of the retailers. HR Focus only acted on written instructions from its clients, the retailers.
Contractual labels versus commercial reality
SARS relied heavily on employment contracts that explicitly designated HR Focus as "employer". The court rejected this formalistic approach, accepting HR Focus' explanation that this designation served two non-tax purposes: providing standing to represent clients at the commissions for conciliation, mediation and arbitration (CCMA), and raising union recognition thresholds by consolidating thousands of employees under one entity.
The court looked beyond contractual labels to examine who actually exercised employer functions - a principle firmly established in the dominant impression test in South African labour law.
Tax consequences flow from employment classification. Once the court found HR Focus was not the employer, both the SDL and VAT assessments failed. SDL liability under section 3 of the Skills Development Levies Act falls on employers. VAT liability depended on SARS’ theory that HR Focus supplied labour for consideration, but agents paying wages on behalf of principals make no taxable supply.
The parol evidence rule modernised
SARS argued that written contracts were conclusive and that extrinsic evidence was inadmissible under the parol evidence rule. The court disagreed, applying the modern contextual interpretation approach from Natal Joint Municipal Pension Fund v Endumeni Municipality 2012 (4) SA 474 (CC).
The court admitted evidence of verbal agreements, engagement forms, payroll reports, and testimony explaining the tactical reasons for contractual designations. This reflects the modern position that contractual interpretation requires considering text, context and purpose together. Courts no longer need to find ambiguity before examining surrounding circumstances.
The ETI complication
SARS argued that HR Focus could not claim to be an agent for SDL purposes while simultaneously claiming employment tax incentive (ETI) as an employer. However, the court found that HR Focus processed ETI claims purely as an agent, crediting rebates back to the retailers/its clients through credit notes.
This finding has broader implications for the hundreds of ETI disputes currently pending the Tax Court hearing of test case IT 46233. In these disputes, SARS takes restrictive positions on ETI eligibility, arguing that labour brokers and employers with seconded staff cannot claim ETI because the individuals are not "employees" under the ETI Act as they do not "work directly" for the employers. Yet the Employment Tax Incentive Act was specifically amended to delete "directly" from the employee definition to allow labour brokers to claim ETI following the Assign Services Constitutional Court decision.
The narrow interpretation adopted by SARS in these disputes represents an ironic reversal from the SARS' position during the HR Focus audit. The judgment refers to a meeting during the HR Focus audit on 3 November 2016 where a senior SARS official confirmed to the taxpayer that labour brokers could claim ETI on their employees. The irony deepens in the current ETI disputes where SARS argues individuals are not employees for ETI purposes, while simultaneously accepting PAYE, UIF and SDL payments for those same individuals and vigorously defending against any refund claims for these taxes.
Key takeaways
HR Focus reinforces the principle that South African courts often examine commercial reality over contractual form. Whether for employment law, tax law, or regulatory compliance, the substance of relationships matters more than their labels. This principle extends beyond payroll services to any arrangement where parties attempt to structure relationships for regulatory advantage.
The judgment also modernises contractual interpretation, confirming that courts will admit contextual evidence even where contracts appear clear. The strict parol evidence rule has given way to a more holistic approach that considers text, context and purpose together.
For practitioners, the lesson is straightforward: align legal form with commercial substance but prepare to prove that substance if challenged. In an era of aggressive tax enforcement, comprehensive documentation of genuine commercial arrangements provides the best protection.
