By Ettiene Retief
The question in regards the requirement to deduct employees’ tax from the remuneration paid to non-executive directors (NED), or whether the NED would be required to be registered for VAT, has been longstanding debate. Often companies applied the more cautious approach and deducted employees’ tax. Previously, SARS issued VAT rulings indicating that directors’ activities do not constitute an ‘enterprise’ supporting the requirement to deduct employees’ tax and requirement for registration as a VAT vendor is the carrying on of an enterprise, however these rulings were withdrawn together with the other rulings in 2007 (with the introduction of the Tax Administration Act and binding rulings mechanism).
Following the 2016 Budget and tax proposals table by the then Minister of Finance, National Treasury and SARS proposed that the matter be investigated and addressed in an Interpretation Note. SARS, without first issuing a draft for public comment (which is the common practice), issued on 10th February 2017 two Binding General Rulings to address the uncertainty. SARS sets out its interpretation in regards employees’ tax in ruling BGR40, and in regards VAT in ruling BGR41. SARS re-issued the BGR41 ruling in regards VAT treatment of NED as ‘issue 2’ on the 5th May 2017.
The rulings provide less substance and grounds for SARS’ interpretation of the laws than would generally be available in an Interpretation Note. However, the rulings are binding on SARS as from 1 June 2017, which provides some comfort for the taxpayer. Also, it must be noted that the rulings are not binding on the taxpayer (company or NED).
The Companies Act defines a “director” to mean a member of the board of a company, alternate directors, and includes any person occupying the position of a director or alternative director, by whatever name designated. The Companies Act does not expressly define a non-executive director. In fact, a NED has the same duties, requirements, and liabilities as that of any other director. In some instances, such as the audit committee members, it is required that the director not be party to the day-to-day management activities. The independence required is to avoid biases and conflicts of interests. In the context of independent enterprise, the independence is that the person is acting for his own account. Section 76(3) of the Companies Act prescribes that, in addition to the limitations regarding personal financial interests, a director of a company, when acting in that capacity, must exercise the powers and perform the functions of director in good faith and for a proper purpose; in the best interests of the company; and with the required degree of care, skill and diligence.
In Howard v Herrigel 1991 (2) SA 660 (A) the Court held that “it is unhelpful and even misleading to classify company directors as ‘executive’ or ‘non-executive’ for purposes of ascertaining their duties to the company or when any specific or affirmative action is required of them”, which was confirmed in Cyberscene Ltd and Others v i-Kiosk Internet and Information (Pty) Ltd 2000 (3) SA 806 (C) that a director stands in the fiduciary relationship to the company of which he/she is a director, even if he/she is a NED. Neither the Income Tax Act nor Value-Added Tax Act specifically define or recognise the NED. This is part of the issue, as fees paid to a NED should be no different than fees paid to an executive director, as both as fees paid for the holding of an office.
SARS confirmed that the independency of an NED from management and day-to-day operations of a company should not be confused with the independency from the company itself. In the BGR40 ruling sets out SARS’s interpretation of the employees’ tax provisions in regards fees paid to NED, and also confirms the impact of such on the provisions that restrict deductions against remuneration (section 23(m) of the Income Tax Act).
SARS defines a NED as a director who is not involved in the daily management or operations of a company, but attends and provides objective judgement on the company’s affairs and vote at board meetings. SARS further concedes that the nature of the duties performed by a NED means that they should not be regarded as common-law employees (applying the common-law dominant impression test). However, the Income Tax Act still requires a statutory test to be applied, which will effectively deem the person to be an employee for purposes tax if the ‘premises’ test and the ‘control or supervision’ test are satisfied.
SARS referenced that a contractual relationship regulating the number of hours for preparation is not ‘control or supervision’, but SARS did not provide a specific view as to ‘control and supervision’ in regards the meetings, as the location, duration , and time allocated to meetings are typically not set by the NED and will be at the company’s premises. SARS generally accepts that no control or supervision is exercised over the manner in which a NED performs his/her duties or their hours of work. It should be noted that the ruling does not apply in regards non-resident NED or independent contractors.
It is confirmed that the section 23(m) provisions that prohibits employees and office holders from claiming certain expenses would not apply in regards NED due to the director’s fees falling outside of the definition of ‘remuneration’. Deductions claimed by a NED must still meet the requirements of the general deduction formula, and some expenses (such as for an office at home, or cell phone and data services) may need to be apportioned where the expense is not exclusively incurred for trade purposes.
As the ruling is effective from 1 June 2017, you can’t rely on this ruling for prior years of assessment where SARS denied deductions claimed on the grounds of section 23(m).
The ruling specifies that director’s fees paid to a NED for services rendered in that capacity on a company’s board do not constitute ‘remuneration’ and therefore not subject to the deduction of employees’ tax. The NED will reflect the income received from services rendered, and must be recognised for provisional tax purposes. It is important that the NED correctly estimate and pay provisional tax, as failing to pay timeously or estimate correctly could result in significant penalties and interest charges.
As the ruling is effective from 1 June 2017, should the company only apply this ruling in regards fees accrued to NED after 1 June 2017? There is a risk of early adoption, but if the company is satisfied that it does not exercise supervision or control over resident NEDs, then early adoption could be applied. Any employees’ tax deducted for the period 1 March to 31 May 2017 must still be recognised in the employer reconciliations, and a tax certificate issued after the close of the 2018 tax year.
Following the BGR40, the same principals of common-law employment, and reference to the independent trade exclusion from ‘remuneration’, ruling BGR41 addressed the VAT implications. The BGR41 ruling stipulates that the NED that carries on an ‘enterprise’ in South Africa is required to register as a vendor and charge VAT where the value of all fees received for NED activities exceed R1-million in any 12 consecutive months.
There are still some questions as to whether SARS correctly interpreted the Value-Added Tax Act, as SARS considers a NED to be an independent contractor as per sub-section (iii)(bb) to the definition of “enterprise” in section 1 of the Value-Added Tax Act. As sub-section (iii)(bb) only applies to services rendered by employees or office holders (as contemplated by sub-section (iii)(aa)) where the remuneration payable constitutes “remuneration” as defined in the Fourth Schedule to the Income Tax Act, and SARS ruled in BGR40 that the amounts paid to NED is not “remuneration”, therefore sub-section (iii)(bb) is not applicable. As the rulings are binding on SARS, there is little risk for the company or NED to rely on such in its present form.
Furthermore, there still remains the question of whether such activities of attending and voting at board meetings comprise the “supply” of “services” as defined in the Value-Added Tax Act, or are they merely the fulfilment of the statutory duties of the NED. Also, the NED is elected to that position in his/her personal capacity to serve a fixed term in terms of the Companies Act, which is different from the typical independent contractor who is appointed under a contract to provide specific services, and who can delegate the performance of the services. The ruling does not address this question, but it is implied that SARS does regard such activities of the NED to be the supply of services.
As the rulings are effective from 1 June 2017, there was is a risk that SARS could attack prior periods based on SARS’s interpretation, considering there has been no relevant legislative changes. However, to address this risk SARS re-issued the ruling in regards VAT in which the Commissioner applies section 23(4)(b) of the Value-Added Tax Act, which effectively allows that the Commissioner to determine a later date for liability to register for VAT. What this means is that SARS deems the NED not to be liable to be registered for VAT prior to 1 June 2017. It is important to note that a NED that is required to be register for VAT should file a VAT registration application before 1 June 2017 to avoid penalties and interest charges.
The VAT registration process can be a little frustrating and delays in registration are common. Specific supporting documentation must be supplied when making the application for VAT, as any missing information or supporting documentation SARS generally treat as an incomplete application, and therefore not a valid application. For an NED that is required to be registered for VAT must ensure that the application is complete, with all required supporting documentation, before 1 June 2017. Where an NED receives fees in aggregate which is less than R1-million in a 12-month period is not required to be registered for VAT, but can elect to register for VAT on a voluntary basis as from 1 June 2017.
Payment of director’s fees must be authorised, and the resolution passed prior to these rulings would likely not have accounted for the impact of VAT. Considering that the law deems the amount paid to a vendor to be inclusive of VAT, the payments made to NED will be inclusive of VAT. This means that the resolution should be updated to recognise the impact of VAT and state to the authorised fees to be excluding VAT, before the payment is made to the NED.
The company (being a registered vendor) can generally claim the input tax deduction in regards the VAT charged by the NED. But in some cases the deduction would have to be apportioned based on the companies taxable supplies. This risk is relevant in a group of companies, where the holding company receives substantial dividends and interest income from its subsidiaries, and the NED is appointed and paid from the holding company. SARS generally applies section 17(1) of the Value-Added Tax Act, in regards apportionment of input tax deductions, based on the ratio of turnover (not only applying ratio of turnover as the method of apportionment) and do not consider the intended use of the goods or services in the making of taxable supplies. This results in apportionment of input tax deductions (including the VAT charged by NED) based on dividends and interest income received by the holding company.