There has been uncertainty regarding the employees’ tax and VAT treatment of fees paid to non-executive directors for some time. The issue was highlighted in the 2016 Budget Review and SARS has also expressed various conflicting views on these points, in interactions with taxpayers.
In February, SARS issued binding general rulings 40 and 41, to bring more clarity on these issues. These rulings reflect a more favourable tax interpretation for South African resident non-executive directors, in relation to employees’ tax and income tax. However, the tax treatment of non-resident non-executives remains punitive.
Are resident non-executive directors’ fees “remuneration” for employees’ tax purposes?
In binding general ruling 40, it was held that non-executive directors are not common law employees and would only be subject to employees’ tax if the statutory tests apply. The statutory tests are the premises test and the control or supervision test. The former requires more than 50% of the services to be performed at the premises of the client, while the latter requires supervision to be exercised over either the hours of work or the manner in which duties must be performed.
Both tests must be satisfied for non-executive directors’ fees to be deemed remuneration for employees’ tax purposes. If only one or neither test is satisfied and the non-executive director is not a common-law employee, the fees received by the non-executive director will not be deemed remuneration for employee’s tax purposes and the director will be deemed to be carrying on an independent trade.
This also means that the general prohibition against claiming certain tax deductions, in section 23(m) of the Income Tax Act, would not apply in relation to these non-executive directors deemed to be carrying on an independent trade. This is because the general prohibition is triggered when one holds an office and derives remuneration in respect of that office. Despite non-executive directors being holders of office, it has been established that the fees they receive are not remuneration. As such, the section 23(m) prohibition will not apply and the ordinary rules for the deductibility of expenditure, losses or allowances will apply.
Different employees’ tax and income tax treatment for non-resident non-executive directors
This ruling specifies that it does not apply to non-resident directors. The situation is different for non-residents, because exclusion (ii) to the definition of remuneration in the Fourth Schedule to the Income Tax Act excludes non-residents from the rule that amounts in respect of services by an independent contractor are not remuneration.
This means that fees paid to non-resident non-executive directors will be considered remuneration and be subject to employees’ tax. It also means that the limitation on available tax deductions in section 23(m) of the Income Tax Act, would apply to non-resident non-executive directors.
The employees’ tax and income tax treatment for non-resident non-executive directors is therefore more punitive than that of resident non-executive directors.
VAT on non-executive directors’ fees
Binding general ruling 41 deals with the VAT treatment of non-executive directors’ fees.
A VAT enterprise generally does not include services for which “remuneration” is received, unless this relates to an enterprise carried on independently of the employer (in terms of proviso (iii) to the definition of “enterprise” in section 1 of the Value-Added Tax Act).
In essence, because of SARS’ conclusion that a non-executive director (resident or non-resident) is carrying on her/his office independently of the company concerned, the exclusion from a VAT enterprise for services for which “remuneration” is received, would not apply. Since there is no available exclusion, the normal test would be applied. This means that a non-executive director is considered to be carrying on an enterprise and is consequently required to register and charge VAT in respect of any fees he receives as director in relation to activities within South Africa, if these fees exceed the R1 million annual threshold for VAT registration.
Put simply, SARS wants VAT on non-executive directors’ fees, even where these are also subject to employees’ tax.
For non-resident, non-executive directors, it is important to note that it is the physical presence in South Africa, and not the “source” of the income for tax purposes, that gives rise to a potential VAT registration liability. In other words, it is attending board meetings in South Africa, that would give rise to a potential VAT registration liability. If the non-resident non-executive director attends the board meetings via video conference or teleconference from outside of South Africa, no South African VAT liability would arise.
In summary
• Resident non-executive directors are not subject to employees’ tax.
• Resident non-executive directors can claim income tax deductions for expenditure incurred in relation to their office as directors, as the general prohibition against claiming certain tax deductions in section 23(m) of the Income Tax Act does not apply to them.
• Non-executive directors (resident and non-resident) are considered to be carrying on an enterprise, and are therefore required to register and charge VAT in respect of fees they receive as director in South Africa if the fees exceed the R1 million annual VAT registration threshold.
• Fees paid to non-resident non-executive directors are considered remuneration and therefore subject to employees’ tax.
• Non-resident non-executive directors are denied various income tax deductions for expenditure incurred in relation to their office as directors, in terms of section 23(m) of the Income Tax Act, because they earn “remuneration”.
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