The question whether non-executive directors (NED) of companies are employees or independent contractors has bedevilled taxpayers, and especially the payroll departments of companies, for years. The question is important because it goes to whether their fees are remuneration, and subject to PAYE, or fees for independent services, and potentially falling within the VAT net. Following an announcement in the 2016 Budget documents, SARS investigated these issues and the results appear in the form of Binding General Rulings 40 and 41 issued on 10 February 2017.
An NED is not defined in the Income Tax Act, 1962 (Act). According to the King III report, an NED must provide objective judgment independent of management, must not be involved in the management of a company, and must be independent of management on issues such as strategy, performance, resources and diversity. Put differently, the NED must not countenance undue influence and must show no bias.
BGR 40 takes these concepts and places them into the context of the Fourth Schedule to the Act, which provides the definitions of “remuneration”, “employee” and “employer”. The definitions are interrelated: an employee is a person who receives remuneration; remuneration is something paid to an employee; and an employer is a person who pays remuneration to another person.
The Fourth Schedule recognises two tests for determining whether a person is an employee.
The first is the so-called common law test, which broadly determines that a person who earns a salary, wage, stipend, commission, fee, bonus or some similar reward for services as an employee.
The second consists of two statutory tests which, even though the recipient is carrying on an independent trade, determine whether the reward for services is remuneration for purposes of the Fourth Schedule. These are the “premises” test, where the services must be performed mainly at the premises of the client; and the “control or supervision” test, where the client exercises control or supervision over the manner in which the duties are to be performed or the hours of work. Both statutory tests must be satisfied in order to render the recipient an employee in receipt of remuneration.
A moment’s reflection should lead one to conclude that a genuine NED, one who meets the criteria set out in King III, for example, cannot be an employee but must be an independent contractor. The prohibitions placed upon employees as to the deductions they may claim against remuneration will consequently not apply to NEDs, who may claim various expenses denied to employees.
Of course, if a person professes to be an NED but the facts indicate otherwise, not only is the company in breach of its governance obligations but it will also be in breach of its obligation to withhold PAYE from amounts paid to the “tame” NED.
Now to BGR 41. If an NED is not an employee, the question arises as to the nature of the amounts paid to the NED. BGR 41 deals with this. The NED, being an independent person, is carrying on an enterprise as defined in the Value-Added Tax Act, 1991 (VAT Act). Employment can never qualify as an enterprise for VAT purposes but the NED is not an employee. The next question is whether the NED is required or chooses to register as a vendor under the Vat Act. The crisp test here is whether the NED is continuously or regularly carrying on the enterprise of an NED. It is submitted that infrequent or occasional services as an NED would not qualify as an enterprise. However, an NED who is conducting that office correctly is likely to be conducting an enterprise because regularity and continuity are surely requirements of a genuine NED.
If the NED’s enterprise generates fees in excess of the compulsory registration threshold, currently R1 million, the NED must register. An NED whose fees are less than the threshold but who nonetheless wishes to register as a vendor may do so provided the fee income has exceeded R50 000 in the preceding period of 12 months.
In summary, an NED whose conduct meets the criteria expected of an independent director is not an employee of the company. The NED must submit invoices for services and, if necessary based on the monetary thresholds, register as a vendor and levy output tax on fees.
February 2017
