In the 2016 Budget Review, the Minister of Finance stated that in terms of the Income Tax Act 58 of 1962 (the ITA) and the Value-Added Tax Act 89 of 1991 (the VAT Act), a non-executive director’s (NED) fees may be subject to both employees’ tax (PAYE) and value-added tax (VAT).
The implications that arose therefrom proved contentious and views differed on whether to deduct PAYE from these fees or if the NED should register as a VAT vendor. It was proposed that the tax treatment of NEDs’ fees be investigated to provide clarity.
The South African Revenue Service (SARS) has now issued Binding General Ruling 40, which deals with PAYE (BGR 40) and Binding General Ruling 41, which deals with VAT (BGR 41).
An NED is not defined in the ITA, however the King Report on Governance for South Africa 2009, Volume 3 (King III) states that the crucial elements of an NEDs role are that an NED:
- must provide objective judgment independent of management of a company
- must not be involved in the management of the company
- is independent of management on issues such as, for instance, strategy, performance, resources and diversity.
A PAYE withholding obligation exists where a South African resident employer pays or is liable to pay remuneration to an employee.
Remuneration is very widely defined in tax legislation and includes almost any type of payment for services rendered. However, any amounts that are paid or payable in respect of services that are carried out independently of the employer do not fall within the definition of remuneration. In this instance, there is no PAYE withholding obligation.
In BGR 40 SARS accepts, in light of the elements set out by King III, that NEDs are not common law employees and that the only way that an NED would then be subject to PAYE would be if the statutory tests were satisfied.
The statutory tests
There are two statutory tests that must be satisfied in order for an independent contractor to be deemed to be an employee. The tests are as follows:
- the premises test: more than 50% of the services must be performed at the premises of the employer
- the control or supervision test: control or supervision must be exercised over either the manner in which the duties must be performed or the hours of work.
If only one or neither of these tests apply, then an NED is not deemed to be an employee and accordingly, the amounts payable to such an NED will not constitute remuneration.
Are employers obligated to deduct employees’ tax in respect of fees paid to NEDs? It follows that as an NED is not considered an employee, the fees paid to an NED for the rendering of their services do not constitute remuneration and are accordingly not subject to the deduction of PAYE.
The VAT treatment of independent contractors If NEDs are not employees and their income not subject to PAYE, are NEDs then classed as independent contractors who may be liable to register for VAT?
An independent contractor is a person who commits their labour to the employer to produce a given result in terms of a contract for services.
The VAT treatment of independent contractors is dealt with in section 1(1) of the definition of "enterprise" in the VAT Act.
Proviso (iii)(bb) to the definition of enterprise essentially stipulates that where the activities of the service provider display the characteristics of an independent enterprise or business activity, that person may be liable to register and charge VAT in respect of such enterprise activities carried on independently. This is distinct to the services rendered by an employee rendering services under an employment contract, to which no VAT obligations arise.
BGR 40 concludes that an NED is not considered to be a common law employee in light of the fact that the services must be supplied independently and personally by the NED to the employer. Any fee paid or payable to an NED is accordingly not considered to be remuneration for the purposes of the ITA.
Consequently, an NED is treated as an independent contractor for VAT purposes and as a result, is required to register and charge VAT in respect of any director's fees earned for services rendered as an NED.
An NED will be obligated to register if the value of such fees exceeds the compulsory VAT registration threshold of ZAR1 million in any consecutive 12 month period as provided for in section 23 of the VAT Act.
An NED may also voluntarily register for VAT in terms of section 23 of the VAT Act where the value of such fees does exceed the compulsory registration threshold but that person complies with the requirements of section 23(3) of the VAT Act.
BGR 40 and BGR 41 are effective from 1 June 2017.
By Keshen Govindsamy, an associate designate