By Faye Nair, Tax Trainee at BDO SA
The South African Revenue Service (“SARS”) recently published two Binding General Rulings (“BGR”) providing its view on the treatment of Non-Executive Director (“NED”) services and fees. A welcomed response from SARS in the wake of significant uncertainty.
Prior to the BGR’s, NED fees were viewed by some as remuneration in terms of the Income Tax Act, subject to employees’ withholdings tax (“PAYE”). The NEDs were able to remain outside of the VAT net on the basis that their services were excluded from the definition of enterprise in the VAT Act. Simply put, vendors argue that if NED fees are subject to PAYE, it should not be subject to VAT as well. The uncertainty originated from the interpretation of the concept of independence as it relates to NEDs and whether NEDs should be treated as employees or independent traders. Despite statutory tests applying to the carrying on of an independent trade, the application of the law to NEDs remained unclear. Of the two statutory tests – commonly referred to as the premises and control or supervision tests – the latter presented the most interpretative complexity. It tests whether the NED’s services or the related working hours are controlled or supervised. Intuitively, NEDs act independently of the company – providing services on an independent basis, uninvolved in the day-to-day operations of the company. So, if the number of hours to be spent on preparation for board meetings are formally agreed on, would this constitute control or supervision? On the other hand, the premises test requires NED services to be performed mainly (>50%) at the premises of the company. This is not difficult to meet if board meetings are held at the company’s premises. However, what if NEDs spend most of their time fulfilling their duties elsewhere, which is often the case? Both statutory tests need to be met for the fee to constitute remuneration, but the lack of clarity on what is meant by independence resulted in inconsistent application of the law. BGR 40 and 41 finally provide a definitive guidance on SARS’ interpretation of the law. Although this is not a change in law, it provides insight into how SARS will assess NEDs going forward.
Employee versus independent trader
In terms of BGR 40 (Income Tax), a NED is not a common law employee due to its duties not forming part of the day-to-day operations of the company. BGR 40 also accepts that the control or supervision test is not met if a NED provides its services in a NED capacity. SARS argue that even though a contractual link may exist in respect of the quantum of hours that may be spent in meetings or the preparation for such meetings, this does not extend to how or what is done during those hours. Since both statutory tests are not met, the NED is deemed not to receive remuneration and the fee is, as a result, not subject to PAYE.
VAT registration liability
Since a NED does not receive remuneration, the NED services should be included in the definition of enterprise for VAT purposes. BGR 41 (VAT) distinguishes between an employee and an independent contractor and brings the latter into the VAT net. If a person commits its productive capacity to another, a contract of employment exists and the person is an employee. If a person commits its labour to produce a result for another, a contract for services exists and the person is an independent contractor. The services of a NED are more akin to the latter and consequently SARS views a NED is an independent contractor that carries on a VAT enterprise. However, this does not create a VAT registration liability in isolation. If a NED continuously and regularly carries on an enterprise in South Africa and the fees exceed or will exceed R1 million in any consecutive 12-month period, the NED is required to register for VAT purposes. The NED will then be required to levy VAT at the standard rate (currently 14%) on its fees (but for potential zero-rating). A NED may in certain instances voluntarily register as a VAT vendor.
The rulings mainly deal with South African tax resident NEDs. However, it is arguable that certain NED’s may still be subject to PAYE and liable to register for VAT purposes. NED payments for services rendered (i) to or on behalf of a labour broker; (ii) who are labour brokers; or (iii) who are non-residents, are regarded as remuneration, irrespective of whether a trade is carried on independently for income tax purposes. For VAT purposes, NEDs receiving remuneration do not necessarily escape the VAT net merely because they receive remuneration. If a NED is an independent contractor in terms of BGR 41, a VAT liability may also arise since tests for independence vis-à-vis remuneration and enterprise should be considered independently. PAYE will then need to be withheld net of the VAT levied on these fees. Non-resident NEDs will have a VAT liability if their services are physically performed in South Africa on a continuous or regular basis. A non-resident NED providing services remotely for consumption in South Africa on a continuous basis could face a significant VAT liability.
NEDs should be familiar with SARS’ interpretation of the law as it is the basis on which NEDs will likely be assessed going forward. The BGRs are effective from 1 June 2017 and, in some instances, SARS may potentially apply the law retrospectively, and impose penalties and interest on the outstanding liability.
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