Are directors exempt from PAYE?

January 2010

The debate

Historically, directors of private companies were excluded from employees’ tax as they did not receive regular remuneration throughout the year. This gave them a distinct advantage over normal salaried employees who had PAYE deducted from their salaries on a monthly basis.

The current definition of employee specifically includes directors of private companies. The question remains whether all directors of private companies would fall into the employees’ tax net by being included in the definition of an employee. There is also an argument that certain types of directors can be excluded from the employees’ tax net by meeting the requirements of trading independently.

The rules

Where an employer pays remuneration to an employee, the employer is required to deduct employees’ tax (commonly known as PAYE) from the remuneration and pay the tax deducted to SARS on a monthly basis.

The withholding of PAYE is only necessary where ‘remuneration’ is paid by an ‘employer’ or ‘representative employer’ to an ‘employee’. All three elements need to be present simultaneously before employees’ tax must be deducted.

Remuneration is very widely defined in tax legislation and includes almost any type of payment for services rendered. However, any amount paid or payable in respect of services rendered by any person in the course of ‘carrying on a trade independently from the employer’ would be excluded.

The tax legislation contains a number of statutory tests that if met, would immediately classify a person as not being independent. Even if the statutory tests are not met, the dominant impression of the relationship still needs to be formed in order to determine if a person is independent or not. SARS have provided guidelines on the dominant impression tests in their Interpretation note 17.

The contention

By trading independently, one of the three critical requirements for deducting employees’ tax is missing, as there would be no ‘remuneration’. Consider the three types of directors that can be appointed by a company, and understand the differences in their broad roles, responsibilities and basis of payment for their services.

Executive directors

• usually involved in the day to day management of the company
• full-time salaried employees of the company.

Non-executive directors

• not an employee, but rather a person external to the company
• not involved with the day to day management of the company
• no specific management responsibility
• usually involved on a part time basis
• ultimate responsibility for the management of the company is shared with the executive directors
• share the legal duties and responsibilities of the executive directors.

Independent non-executive directors

• not employed by the company, present or past
• not a retained professional advisor that is influenced by his / her fee
• not a supplier or customer of the company
• no family connections with someone in the company or group
• no significant dependence on his director’s fee from the company
• the ability to resign is a test of independence.

It is clear from the normal roles and responsibilities attributable to executive directors in relation to the company that they would not qualify as being independent.

However, once the tests (statutory and dominant impression) of independent contractors is applied to the roles and responsibilities of non-executive directors and independent non-executive directors, there exists a legitimate argument that these types of directors could indeed qualify as being independent and fall outside the employees’ tax net.

It is evident in the explanatory memorandum issued by SARS, when the definition of employee was amended to include directors of companies, that the intention of the legislator was to include into the employees’ tax net the director that operates exactly on the same basis as a salaried employee save for the fact that they are also a director of the company.

These directors would no longer receive the benefit of delaying the payment of taxes based on the provisional tax system, but employees’ tax would be deducted on a monthly basis. Based on the specific relationship and duties of a non-executive director in relation to the company, the intention of the legislator could not have been to include these directors in the employees’ tax net as with normal salaried employees.

The litmus test

Independence can not be applied carte blanche to all non-executive directors. To determine whether a non-executive director could possibly qualify as being independent in terms of the tax legislation in relation to a company, consider the role and responsibilities that each of the non-executive directors have in relation to that company, tested against the statutory and non-statutory tests in terms of the legislation.

Contact us

Cape Town Mike Teuchert Tax Partner T +27 (0)21 481-9000	Port Elizabeth Robin Nel Tax Manager T +27 (0)41 373-4200
Durban Tony Berman Tax Manager T +27 (0)31 576-5500	Pretoria / Tshwane Lawrence Hummel Deputy Managing Partner T +27 (0)12 346-1430
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Johannesburg AJ Jansen van Nieuwenhuizen Tax Director T +27 (0)11 322-4559

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© 2010 Grant Thornton South Africa. All rights reserved. Grant Thornton South Africa is a member firm within Grant Thornton International Ltd (‘Grant Thornton International’). Grant Thornton International and the member firms are not a worldwide partnership. Services are delivered by the member firms independently. You may quote freely from this publication, provided you acknowledge the source. This publication is an outline for information purposes and should not be relied upon for detailed planning. Readers are advised to consult professional advisors for guidance relating to new or existing legislation which might affect their business and personal decisions.