August 2010 : issue 4

Independent Directors not subject to PAYE?

For a long time directors were deemed not to be employees and therefore not subject to Pay as You Earn (PAYE). The legislation was changed to bring directors under the PAYE net. There however seems to be no agreement as to the status of Independent directors. Some parties are of the opinion that independent directors are not caught in this legislated provision. This stems from the reason that they are 'independent' and thus cannot be seen as employees of the company. This would then put independent directors in the same stead as independent contractors. This article seeks to contribute to the debate by disagreeing with the above mentioned approach based on the provisions of the 4th Schedule of the Act.

Independent directors are often not involved in the day to day running of the business hence their tag of independence. They are however no less directors than the other directors. The idea is that while the executive directors may carry their management bias in board meetings and the independents provide the balance to help them make objective decisions. The hope is that the executive directors can remove their employee hat and wear their director hat and think in a different capacity. The payment for directorship duties is separate from the remuneration from being employees. Directorship becomes a separate occupation which is remunerated separately from employment. Director's payments even have their own code under employee remuneration codes. For tax purposes however, the Act does not seem to separate between executive and nonexecutive, independent or otherwise.

The Act defines an employee as, "a) any person (other than a company) who receives any remuneration or to whom any remuneration accrues... [and] any director of a private company who is not otherwise included in terms of paragraph (a)." Remuneration is in turn defined as, "any amount of income which is paid or is payable to any person by way of any salary, leave pay, wage, overtime pay, bonus, gratuity, commission, fee, emolument, pension, superannuation allowance, retiring allowance or stipend, whether in cash or otherwise and whether or not in respect of services rendered." Directors are paid amounts often referred to as director's emoluments. Emoluments are included as remuneration so payments to directors therefore are remuneration and subject to PAYE. It sounds logical until one realizes that excluded from remuneration is remuneration paid to independent contractors. This is the gap some seek to exploit and claim that independent directorship and independent contracting are rather synonymous.

A director who claims to be an independent contractor needs to pass both the statutory and common law tests. These two tests, test among others, the independence to perform work without any control from the employer, exposure of the worker to profits and losses and flexibility of the worker to substitute themselves with someone in the event of tight schedules or the discretion of the worker. When the tests are applied it is possible that for directors there may be no conclusive result as to their status. An independent director is required to attend board meetings at a certain time (and thus be deemed to be under the control of the employer and making him an employee) but is independent in the way that work is performed (meaning he is not controlled by the employer and is an independent contractor). If the control test is used, even SARS admits that the concept of control has "undergone substantial refinement over the years." This sounds like code for 'may not be conclusive.' If argued well, the independent director may indeed be an independent contractor.

It seems because of the potential to escape that the based on the issue of remuneration, the definition of employee was expanded to include the director of a private company as quoted above. The Act distinguishes only between the directors of a private company and directors of entities that are not private companies. Thus if independent directors of a public company are independent contractors, they are not employees and do not have to have PAYE deducted from their pay. If an independent director does not qualify as an independent contractor or is a director of a private company then he is subject to PAYE. If all the three elements of PAYE being deducted are met i.e. there is an employer, there is an employee (by specific inclusion) and there is remuneration, the independence of a director becomes inconsequential. From an Income Tax Act perspective there may be a small chance for a company to escape the liability of PAYE, but the final blow is struck by the outgoing Companies Act. Section 225 of the Companies' Act states that, "No company shall pay to any of its directors (whether in his capacity as a director or otherwise) any remuneration free of any taxation in respect of his income, or otherwise calculated by reference to or varying with the amount of such taxation, or with the rate of taxation on incomes, except under a contract which was in force on the thirteenth day of June, 1949, and which provides expressly, and not merely by reference to the articles of the company, for payment of remuneration as aforesaid." So if one was appointed as a director after 1949, a company is breaking the law if it does not withhold any tax on directors' remuneration. This withholding tax is correctly called PAYE. Once the new Companies Act takes over there may indeed be a way out.

From the above, directors legally escaping liability for PAYE seems to require Houdiniesque skill. At best the issue regarding independent directors of companies other than private companies is a grey area that can be exploited. For companies, SARS Practice Note 17 states 'An employer who has incorrectly determined that a worker is an independent contractor is liable for the employees' tax that should have been deducted, as well as the concomitant penalties and interest.' The cost of looking for a way out of accounting for PAYE may seem hardly worth the risk. Companies are strongly encouraged to seriously consider the facts before not deducting PAYE from independent directors.

Independent directors are not necessarily independent contractors.