When directors must PAYE

COMPANY directors were excluded from monthly employees' tax because they didn't receive regular remuneration throughout the year. This gave them a distinct advantage over salaried employees who had pay-as-you-earn (PAYE) tax deducted on a monthly basis. It's evident in the explanatory memorandum issued by the South African Revenue Service (Sars) - when the definition of an employee was amended in March 2002 - the intention of the legislator was to only include directors who operate on the same basis as salaried employees in the employees' tax net.

This means directors involved in the daily operations of a company will no longer receive the benefit of delaying the payment of taxes based on the provisional tax system but will be subject to PAYE.

Michelle Scholtz, tax consultant at Grant Thornton, says the intention of the legislator couldn't have been to also include non-executive directors into the definition, as they usually trade independently. "However, independence can't be applied carte blanche to all non-executive directors," she says. "The question is whether all directors would fall into the employees' tax net by being included in the definition and whether certain types of directors can be excluded by meeting the requirements of trading independently."

By trading independently, one of the three critical requirements for deducting employees' tax is missing: namely, remuneration. That's very widely defined in tax legislation and includes almost any type of payment for services rendered. The Act stipulates the withholding of PAYE is only required where remuneration is paid by an employer or representative employer, such as a liquidator, guardian or curator, to an "employee". All three elements need to be present simultaneously before PAYE must be deducted.

According to the Act, any amount payable in respect of services rendered by a person in the course of "carrying on a trade independently from the employer" would be excluded from paying PAYE. The Act contains a number of statutory tests that, if met, would classify a person as being independent. But even if the statutory tests are met, the dominant impression of the relationship still needs to be formed in order to determine if a person is independent or not. Sars has provided guidelines on the dominant impression tests in its interpretation note.

"To determine whether a non-executive director qualifies as being independent we should consider the role and responsibilities he has in relation to that company, tested against the statutory and non-statutory tests in terms of the legislation," says Scholtz. "It's clear from the normal roles and responsibilities of executive directors in relation to a company that they wouldn't qualify as being independent."

Says Scholtz: "However, once the statutory independent contractor tests are applied to the non-executive director - and he's found to be independent - the dominant impression tests should still be applied to his roles and responsibilities. The outcome of the dominant impression test would then provide a persuasive argument as to whether he's independent or not."

It's imperative for a company to consider the three types of directors that can be appointed and understand the differences in their broad roles, responsibilities and basis of payment for their services to determine the company's own tax responsibilities.

How to differentiate

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 someone 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.

* Shares the legal duties and responsibilities of the executive directors.

Independent non-executive directors:

* Not employed by the company, current or past.

* Not a retained professional adviser influenced by his fee.

* Not a supplier or client 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.