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DIRECTORS AND PAYE
Introduction
The Minister of Finance announced in the annual Budget Speech presented to Parliament
on 21 February 2001 that directors of companies and members of close corporations would
in future become liable to pay PAYE on earnings derived by them. Currently directors of
private companies, including members of close corporations, are excluded from the PAYE
regime by virtue of the fact that paragraph (vii) of the definition of “remuneration” contained
in the Fourth Schedule of the Income Tax Act of 1962, as amended (the Act) specifically
excludes therefrom amounts paid to directors of private companies.
During 1991 attempts were made to amend the legislation such that directors of companies
became liable to PAYE but ultimately those amendments were abandoned as a result of the
difficulties encountered in dealing with the fluctuations in earnings derived by directors of
private companies.
The legislation regarding the proposal made in the budget has now been enacted as the
Revenue Laws Amendment Act, Act 19 of 2001.
The legislation will take effect from 1 March 2002 and will result in an increase in the
administrative burden faced by companies, particularly smaller companies, in determining
the amount of PAYE to be paid over each month in respect of directors of private companies
and members of close corporations.
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Two Categories of Director
It is important, in my view, to distinguish between two main categories of directors namely,
the so-called salaried director who is in reality in employment, but because of the current
definition of “remuneration” is not liable to pay PAYE on a monthly basis. The second
category relates to those persons who can be regarded as the owner managers of the
company or close corporation and whose earnings are determined only once the financial
statements of the entity in question are finalised by the accountants or auditors.
Management Service Companies
Many of the large groups in South Africa formed management service companies such that
the directors of the group were remunerated by the management services company so that
the directors could obtain the cashflow advantage of not having to pay PAYE on a monthly
basis. This was in accordance with the strict provisions of the legislation in force at the time.
It is possible in my view that many of these group management services companies will be
collapsed as they will no longer confer any advantage on the directors in question.
Definition of Remuneration
The legislation enacted on 27 July 2001 seeks to deal with the PAYE consequences facing
both salaried directors and owner/manager directors.
The exclusion from remuneration contained in paragraph (vii) referred to above will be
withdrawn with effect from 1 March 2002.
The removal of paragraph (vii) from the exclusions contained in the definition of
“remuneration” means that any amount of salary, allowances or indeed any fringe benefits
made available to a director of a company will, with effect from 1 March 2002, become liable
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to PAYE. The distinction between directors and normal employees will therefore fall away
from 1 March next year.
Owner/Manager Director
The legislation now contains a new paragraph namely, paragraph 11C, introduced to deal
with the PAYE consequences facing the owner/manager director.
The owner/manager category of directors is more difficult to deal with in that generally such
persons do not receive a monthly salary. Such persons will draw an amount out of the
company each month on loan account. When the financial statements are finalised the
actual salary and bonuses etc will be determined. Paragraph 11C of the Fourth Schedule
prescribes a formula that must be used in determining the amount of remuneration to be
subject to PAYE in the hands of such directors.
Deemed Remuneration
The law prescribes that every director of a private company shall be deemed to have
received from that private company during any month an amount of remuneration
determined in accordance with the formula:
Y=
where -
T
N
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Y
represents the amount to be determined
T
represents the amount of remuneration paid to that director by the company
in respect of the last year of assessment after deducting therefrom any
contribution made by the employee to any pension fund or retirement annuity
fund. This amount generally represents the amount that would normally be
subjected to PAYE in the hands of an employee. In addition any amounts
paid to the director in respect of loss of office or lump sums payable by any
pension fund, retirement annuity fund or provident fund or amounts received
in commutation of amounts due under any contract of employment shall be
disregarded in determining T. Any amounts that have been included in the
director’s previous assessment as a result of the exercise of options in terms
of section 8A shall also be ignored.
N
represents the number of completed months which the director was employed
during the previous year of assessment by the company in question.
By virtue of the fact that the annual financial statements of the company or close corporation
may not have been finalised and hence the director has not been assessed for the previous
year of assessment, the amount referred to as T in the formula will be based on the balance
of the remuneration paid to the director in respect of the year of assessment preceding that
last year of assessment increased by an amount equal to 20%. In the event that the
preceding year of assessment has not yet been assessed the company will be obliged to
request a directive from the Commissioner as to the quantum of remuneration which is
deemed to have been received for the purposes of paragraph 11C.
An example in respect of an owner/manager director is set out below :
Example : Owner/Manager Director
Assume income for tax year 1 March 2001 to 28 February 2002 is not yet finalised.
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Director’s remuneration for tax year 1 March 2000 to 28 February 2001 amounted to
R300 000.
Calculate the amount on which PAYE must be deducted for the tax year 1 March 2002 to
28 February 2003.
Income per last year of assessment
Increase by 20%
Deemed remuneration for 2003
R300 000
R 60 000
R360 000
T
N
R360 000
=
12
= R 30 000
Y=
Apply the formula :
PAYE would be required to be deducted, according to the tables, from an amount of
R30 000 per month.
Registration as Employer
Those companies that are not currently registered as employers for employee’s tax
purposes by virtue of the fact that amounts are only paid to the directors of such companies
will be obliged to register for PAYE purposes with effect from 1 March 2002.
The
administrative burden faced by such companies will increase in that calculations will have to
be done in conformity with the formula dealt with above so as to arrive at the amount of
remuneration liable to PAYE on a monthly basis.
Salaried Director
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The one concern that must be raised regarding the legislation is the fact that a salaried
director may, in certain circumstances, be worse off than a normal employee. If one
assumes that a salaried director is in receipt of a salary as well as an incentive bonus,
dependent upon the individual’s performance and also the company’s financial results and
such person received a bonus say in the 2002 tax year it will be necessary that PAYE be
deducted from the amount of salary actually paid to the director in question with effect from
1 March 2002. In addition thereto PAYE will, with effect from 1 March 2002, be required to
be deducted from the bonus paid to the individual in the 2002 tax year even though there is
no certainty that such person will receive a bonus in the 2003 tax year. The Commissioner
has indicated that where it is believed that the director’s remuneration will be lower than the
previous year’s remuneration a directive can be obtained in accordance with the general
provisions contained in the Fourth Schedule of the Act. This will result in an increase in the
administrative burden faced by both employers and the Commissioner: South African
Revenue Service. This may not be a practical solution to the difficulties identified earlier.
The new provisions are best illustrated by way of examples which are set out below.
Example : Salaried Director
Tax Year 1 March 2001 to 28 February 2002
Salary
Bonus
Gain on share options exercised
Gross remuneration
Less: pension contributions
Taxable income
R120 000
R 90 000
R 50 000
R260 000
R 9 000
R251 000
Tax Year 1 March 2002 to 28 February 2003
Assume salary of R144 000 for the year, paid at a rate of R12 000 per month.
Salary
Bonus
Gross remuneration
Less: pension contributions
Taxable income
R144 000
R NIL
R144 000
R 10 800
R133 200
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PAYE must be deducted from the salary paid to the director each month after deducting
therefrom the allowable pension contributions.
Salary, net of pension, per month subject to PAYE thus : R11 100.
Paragraph 11C applies :
Deemed monthly remuneration
T
N
R201 000 *
=
12
Y=
Actual remuneration per month
Deemed remuneration liable to PAYE
Total amount subject to PAYE each month
R16 750
R11 100
R 5 650
R16 750
* R251 000 less R50 000 in respect of the gain on share options exercised.
The salaried director will be subject to the normal rules pertaining to PAYE as well as
paragraph 11C which deems certain amounts to be remuneration for the purposes of
calculating the PAYE that is to be deducted and paid over to SARS each month. By virtue
of the fact that a bonus was paid in the 2002 tax year this will result in the amount of
remuneration being inflated in the 2003 tax year particularly where the director does not in
fact receive a bonus in that year. In this regard the salaried director is in fact worse off than
been a normal employee and should in my view seriously consider relinquishing both in fact
and in law their position as a director so as to prevent this from happening in the future. In
the event that the person resigns as a director PAYE will be required to be deducted from an
amount of R11 100,00 per month only and in the event that a bonus is ever paid PAYE
would then be deducted from the amount as and when it is paid as opposed to in advance
of the amount being received.
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The future of Provisional Tax
All directors of private companies and members of close corporations are required to be
registered for provisional tax purposes and in the case of a salaried director it would appear
that no provisional tax would be required to be paid in the event that the salaried director
does not receive investment income in excess of the exempt amounts such as interest,
rentals or other forms of income not subject to PAYE. The owner/manager director will in all
likelihood remain liable to pay provisional tax at the various dates, that is in August and
February of each year. Provisional tax will remain payable on actual income whereas PAYE
would have been deducted from historic earnings as opposed to current earnings.
It is clear though that companies and close corporations will need to review their payroll
systems so as to ensure that they can comply with the new provisions that come into force
on 1 March 2002 and that they can perform the necessary calculations required in order to
determine the amount of PAYE to be paid over for directors on a monthly basis.
Skills Development Levy
By virtue of the fact that the definition of “remuneration” will be amended from 1 March 2001,
all amounts subjected to PAYE will from that date also become liable to the skills
development levy. This means that employers will incur additional costs in that the skills
development levy of 1% will be required to be paid over on amounts of remuneration paid to
the company director and member of a close corporation.
UIF Contributions
It must be noted that the contributions payable to the Unemployment Insurance Fund are
under review. It is more than likely that the administration of the UIF will pass over to the
Commissioner: South African Revenue Service.
More importantly the definition of
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“remuneration” contained in the Fourth Schedule of the Act will be relied upon as the term to
be used in determining contributions payable to the UIF.
It is also intended that UIF will become payable on remuneration payable to directors up to a
maximum amount per annum. This will also go to increase the cost incurred by an employer
in the future.
The company would be obliged to pay over 1% of remuneration payable to directors and
members of close corporations up to a maximum ceiling of remuneration per annum. In
addition the directors of companies will themselves be required to contribute 1% of
remuneration to the UIF also.
Conclusion
It is important that directors of companies and members of close corporations are aware that
the changes dealt with above will take effect from 1 March 2002. Directors and their
companies will therefore need to manage their cashflows so as to ensure that the
companies that they manage and own are in a position to pay the PAYE over on a monthly
basis, failing which interest and penalties will become payable.
Beric Croome
Director:
EDWARD NATHAN & FRIEDLAND (PTY) LTD