The tax law draws no distinction between executive and non-executive directors (NEDs). A director is an office holder of a company and therefore any income received for performing directors' duties has to be taxed as earnings.
This is not a statement to make a tax adviser popular with the NED community. However it's not a new iteration of the tax law, which has always given this as the starting point when the taxation of NEDs is under consideration. However HMRC have not always focussed closely on this subject and so historic arrangements have continued in many cases. This is changing as HMRC pay increasing attention to ensuring that the correct amounts of tax, under the correct pieces of legislation, are paid at the correct time.
We are often asked about the interaction of the 'IR35' provisions with fees paid to NEDs whose services are provided by a limited company. As a general point, where businesses and other bodies – engagers – make payments to other entities such as limited companies, partnerships or limited liability partnerships ("the corporate entity"), there is no obligation for the business making the payment to account for tax under the PAYE system on those payments. Instead it is the responsibility of the corporate entity to look at the employment status of the worker, and if they would be considered an employee of the engager were it not for the existence of the corporate entity, under IR35 legislation it's the corporate entity's responsibility to operate PAYE. But – and here's the important bit – if the individual is an 'office holder' which includes a director, and see first sentence, then we never get to looking at IR35. Income from directors' duties is taxed as employment income under first principles.
Sometimes a NED may have two or more workstreams with a company. There will be the work as a director, and then perhaps consultancy work as part of the NED's usual professional activities. In such cases if there are two separate agreements, whilst the directorship income should be taxed via payroll, any work outside of this under a discrete contract will fall to be considered under 'IR35', if the engagement is between the engaging company and a limited company.
It's very common for a company to pick up travel expenses for NEDs to attend Board meetings and, where they run over a couple of days, the costs of accommodation and food at a convenient hotel. All of this is also taxable. The NED may say that he or she is truly home based' as they do a significant amount of preparation there. This is a difficult argument to adduce; the definition of a 'home based' worker is very tightly drawn and it is very unlikely that any claim for tax relief on this basis for most NEDs would succeed. Many companies settle that tax on travelling and subsistence on behalf of NEDS by including it on their PAYE Settlement Agreement (PSA). PSAs have the advantage of being convenient but the disadvantage of being expensive; because there's an employer only NI charge, and the tax on the expenses has to be grossed, the effective tax rate for a 40% taxpayer is touching 90%.
Of course there are exceptions to every rule. By concession, no PAYE need be deducted from directors who fit the following fact patterns:
- a partner in a professional partnership, and the director's fees are paid to the partnership rather than to the director personally.
- if a company ('A') has a formal right to appoint a director to the board of another company ('B') (in many cases because of A's investment in B) any fees that B pays in respect of the duties performed by the director may be considered to be trading income of A, provided that the fees are paid directly to A.
- if no such right exists, if a company provides directors' services to the board of another, the fees may still be treated as trading income provided:
- the company is resident in the UK and subject to UK corporation tax, and
- the director does not control the company individually or together with a member of his family.
Whilst Clause 3 may seem to cover the director trading via a personal service company, the point about control cannot usually be satisfied. Please note however that the concessionary treatment cannot be assumed and in every case where it appears this may apply, HMRC must be approached to secure agreement. If they agree that concessionary treatment is appropriate, they will send out a NT tax code to the company. Unless and until that notification is received, the company must account for tax under PAYE as usual.
There is one final point about National Insurance. This is still due, because legally, the earnings are strictly to be taxed as employment income. HMRC's concessionary treatment is just that, a concession for tax, which does not apply to NI. Thus all earnings from a directorship whether executive or non-executive should be charged to Class 1 NIC, both primary and secondary.
This brief walk through demonstrates that there are many things to take into account when considering the tax treatment of non-executive directors. But the rule of thumb is, as set out in the first paragraph: the tax law draws no distinction between executive and non-executive directors.
This article was written by Ellie Gamble, Associate Director at Grant Thornton UK LLP. For further information please contact Ellie Gamble on 020 7728 2217 or email ellie.gamble@uk.gt.com.
