Article On Income Tax Treatment Of Non-Executive Directors (19 January 2011)

A good article I have read today on income tax treatment of non-executive directors of companies on The Star newspaper

The Star, starbiz, Wednesday January 19, 2011

Did you know non-executive directors are a special group of taxpayers?

Tax Insights – By Kang Beng Hoe

COMPANY non-executive directors are a special breed of taxpayers under our tax laws.

They are treated differently from their position recognised in contract law. Directors are not employees; they do not have a master-servant relationship with the company of which they are directors. They have what is commonly known as a contract “for” service with the company. This is distinct from an employee’s contract, a master-servant relationship evidenced by a contract “of” service.

If this sounds confusing, it is. An eminent judge in Britain drew the difference between a ship’s master, a chauffeur and a reporter on the staff of a newspaper all being employed under a contract of service whereas a ship’s pilot, a taximan and a newspaper contributor are employed under a contract for services.

Directors are holders of “office” for a term, which is not defined in the tax legislation and is said to be of “indefinite context”. However, under most tax laws, including ours, directors are included in the definition of “employees” and the term “employment” includes the holding of an “office”.

What is the significance of this rather convoluted tax treatment? Well, the reason is not difficult to guess: to garner more taxes for our tax collectors.

Without this extended definition, directors pay tax on their fees and other cash benefits such as attendance allowances and nothing else.

Their treatment as employees means that they are taxed on “perquisites” and “benefits-in-kind”, which they receive as directors of the company that pays them.

The home utilities costs incurred by a director, if paid for by the company, would be a “perquisite”. The value of accommodation provided to a director would be a “benefit-in-kind”.

The law on the taxability of “benefits-in-kind” derives from the English common law, i.e. the judicial pronouncement of courts in England.

In a landmark case, the House of Lords took the view that a benefit which is not convertible into money would not constitute income and should not be taxable on the employee receiving it. The case involved a bank manager who was allowed to occupy the upper floor of the said bank premises. The tax authorities sought to regard the value of the living accommodation as income to the employee. The court took the view that since the manager could not convert the benefit into money by say, assigning his occupying right to another person for cash, the benefit was not income to him. This decision became a general principle, that a benefit would only be taxable if it is capable of being converted into money or money’s worth.

Our tax laws, in light of this principle, contain a specific provision to tax a housing benefit provided to an employee, thus effectively nullifying the general rule.

No similar specific provision has been enacted to tax benefits such as the use of a car. Thus, a director who has been provided the use of a car might argue that this benefit is not convertible into money and he should pay no tax on it.

He would find his claim thwarted by the fact that specific words have been added to the taxing provision to tax a benefit (not being a benefit convertible into money).

These words are clearly designed to put our present day non-executive director (and all employees as well) receiving non-monetary benefits on quite a distinct fiscal path from that of our legendary bank manager.

So non-executive directors should be in no doubt that the tax man would seek to tax many, if not all the benefits which they receive as directors. The benefits are becoming more varied, with levels of remuneration packages increasing.

This is in part due to the recognition by companies, particularly public companies, that directors’ responsibilities and the risks associated with them have increased substantially in recent years.

A recent study of directors’ remuneration of financial institutions made a strong case that fees and other payments should be trending upwards if talented and experienced individuals are to fill a depleting pool of qualified directors.

Public companies generally make payments to their non-executive directors in some of the following forms:

  • Director fees. These are generally fixed to motivate responsibility.
  • Meeting fees are paid to encourage participation.

Both fees are taxable in full. A recent change in the law allows the fees to be taxed in the year they are received rather than in the year for which they are paid.

Fees received from a foreign tax resident company are not taxable on the basis of it being foreign income. Exceptionally a Malaysian incorporated company can be tax resident outside Malaysia if it is managed and controlled from outside the country.

Ex-post and ex-gratia payments are made to recognise long service and substantial contributions.

These are taxable in full unless they meet the criteria of “retirement gratuities”.

Stock awards paid to cultivate a longer-term perspective and sense of belonging are taxable on the market value of the stocks.

In certain instances, the use of a personal service company of the director to receive the fees could be used to benefit from the lower 20% rate.

However care should be taken in structuring this to avoid challenge as a tax avoidance arrangement.

The question often arises as to whether the expenses of travelling to attend board meetings could be deductible against the fees received where such costs have to be borne by the director.

The general principle is that travelling from home to office is not deductible and the tax authority will apply this rule to disallow such a claim.

  • Kang Beng Hoe is an executive director of Taxand Malaysia Sdn Bhd, a member firm of the Taxand global organisation of independent tax firms. The views expressed do not necessarily represent those of the firm. Readers should seek specific professional advice before acting on the views.