Payments to non-executive directors

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There is a common misconception that the payment of fees to non-executive directors can be made without having to account for tax and National Insurance (NI) by way of the PAYE system. Unfortunately, this is not usually the case. This article covers some of the common errors made when making payments to non-executive directors.

The correct treatment

Directors are considered to be “office holders” under current legislation. The practical effect of this is that, for the purposes of accounting for tax and NI, directors are treated in the same manner as employees. This means that employers are required to operate PAYE in respect of any fees paid to directors.

Unfortunately, neither the legislation nor HMRC differentiates between executive and non-executive directors. The making of gross payments to non-executive directors on the assumption that they are self-employed is therefore incorrect. Any businesses making such payments could find themselves facing liabilities to arrears of tax and NI that should have been deducted via PAYE – irrespective of whether the non-executive director has already accounted for tax and NI by way of self-assessment.

Personal Service Companies

It is not uncommon for individuals to operate through Personal Service Companies (PSC). In the past it has been the practice for individuals to use limited companies as a vehicle for the provision of services due to the NI advantages arising from the withdrawal of funds by way of dividends rather than salary.

Specific legislation – commonly known as “IR35”- has made the use of such structures less inviting. The legislation specifies that where, but for the imposition of the PSC, a worker would otherwise have been treated as an employee by a business, the PSC will be required to operate PAYE on all monies paid by the business in respect of the work undertaken,

Whilst the use of PSC arrangements may, on the face of it, be attractive to a business, the IR35 provisions do not, unfortunately, apply to directors. The status of directors as office holders overrides the IR35 legislation and the responsibility to operate PAYE on fees paid remains with the employing business. As with payments to directors treated as “self-employed”, a business could face a liability to arrears of tax on payments made in the past – irrespective of whether the tax has already been paid. (However, because the legislation relating to Social Security differs from that applying to tax, any liability for NI would remain with the PSC).

Extra-statutory concession A37

That is not to say that directors’ fees can never be paid gross to a limited company. HMRC extra-statutory concession ESCA37 allows for such payments to be made gross by concession under certain limited circumstances.

The terms of the concession allow for fees to be paid gross where one company has the right to appoint a director to the board of another. Such a right will usually arise from a shareholding that one company holds in the other, for example where a bank or a venture capital company has the right to appoint a director to the board. As long as the fees are paid to the company (and not the director personally) they may be paid gross as long as the receiving company is chargeable to corporation tax and accepts responsibility for the tax liability due on the fees. However, it should be noted that the concession cannot be used if the director is a shareholder of the company to which the payments are made. Also, since Extra Statutory Concessions represent a relaxation of the strict interpretation of legislation, HMRC may seek to disapply their use in cases where they consider that the “spirit” of the concession has not been followed.

Consultancy fees

Directors often receive payment in the form of “consultancy” fees. The correct treatment of such fees will depend on the nature of the duties performed. Payment for any duties that one would normally expect to be performed by a non-executive director must be subject to the appropriate deductions for tax and NI via the PAYE system. If, however, the non-executive director performs other duties for the company it may be possible for such payments to be made by way of a PSC. However, the non-director duties must be clearly identifiable and distinct from any work undertaken in the individual’s capacity as a director.

Conclusion

HMRC take the strict approach in respect of payments made to directors, and they will invariably look to the company to account for tax and NI in the first instance. Even if PSCs have accounted for tax and National Insurance due on such payments, there is no guarantee that the strict criteria allowing the set-off of tax and NI already paid will be met – raising the possibility of the same amounts being subjected to tax and NI twice. Companies paying directors’ fees into PSCs will therefore face arrears of tax and NI, to which interest and penalties may also be added. Such companies should take action as soon as possible.