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IN 5 (2) Income Tax acT: InTeRPReTaTIon noTes IN 5 (2)
Income Tax Interpretation Note 5 (Issue 2)
Employees’ Tax: Directors of Private Companies (which include persons in Close Corporations who performs functions similar to Directors of Companies
DATE: ACT: SECTION: SUBJECT:
1. Purpose
23 January 2006
INCOME TAX ACT, 1962 (the Act)
Paragraphs 1, 9 (5) and 11C if the Fourth Schedule
Employees’ tax: directors of private companies (which include persons in close corporations who perform functions similar to directors of companies)
This Note has been amended to incorporate the relief measure [insertion of subparagraph (6) into paragraph 11C of the Fourth Schedule to the Act by section 85 (1) (d) of the Revenue Laws Amendment Act 45 of 2003, which was introduced with effect from 1 March 2004 to exclude the formula-based approach in respect of directors of private companies earning more than 75% of remuneration in the form of xed monthly payments. This amendment was necessary due to the complex method of determining the employees’ tax imposed on these directors who received remuneration on the same basis as ordinary employees. This Note also incorporates other amendments effected by section 85 (1) mentioned above.
2. Background
Prior to 1 March 2002 directors of private companies were excluded from the employees’ tax (PAYE) system of tax collection as they did often not receive regular remuneration throughout the tax year. Instead, they often drew on their loan accounts until their remuneration was nally determined at the end of the tax year or in the following tax year. This meant that these directors could settle their income tax liabilities in three payments over an 18-month period via the provisional tax system. They, therefore, enjoyed an advantage over other employees who were required to settle their income tax liabilities by way of monthly PAYE deductions.
Experience indicates that persons from whom employees’ tax is not deducted, and who do not make adequate provision for their tax liabilities, often fall into arrears and have great dif culty in settling the arrears while paying their current tax liabilities. This not only delays the ow of funds to the scus but also adds signi cantly to the cost of collection of the taxes to the scus, which is ultimately passed on to all taxpayers.
In his 2001 Budget Speech, the Minister of Finance announced an investigation into the possibility of bringing directors of private companies into the PAYE tax collection system. This resulted in a feasibility study being conducted and subsequent amendments to the Fourth Schedule to the Act (the Fourth Schedule) which came into operation with effect from 1 March 2002.
Generally directors do not receive regular, xed remuneration and the determination of their remuneration was often postponed until after the end of the year of assessment. It was found that the most practical way of determining and collecting PAYE in respect of directors’ remuneration in the current year of assessment is by calculating the PAYE by way of a formula on the actual remuneration paid or payable to them in a previous year of assessment.
3. The law
The Fourth Schedule was amended to provide for the following:
3.1 De nitions
3.1.1 A director of a private company is speci cally included in the de nition of ‘employee’ in the Fourth Schedule to ensure that the director is treated as such for PAYE purposes.
3.1.2 Paragraph (vii) of the de nition of ‘remuneration’ has been deleted to no longer exclude the remuneration of directors of private companies from the de nition.
3.1.3 The de nition of a ‘director’ in section 1 of the Act includes a person who, in respect of a close corporation, holds any of ce or performs any functions similar to the functions of a director of a company other than a close corporation. The de nition of a ‘company’ in section 1 of the Act includes a close corporation. In terms of section 38 (2) (b) of the Act, a close corporation is not recognised as a public company by the Commissioner. It is therefore treated as a private company for income tax purposes in terms of section 38 (13) of the Act.
3.2 Paragraph 11C
Paragraph 11C was inserted into the Fourth Schedule to calculate the director’s remuneration based on a formula where the director’s actual remuneration cannot be determined. With effect from 1 March 2004 (as explained in paragraph 1 above) a relief measure was introduced by way of the insertion of subparagraph (6) into paragraph 11C in respect of directors of private companies earning more than 75% of their remuneration during the previous year of assessment as xed monthly payments.
3.3 Deduction of employees’ tax from a director’s remuneration
Paragraph 9 (5) of the Fourth Schedule states that the determination of employees’ tax to be deducted from the remuneration of a director must take into account the deemed employees’ tax to be determined in terms of paragraph 11C (2) and paid by the company to the Commissioner.
3.4 Liability of private company for deemed employees’ tax
Subject to paragraph 11C (6), paragraph 11C (2) of the Fourth Schedule states that every private company must on a monthly basis pay to the Commissioner an amount deemed to be employees’ tax in respect of every director. The amount of employees’ tax must be determined in accordance with paragraph 11C (3) of the Fourth Schedule.
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