A ruling by the South African Revenue Service (Sars) that non-executive directors are required to register and charge VAT where they earn director’s fees exceeding the compulsory VAT registration threshold of R1 million during a 12-month period will likely create a significant administrative burden for non-executive directors and the companies they serve.
The ruling also raises questions about whether Sars will be able to cope with the large number of VAT registration applications that are likely to be submitted over the next three months before the ruling becomes effective.
Moreover, many listed companies – often holding companies earning mainly dividend income – are not registered for VAT and will not be able to claim a VAT deduction even though their non-executive directors will charge 14% VAT.
After a prolonged period of uncertainty about whether amounts payable to a non-executive director are subject to the deduction of employees tax, Sars issued two Binding General Rulings on the issue on Friday.
Parmi Natesan, executive at the Centre for Corporate Governance at the Institute of Directors in Southern Africa (IoDSA), says there has been much confusion and debate around the issue in the past, with the IoDSA and other bodies having written to both Sars and National Treasury requesting clarity on the varying interpretation of both the Income Tax Act and the Value-Added Tax Act.
The IoDSA welcomes the fact that clarity has been provided, she says.
Gerhard Badenhorst, tax executive at ENSafrica, says Sars has previously ruled that director’s remuneration is not subject to VAT and although the rulings did not specifically refer to non-executive directors, the scenario described in the ruling was typically that of a non-executive director.
The rulings were withdrawn in 2009, but it was generally accepted that Sars still subsequently applied the principles set out in these rulings.
Badenhorst says in his experience, most companies considered non-executive directors to be employees.
“In most instances, companies purely deducted employees tax and they [non-executive directors] weren’t registered for VAT.”
The Sars ruling now explicitly states that director’s fees received by a non-executive director for services rendered on a company’s board are not subject to the deduction of employees’ tax.
“I think the administrative burden will be substantial for all parties involved and only time will tell whether the additional revenue collected by Sars will be substantial.”
Badenhorst says a further practical issue or question that has arisen is with regard to the VAT registration process.
“It is currently a difficult process to register for VAT purposes as Sars often rejects VAT registration applications for various reasons, which causes the applicant to submit his or her application a number of times before the application is eventually accepted. The issue is whether Sars will be able to cope with the large number of VAT registration applications that are expected to be submitted over the next three months.”
While the ruling applies from June 1 2017, industry commentators differ on whether non-executive directors could face a VAT liability, penalties and interest related to prior tax periods.
Badenhorst says generally Sars would issue a binding general ruling in draft form, allowing industry to comment before a final ruling is issued, but in this case the ruling was issued in final form, and this issue would have to be clarified.
Since the ruling applies from June 1 2017 it seems that Sars may not seek to apply it retrospectively.
But Chris Eagar, attorney and director at Finvision VAT Specialists, says the ruling is not legislation and merely a confirmation of Sars’s interpretation. Therefore it doesn’t change the law.
If Sars agrees that the situation was unclear in the past, it may decide not to actively pursue the application of the law retrospectively. However, its role is to apply the legislation as it stands. In such instance, there would be a historic liability going back five years, he says.
Non-executive directors and their employers would typically be on friendly terms and companies could decide to pay the VAT to the director retrospectively, with the employer claiming an input tax credit (if it is entitled to do so). In this way the director will not be out of pocket as far as the tax is concerned, upon payment to Sars.
But penalties and interest may still need to be paid, Eagar argues.
Under the Tax Administration Act, penalties range from 10% to 150%, but it is unlikely that Sars would impose these penalties, as the default seems to have arisen due to “bona fide inadvertent error”. The 10% late payment penalty will remain, however. Where the default constitutes a so-called “first incidence”, it is likely that Sars would waive this penalty upon application. This still leaves the potential VAT liability over the five-year period as well as the interest payable, he says.
Sars did not respond to a request for clarity on whether the ruling would be applied retrospectively by the time of publication.
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