Non-executive directors (NEDs) play a hugely valuable role in most organisations but, increasingly, payments made to NEDs 'off payroll' (ie without deduction of tax or NIC) are attracting more attention from HMRC. Unfortunately for companies, paying NEDs is a complex area and HMRC knows that PAYE errors are common.
HMRC's starting point is that NEDs should be treated in the same way as executive directors for PAYE purposes. This is because both executive and non-executive directors are regarded as office holders. There is no statutory definition of the word 'office' but it has been judicially defined as a:
"permanent, substantive position which had an existence independent from the person who filled it, which went on and was filled in succession by successive holders." [Rowlatt J in Great Western Railway Company v Bater 8TC231.]
As an office holder, these individuals are taxed in relation to their director fees under s5 ITEPA 2003 and s3 SSCBA 1992. Payments falling under these provisions are subject to PAYE and NIC via the payroll.
HMRC does not accept that it is possible for NEDs to carry out office holder duties in a self-employed capacity. However, a NED may also provide consultancy services to the same company and it is the nature of the consultancy arrangement which determines its tax and NIC treatment.
Personal service companies
In the past, a practice has grown of NEDs invoicing for their services via a personal service company (PSC). The NED may receive, via the PSC, fees relating to several unrelated companies with which he or she holds offices. Historically, many had held the view that such fees could be paid gross to the PSC: HMRC has never subscribed to this view.
In most cases, the NED, not the PSC, was personally appointed to the director role. There has been much debate over whether fees paid to the PSC for the owner personally carrying out director duties should be subject to PAYE and NIC via the payroll. However, as a catch-all, the changes to IR35 (at Chapter 8 Part 2 s49(1)(c) ITEPA 2003) contained in Finance Act 2013, will impact on PSCs that receive NED fees gross from 6 April 2013 onwards. Now, where either:
(i) the NEDs are individuals appointed as directors of the engaging company, or
(ii) their PSCs are appointed as corporate directors of the engaging company but the NEDs personally perform the non-executive director duties,
the IR35 rules must be operated. These changes apply because, as a matter of law, a NED holds the office of non-executive director in a personal capacity and is therefore an office holder for the purposes of the legislation. The changes bring IR35 for income tax purposes into line with the equivalent NIC legislation, which already applies to office holders.
Where IR35 applies for income tax and NIC, the PSC is obliged, generally at the end of the relevant tax year, to deduct PAYE and account for Class 1 NIC on all gross payments received by the company in respect of the NED's duties. The new rules give HMRC the power to use IR35 to scrutinise whether any fees received for consultancy should be reclassified as fees deriving from the office holder's duties.
If the NED sets up an offshore company, but remains resident and provides services in the UK, then IR35 can apply under s56(7). However in this situation, if the PSC does not operate IR35 as required, there is a risk that the end client could end up with a PAYE and NIC liability should HMRC invoke the provisions of s689 ITEPA 2003.
The attached table highlights some of the other complex situations that can arise but it is always wise to seek advice on specific NED contracts as there are many complications (for example the strict conditions under which concession A37 can apply).
HMRC has indicated that its compliance activity in this area will increase. Both companies and NEDs should seek expert help to review their compliance position now before HMRC does it for them.