Many companies engage the services of a non-executive director (NED) as an independent adviser to the executive directors. There will frequently be no contract of employment, and fees will often be paid on invoice.
Determining whether an individual is an employee, a worker or self-employed is known to be a challenging and grey area, as detailed by Matthew Taylor in his review of modern working practices. However, the tax treatment of an office holder is very clear, as the legislation prescribes that an office holder is treated as though they are an employee. As such the fees are treated as earnings and are subject to PAYE and class 1 national insurance contributions (NIC).
Case law has determined that an office is a position created by a constitutional document, and the position exists independent of the person who occupies it and may be filled by successive holders. On the basis that a position of NED is a statutory role, they will be holding an office.
Despite the fact that a NED may enjoy a considerable degree of autonomy, the tax legislation treats office holders as employees. This means that payments made to a NED for their role as an office holder must be made through the payroll, accounting for both PAYE and class 1 NIC, including employer’s NIC. HM Revenue and Customs (HMRC) know that this is commonly an area for errors and we are seeing many associated tax and NIC settlements made by companies.
We are also seeing increased focus by HMRC on the issue of NED expenses, particularly in relation to travel and subsistence. Often NED’s claim for costs of travel to board meetings but in many cases, these are held at the head office which is likely to be a permanent workplace. On this basis payment or reimbursement of travel expenses will result in a tax and NIC liability.
Where the company has failed to account for PAYE and NIC, HMRC is likely to see this as a careless error and seek settlement of outstanding payroll liabilities going back six years, along with interest and penalties.
Where the NED has accounted for their tax and NIC under self-assessment, this can be used to mitigate the settlement. However, there is usually a shortfall due to the absence of employer’s NIC charged under self-assessment and the disallowance of certain expenses such as travel and subsistence.
Consultancy services alongside NED duties
Whereas payment for NED duties as an office holder must be put through the payroll, it is possible to have a separate contract with the same individual for genuine consultancy services. The terms of that consultancy contract and the facts of the case will determine whether it is one of employment or self-employment.
If payments for self-employed consultancy services are made gross, extreme care must be taken in structuring these contracts. Separate contracts must clearly distinguish between the role of NED and the role of consultant. Additionally, the NED should be adequately remunerated for their office, to avoid a challenge from HMRC as to the split of fees between the two roles.
Use of a personal service company for NED duties
Individual named as NED at Companies House
It is common for payments to be made to the NED’s personal service company (PSC) for their duties as an office holder. However, if it is the individual that is personally named at Companies House, HMRC is likely to challenge the contractual chain as being directly between the individual and the company for which they are NED, leaving that company liable to settle the payroll arrears.
PSC named as corporate director at Companies House
There are occasions where the PCS is appointed as a corporate NED. In turn the PSC provides the individual to represent the PSC at the Board meetings.
Since April 2013, the legislation has been updated to align the tax and NIC rules to ensure that office holders providing services through a PSC will be caught under the IR35 legislation. Whereas this gives HMRC the power to pursue the PSC for PAYE and NIC under IR35, there is still the potential for HMRC to argue that the contractual chain is a sham and that the individual is personally providing the services as a NED. In this case the appointing company would still be liable for the arrears of PAYE and NIC.
It should be noted that in 2015 provision was made for amendment to the Companies Act to restrict company directors to natural persons, subject to limited exceptions. This has not yet been put in force.
For many years, businesses with appointee directors on their board (for example where an investor has the right to appoint) relied upon an extra-statutory concession which allowed for director’s fees paid to an appointing company to be treated as trading income of that company, rather than employment income of the individual, provided certain conditions were satisfied.
This concession was often misapplied, where the strict conditions were not met. Furthermore, this concession was given a legislative footing from 6 April 2018, which tightens the obligations. It is recommended that where appointee directors are involved the position is reviewed against the new legislated conditions, to ensure that HMRC could not challenge the payment of fees and/or expenses to be employment income of the individual.
How can RSM help?
Establishing the correct tax and NIC treatment for NED’s fees and expenses is complex and the rules are often misunderstood. We can assess the background arrangements and review the contractual arrangements to help determine the correct treatment.
If mistakes have been made, we can help you resolve these with HMRC on a voluntary basis, mitigating the settlement where possible. Early action can significantly reduce penalties, which can often be suspended and cancelled upon meeting certain conditions set.