Let’s suppose you hire a non-executive director (NED) with a diverse portfolio of working with start ups and businesses that aspire to grow. The NED works as a freelancer and insists that they should be paid a gross salary, i.e. without any deductions of tax or national insurance contribution (NI). Is it allowed for an entity to follow this practice as per HMRC?
The Status of Directors
A company performs its functions through 2 types of workforce, i.e. company directors and employees. Directors, appointed at the discretion of shareholders or board members, are effectively the company’s agents and are central to its strategic decision-making and ensure that a company fulfils its statutory obligations. In addition to this, most directors also assume an active role in an organisation’s trade. The job roles have clear segregation as per their nature, but the segregation isn’t material enough for these roles to be identified separately in most companies.Â
However, it is vital to understand the difference for two important reasons. The directors are treated as officeholders who aren’t covered under the national minimum wage, but their earnings as a director are covered due to the work they do for the company. Secondly, tax and d National Insurance implications on the earnings depend on the roles from which the earnings have been generated.
Point to be Noted
Directorship is not employment in itself, but legislation treats it as one for PAYE income tax and National Insurance purposes.
What is the Status of Non-Executive Directors
A director can also be termed as a non-executive director, i.e. it doesn’t require a director to assume an active day-to-day role, but his/her contributions to policy and decision-making remain vital. Despite the different roles and responsibilities of executive and non-executive directors, the tax rules applicable to the earnings of both are the same. It is widely assumed that some non-executive directors can get an exemption from these taxation rules by collecting their fees through a limited company owned and controlled by them. This is a faulty assumption.
Video: Paying Non-Executive Directors off the Record; Problems & Solutions
Tax on Non-executive director salaries
IR35 and Salary for Director
Non-executive directors are barred from getting any tax benefits through IR35, which, if explained simply, is a law for preventing tax avoidance from employees who use intermediaries to receive their remuneration (in this case non-executive director remuneration).
Under IR35, a non-executive director is asked some questions by HMRC; one of the questions determines whether the worker or their business is an officeholder for the end client. The answer, as far as NEDs are concerned, is yes; this deems them to be labelled as ‘employed’ for self-assessment tax return purposes by the HMRC.Â
The question covers both the NED and their business (limited company) and clarifies the case that even if the client hires the limited company, it is effectively the NED performing the duties, so the tax and NI will be deducted as per usual.
Moreover, the reimbursed expenses to NEDs (or their companies) to cover the cost of their travel to or from meetings at the company’s premises are also treated as part of their remuneration and subjected to the same tax and NI rules. Expenses are taxable as employment income.
Payments that are Exempted from PAYE
NEDs can also be engaged in addition to the services they provide under the banner of their directorships. It could be a possibility to segregate the compensation for these services for tax and NI purposes. Let’s say that the non-executive director is also providing consultancy services as a self-employed professional, i.e. freelance work; it is possible to pay a gross salary in this case, provided separate contracts are in place.Â
Point to be Noted
The contract drawn for freelance work should be carefully devised to avoid any clauses that make it sound like employment. Moreover, the nature of the work should be distinct from the duties the NED is performing as a director. If this is not the case, HMRC can term the income from the freelance work as similar in nature to the income resulting from directorship, thus liable for tax and NI purposes.Â
A professional accountant with the right skill set should be sourced to help in referring legal partners to help draw separate contracts that significantly contrast the nature of freelance services and directorship duties to avoid adverse surprises from the HMRC.Â
Conclusion
To put it simply, all the income resulting from services being provided as a NED is deemed by law to be subjected to PAYE tax and NI, even if received through an intermediary, i.e. a limited company. Nevertheless, if a non-executive director provides services that are different from directorship duties, as a freelance expert, a gross salary can be possible.
