Financial and Tax Wisdoms

Being appointed to the board of directors is an honour and opportunity most business professionals welcome. The appointment represents a unique opportunity to utilise ones expertise and judgement, however the appointment does not come without responsibility.

Being appointed to the board of directors is an honour and opportunity most business professionals welcome. The appointment represents a unique opportunity to utilise ones expertise and judgement, however the appointment does not come without responsibility.

Directors have a responsibility in terms of the King II Report on Corporate Governance to exercise a duty of care and skill in the affairs of the company.

The fiduciary relationship arises from the purpose for which a director is entrusted with his office and for which he (and his co-directors, where relevant) are entrusted with their powers to manage the affairs of a company. It seeks to ensure that the office is used and those powers are exercised for, and only for, the benefit of the company as a whole, and never for any personal advantage; and that directors act honestly in their dealings with their colleagues and with shareholders, and with transparency where there is a risk of conflict between corporate duty and private interest.

There are four fundamental fiduciary duties in SA law. Directors may not:

1. Exceed their powers;
2. Exercise their powers for an improper or collateral purpose;
3. Fetter their discretion; or
4. Place themselves in a position in which their personal interests conflict, or may possibly conflict, with their duties to the company.

Even if the directors are not personally liable for debts of the company, in terms of their limited liability status, has anyone considered who is ultimately responsible for the payment of company taxes, penalty or interest?

The Companies Act of 1973 addresses directors liability in section 424, where it provides that directors may be held personally liable in instances where SARS can establish that the business or company has been carried on recklessly or with intent to defraud creditors, or carried on fraudulently. The director will be held liable provided that he/she was knowingly a party to the carrying on of the business or company in the aforesaid manner.

Directors can also be held personally liable in terms of section 37 of the Companies Act, where a director authorises or permits a loan to any company which is the holding company or a fellow subsidiary, and the loan was not fair to the company or failed to provide reasonable protection for its business interests.

Both the Income Tax Act and the VAT Act provide that in the case of a company, the natural person who is responsible for the duties imposed by those Acts is the public officer. The public officer is personally liable for the payment of any tax, interest or penalty payable by him in his representative capacity to the extent that while the amount is still unpaid:

• he alienates, charges or disposes of any money received or accrued on which the tax is chargeable, or
• he disposes of or parts with any funds or moneys in his possession that belongs to the company he represents after the tax, penalty or interest has become payable, and that the tax, penalty, or interest could have been payable from that money.

SARS may only recover amounts due from the public officer if either of the two requirements is met. Therefore it seems that the public officer is protected to a certain extent.

However, as for the director, member or even shareholder, this is not the case. Section 48(9) of the VAT Act provides that every member, shareholder or director who controls or is regularly involved in the management of the companys overall financial affairs can be held personally liable for any tax, additional tax, penalty or interest for which the company is liable.

This section therefore provides SARS with a powerful tool as a director can be held personally liable for any VAT, additional tax, penalty or interest under the VAT Act.

Furthermore, this also includes a shareholder who has control OR is regularly involved in the companys overall financial affairs. The legislature does not provide any guidance regarding the words “controls”, “regularly”, “involved” and “overall”. There is neither a test of what constitutes control nor any formula or method for such a determination.

Control is defined in terms of International Financial Reporting Standards (“IFRS”), as having the power to govern the financial and operating policies of an enterprise so as to obtain benefits from its activities. Control is presumed when the parent acquires more than half of the voting rights of the enterprise. This implies that holding companies, being the controlling shareholder, may be held liable for outstanding VAT of the subsidiary.

Furthermore, the relevant section (i.e. section 48(9)) was amended in 2004, to include members of a Close Corporation (“CC”). Therefore the VAT Act now refers to every member of a CC or shareholder or director of a company.

These provisions however, must not be misread to implicate all directors, members or shareholders: it is only where the director, member or shareholder controls or is regularly involved in the management of the company’s overall financial affairs that the director, member or shareholder may be held liable. SARS will have to consider the facts of the case to establish the extent of the involvement or the degree of control.

It is therefore clear, that this is a very onerous provision as it imposes personal liability, in certain instances, on shareholders and directors for what is in reality, a liability of the company. If one considers that a company is a separate legal person, distinct from its members and directors, shareholders must reconsider the notion of simply brushing aside the legal existence of a company.

Interestingly enough, section (16)(2C) of the Fourth Schedule to the Income Tax Act also provides that where an employer is a company, every shareholder and director who controls or is regularly involved in the management of the company’s overall financial affairs shall be personally liable for employees tax, additional tax, penalty or interest for which the company is liable.

Furthermore, similar provisions exist in the Unemployment Insurance Contributions Act in respect of the Unemployment Insurance Fund (“UIF”) withheld by the employer and not paid over within the required time.

Based on the above, it appears that directors, members and shareholders may be held liable for the non payment of VAT, PAYE and UIF. It is our understanding that there is currently no similar provision relating to the non payment of income tax of a company. It is significant to note that during the course of 2005, SARS released interpretation note 25 of 4 February 2005. This document serves to summarise the concept of personal liability of directors, members and shareholders in respect of the non payment of employee’s taxes to SARS in terms of the Fourth Schedule to the Income Tax Act. However this interpretation note is not very instructive as to how the relevant provision would be applied in real terms.

We also looked at the New Zealand (“NZ”) legislation for guidance. It is interesting to note that both the NZ Income Tax Act and the NZ GST Act,  provide that where an arrangement has been entered into, and the effect of the arrangement is that the company is unable to satisfy the income tax or GST liability of the company, and it can be reasonably concluded that a director would have anticipated that the tax liability would arise in accordance with  the Act, then all the directors at the time that the arrangement was entered into are jointly and severally liable for the tax liability as agent of the company. This is indeed quite a burdensome provision and has severe consequences for directors provided it can be proved that there was an arrangement in the first place.

At the time of writing, we were not aware of any court cases where a taxpayer has been held liable under section 48(9) of the VAT Act or under section 16(2C) of the Fourth Schedule to the Income Tax.

Notwithstanding the fact that section 48(9) of the VAT Act, has not been enforced in the past, and appears to be a draconian provision, directors, members and shareholders are warned not to rest on their laurels. The NZ experience is that the provision is used as a stick to beat the individual, even if it is later dropped.

In a climate where SARS takes the view that taxpayers have a “catch me if you can” attitude, directors, shareholders and members would be well advised to take note of the powers given to SARS in the VAT Act, the Income Tax Act and indeed in all the various fiscal statutes.

Clearly, the way has been paved for SARS to reach the “tentacles” as far as directors, members and shareholders, in instances where there appears to be mischief.

Issued on behalf of:
Deloitte:
Contact: Geraldine Connell, Director Tax Tel No: (011) 806 5030

For further information, contact:
Corporate Communications Consultants (Pty) Ltd
Contact:unice Johnston
Tel: 011) 783-8926

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