Recently, the High Court in OCP v Ketua Pengarah Hasil Dalam Negeri [2024] MLJU 385 ruled in favour of the taxpayer, where it was held that the director’s fees earned by the taxpayer as an independent director of various listed companies were not employment income. The taxpayer was successfully represented by the firm’s Tax, SST & Customs Partner, S. Saravana Kumar and Associate, Amira Mohd Rafie Ravi.
This alert summarises the findings of the High Court regarding the determination of whether director fees, allowances and consultancy fees of an independent non-executive director constitute employment income under Section 4(b) of the Income Tax Act 1967 (ITA).
Brief Facts
The taxpayer is an individual and a tax resident of Malaysia. After retiring from his professional practice, the taxpayer continued to serve as an independent non-executive director on the boards of several public listed companies. He received director’s fees and allowances from these companies. Additionally, he sat on the boards of 7 or 8 unrelated companies, providing consultancy services from time to time. In return, he received consultancy fees for the services rendered.
He incorporated two management companies in Malaysia, namely OCP Holding Sdn Bhd and Garzania Sdn Bhd (Management Companies). All director fees, allowances, and consultancy fees received were then remitted to the Management Companies and were taxed under Section 4(a) of the ITA.
The Management Companies then paid monthly salaries to the taxpayer, which he further subjected to income tax in his personal capacity as business income under Section 4(a) of the ITA. This practice had been consistently adopted by the taxpayer since 1998 and was accepted by the Inland Revenue Board (Revenue) until 2015.
Following a tax audit, the Revenue treated the director fees, allowances and consultancy fees as employment income under Section 4(b). Subsequently, additional tax assessments were raised against the taxpayer for the years of assessment (YAs) 2002 to 2012 (Assessments) despite the taxpayer having subjected the earnings to income tax through the Management Companies and the salaries earned by him from the Management Companies.
The taxpayer appealed to the Special Commissioners of Income Tax (SCIT) but the appeal was dismissed. The SCIT held that the taxpayer was an employee as the appointment as an independent director falls within the ambit of “employment” and the income should be taxed under Section 4(b).
Subsequently, the taxpayer appealed to the High Court. The main issues before the High Court were twofold, namely:
(1) Whether the SCIT erred in finding that the Revenue was entitled to treat the taxpayer as an employee of the public listed companies by virtue of his appointment as an independent director.
(2) Whether the taxpayer’s earnings should be taxed as employment income under Section 4(b) instead of as business income under Section 4(a).
The Taxpayer’s Contentions
On appeal, the taxpayer argued that director’s fees, allowances and consultancy fees received from the companies where the taxpayer served as an independent non-executive director should not be subject to income tax as employment income under Section 4(b). This argument was primarily based on the following reasons:
(a) Independent directors are not employees and therefore, receipts of directors’ fees should not be treated as employment income under Section 4(b).
(b) Directors’ remuneration was not an indication of employment.
(c) The SCIT erred in disregarding evidence submitted by the taxpayer in the form of letters issued by the company secretary.
(d) The issuance of Form EA was not the sole determinant of employment status.
(e) The SCIT erred in disregarding similar cases in other Commonwealth jurisdictions which held that an independent director was not an employee.
The Revenue’s Contentions
On the other hand, the Revenue contended that payments received by the taxpayer as an independent director should be treated as employment income and subjected to tax under Section 4(b) for the following grounds:
(a) The term employment in Section 2 of the ITA was not restricted to the existence of a master and servant relationship but also included any appointment or office for which remuneration was payable.
(b) There was an appointment of the taxpayer as an independent non-executive director.
(c) The director’s fees and allowances received by the taxpayer constituted remuneration.
(d) The listed companies that appointed the taxpayer had issued Form EA.
The High Court’s Decision
In allowing the taxpayer’s appeal, the High Court found that the taxpayer, as an independent non-executive director, was not an employee for the following reasons:
(a) There was no existence of a master-servant relationship
In determining whether a master-servant relationship exists, the High Court referred to the Federal Court’s decision in Hoh Kiang Ngan v Mahkamah Perusahaan & Anor [1995] 3 MLJ 3693, which laid down the “degree of control” test for deciding if a contract of service exists. The greater the degree of control, the more likely the individual should be considered an employee. There was no such restriction imposed on the taxpayer by the various public listed companies where he served as an independent director.
It was also found that the SCIT failed to take into consideration the decision of Lim Chao Liang & Lim Chao Li v Ketua Pengarah Hasil Dalam Negeri (Rayuan No. PKCP(R) 90/2012), which was on the same issue. In the Lim Chao Liang case, the SCIT held that there was no element supporting that there was a master-servant relationship in a case of a company director considering the following factors:
(a) There was no contract of employment.
(b) There were no offers of employment to carry out responsibilities and duties as a director.
(c) There were no EPF and PERKESO accounts opened.
(d) There were no pension benefits.
(e) There was no ID card as an indication of an employee.
(f) There was no requirement to wear uniform.
(g) The director had the liberty and discretion to decide the amount and regularity of time to devote to exercising his duties as a director.
(h) There was no fixed office.
(i) There was no entitlement to any recourse in the Industrial Court under the Employment Act 1955 or Industrial Relations Act 1967 if one is removed as a director.
In the present appeal, the facts were similar to those in the Lim Chao Liang case, where the Revenue’s witness had testified during the trial that he had not seen any offer of employment, increment letter or employment handbook given by the public listed companies to the taxpayer.
Based on the foregoing, the High Court ruled that there was no relationship of master and servant between the taxpayer and the listed companies on whose board he sat as an independent director.
(b) No evidence of contribution to the Employee Provident Fund
Section 43(1) of the Employee Provident Fund Act 1991 makes it clear that employers cannot be exempted from contributing EPF and PERKESO to their employees.
The High Court found that during cross-examination, the Revenue’s witness conceded that the Revenue obtained no evidence showing that the taxpayer received the common employees’ benefit such as EPF or PERKESO from the companies in which the taxpayer served as an independent director.
(c) Receiving director’s remuneration does not imply employment
This stance is consistent with the Court of Appeal’s decisions in Chong Kim Seng v Metatrade Sdn Bhd [2004] 3 MLJ 1 and Ever-Yield Sdn Bhd v Yap Keat Choon and other appeals [2023] 2 MLJ 90, which established that being appointed as a director and receiving remuneration for the services provided did not automatically confer employee status. Directors’ fees were typically approved during the Annual General Meeting.
In contrast, the High Court observed that an employee’s salary was paid on a regular basis – daily, weekly, or monthly. More importantly, the salary of an employee was predetermined before the commencement of employment. If an employee was not remunerated as agreed, they could seek recourse through the Industrial Court.
Upon analysis of the present matter, it was found that the taxpayer did not have such rights. As an independent director, not only did the taxpayer not receive his director’s fees monthly, but his fees were only paid upon approval during the Annual General Meeting of a company, and the approved fees would be segregated among the board of independent non-executive directors. Therefore, the High Court found that the SCIT erred in her understanding of the role, responsibilities, and liabilities of an independent director such as the taxpayer and had misconstrued the tax treatment of the director’s fees received by the taxpayer.
(d) The Issuance of Form EA does not confer employee status
The SCIT was also found to have erred in concluding that the Form EA was prima facie evidence that the taxpayer was an employee. In the High Court’s view, Form EA was merely an administrative document prepared by the Revenue to collect necessary information from employers. The form did not supersede the law enacted by Parliament. Moreover, the issuance of Form EA by companies was not within the taxpayer’s control. Therefore, the receipt of an Form EA by the taxpayer did not necessarily or automatically mean that he was an employee.
(e) Local and Commonwealth cases
The High Court’s decision in Sime Darby Bhd & Ors v. Dato’ Seri Ahmad Zubair @ Ahmad Zubir bin Hj Murshid & Ors (Tun Musa Hitam & Ors, third parties) [2012] 9 MLJ 464 established that a non-executive director was not considered an employee due to the intermittent nature of the duties performed by them compared to executive directors. Non-executive directors did not draw a salary and were not expected to work full-time like executive directors. Additionally, they might lack specific training or experience in the company’s business and were often allowed to serve as directors for multiple companies, subject to regulatory limits.
In addition to the Sime Darby case, the High Court also found support from decisions in Commonwealth countries such as India and Australia, which held that an independent director was not an employee, despite receiving remuneration and having a contractual agreement.
Conclusion
The High Court found that the taxpayer was never considered an employee of the public listed companies in which he served as an independent non-executive director. Hence, the director’s fees, allowances and consultancy fees received by the taxpayer should be taxed as business income for a non-executive independent director rather than as employment income under Section 4(b) of the ITA.
In essence, this judgment underscores the importance of analysing the substance of an individual’s role and responsibilities, such as the taxpayer’s position as an independent non-executive director, in determining their employment status. Furthermore, this ruling also provides clarity on the distinct nature of non-executive directorships and establishes a precedent for future tax assessments involving similar circumstances.
1 April 2024