Case Spotlight: The Tax Treatment Of Independent Non-Executive Directors (INEDS) In Malaysia

Author:  Nadia Emira Sazahan & Alia Atiqah Omar @ Mohd Fadli

Introduction

In Malaysia, Independent Non-Executive Directors (INEDs) play a vital role in promoting good corporate governance. They provide unbiased perspectives, independent judgment, and oversight of management, all while safeguarding the interests of shareholders. However, their tax treatment in Malaysia has been a subject of debate, particularly regarding whether their remuneration should be classified as employment income or business income.

Who Are Independent Non-Executive Directors?

  An INED is a board member who does not engage in the daily management of a company and has no significant relationship with it that could compromise their independent judgment. Their primary role is to offer objective insights on corporate strategies, financial integrity, and risk management. INEDs are not classified as employees.

INEDs differ from Executive Directors, who are full-time employees actively involved in managing a company’s operations. Executive Directors typically hold leadership positions such as CEO, CFO, or COO and are directly responsible for executing corporate strategies, overseeing daily business functions, and making operational decisions. Who Are Independent Non-Executive Directors? Unlike Executive Directors, INEDs do not receive traditional salaries, bonuses, or employment benefits. Instead, their compensation is linked to their role as independent advisors. Common forms of remuneration for INEDs include: (a) Director’s Fees: Fixed payments for attending board meetings or serving on committees.

(b) Sitting Allowances: Payments for attending specific meetings or events.

(c) Retainer Fees: Regular payments to retain the INED’s services, regardless of meeting attendance.

(d) Expense Reimbursements: Non-taxable if they are genuine reimbursements supported by receipts (e.g., travel or accommodation costs). However, if provided as fixed allowances without substantiation, they may be treated as taxable income. Tax Treatment of INED Remuneration

In Malaysia, the Inland Revenue Board (IRB) differentiates between employment income and other types of income. Employment income, which includes salaries and bonuses, is taxable under Section 13(1)(a) of the Income Tax Act 1967 (“ITA 1967”).

However, since INEDs are not considered employees, their remuneration is generally classified as business income under Section 4(a) of the ITA 1967. If an INED separately provides consultancy services outside their director role, such income may fall under Section 4(b) (professional income), depending on the nature of the engagement.

It is important to note that this classification depends on whether the INED receives payments in a personal capacity or through a service or management company. If received personally, the IRB may still consider it employment income, depending on the circumstances. Why INED Remuneration Is Not Taxed As Employment Income

1. No Employer-Employee Relationship: INEDs operate independently and are not under the company's control like regular employees. They do not perform daily operational tasks and are not supervised in the same way.
   

2. Contractual Arrangement: INEDs are typically engaged through a contract for services, which indicates a business relationship rather than an employment relationship.
   

3. Nature of Services: INEDs provide advisory and oversight services, similar to consultants, reinforcing the classification of their income as business or professional income.
   

4. Tax Compliance: INEDs must declare their remuneration as business income and file their taxes accordingly, usually via Form B. They should also maintain proper business records. While Goods and Services Tax (GST) was previously in effect, Malaysia currently implements the Sales and Services Tax (SST) regime. INEDs should evaluate whether their services fall within the taxable scope for SST if their income exceeds the registration threshold.

Recent Legal Precedents In a landmark case, Datuk Oh Chong Peng v Ketua Pengarah Hasil Dalam Negeri [2024] 5 CLJ 989, the appellant, after retiring, served as an Independent Non-Executive Director on multiple public company boards, receiving fees and allowances. He also occasionally provided consultancy services to companies where he was not a board member and received consultation fees.

These payments were received by the appellant’s management companies and taxed under Section 4(a). The management companies then paid the appellant a salary. This salary would generally be taxable under Section 13(1)(a) as employment income unless the appellant was engaged in a self-employed capacity.

The High Court ruled in favour of the appellant, determining that the payments did not constitute employment income. The judge emphasized the absence of a master-servant relationship, which is crucial in distinguishing between employees and independent directors. Key findings from the ruling include: (a) INEDs do not enjoy the same rights and obligations as employees, such as regular salary payments or statutory contributions like EPF and SOCSO.

(b) Director fees are typically approved at annual general meetings and are not fixed monthly salaries, suggesting they are not guaranteed income.

(c) The remuneration received by INEDs is treated as business income under Section 4(a), not as employment income under Section 13(1)(a).

The court further emphasized that receiving remuneration for services rendered does not automatically establish an employment relationship. As established in Ever-Yield Sdn Bhd v Yap Keat Choon & Other Appeals [2023] 2 MLJ 90, a director is not inherently an employee. However, the ruling does not imply all INED remuneration falls under Section 4(a). Separate consultancy income may still be assessed under Section 4(b) if the services rendered are distinct from the directorship role. Practical Implications For Companies And INEDs

For companies, it is essential to structure INED remuneration correctly to comply with tax regulations. Payments should be clearly documented as fees for services rendered, and any reimbursements must be supported by valid receipts or invoices.

Additionally, INEDs should monitor whether their taxable supplies (e.g., director and consultancy fees) exceed RM500,000 annually, as they may be required to register for Sales and Service Tax (SST) or any future GST implementation, depending on the prevailing tax framework. Case Studies For Better Understanding

Case Study: The Boardroom Advisor

XYZ Corp appoints Mr. Tan as an INED to provide strategic advice. Mr. Tan receives a director's fee of RM10,000 annually and is reimbursed RM2,000 for travel expenses. Since he is not an employee, Mr. Tan reports the RM10,000 as business income and excludes the reimbursed RM2,000 from taxable income, supported by receipts.

Case Study: The Annual General Meeting

At the AGM of ABC Ltd., shareholders approve a sitting allowance of RM500 for each INED per board meeting. These payments are documented as service fees, not salaries. The INEDs report these allowances as business income under Section 4(a).

Case Study: Tax Filing for INEDs

Ms. Lim earns RM15,000 in director's fees from each company. She keeps records and files her tax return under Section 4(a). While she is not "self-employed" in a traditional business, her director’s fees are treated as business income for tax purposes.

These case studies illustrate how INEDs navigate their unique compensation structures and tax obligations, making the concepts more relatable and easier to understand for the public Conclusion

The remuneration of Independent Non-Executive Directors in Malaysia is generally not taxed as employment income due to the absence of an employer-employee relationship and the contractual nature of their engagement. Instead, their income is treated as business or professional income, requiring them to file taxes accordingly. Both companies and INEDs must understand these distinctions to ensure compliance with Malaysian tax laws and avoid disputes with the IRB.

By understanding the tax implications of INED remuneration, companies can attract and retain qualified directors while maintaining good corporate governance practices. At the same time, INEDs can fulfil their roles with clarity and confidence, knowing that their tax obligations are properly addressed.

Where INEDs also provide separate consultancy services beyond their directorship duties, the income derived may be classified under Section 4(b) as professional income. Disclaimer:

This newsletter is for informational purposes only and does not constitute legal advice. Please consult with a qualified legal specialist for advice tailored to your specific situation