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Tax treatment of directors fees

The Corporation Code requires that each corporation must have at least five but not
more than 15 directors. These directors hold very important positions in a corporation
since most of the corporate acts must be approved by the board of directors during
regular or special meetings.
Directors are owners of the corporation since they are required to own at least one share
of stock, which must be recorded in the companys books.
Notwithstanding their ownership of the stocks of the corporation, directors are allowed to
receive compensation, provided that such is specifically mentioned in the by-laws of the
corporation. In the absence of a provision in the bylaws, directors are not allowed to
receive any compensation except for reasonable per diem, which must be approved by
the stockholders who own majority of the outstanding capital stock of the corporation.
Moreover, the total yearly compensation of directors must not exceed 10 percent of the
net income before income tax of the corporation during the preceding year.
The rationale for the forgoing limitations is to prevent directors from abusing their
authority by granting themselves excessive compensation. As owners of the
corporation, directors are expected to render service gratuitously to the corporation and
to be adequately content with their shares in the profits of the corporation as
compensation for their services.
From a tax perspective, directors fees are considered taxable income subject to income
tax and, consequently, to withholding tax.
An issue arises on the applicable rate of tax to be withheld on a directors fees in cases
where the director is also an employee of the corporation.
This is a settled issue, but the Bureau of Internal Revenue (BIR) further clarified this in
Revenue Memorandum Circular (RMC) 34-08. Under RMC 34-08, if there is an
employer-employee relationship between the director and the corporation, the directors
fees would fall under compensation income as defined in Revenue Regulation (RR) 2-
98. In this regulation, the term compensation is defined under RR 2-98 as all
remuneration for services performed by an employee for his employer under an
employer-employee relationship, unless specifically excluded by the Tax Code. Thus, if
the director is also an employee of the corporation, the directors fees are subject to the
withholding tax rates applicable to compensation.
On the other hand, if the director is not an employee of the corporationi.e., his duties
are confined to the attendance of and participation in the meetings of the board of
directorsdirectors fees are considered gross income derived from the conduct of
trade or business or exercise of profession. As such, the fees are subject to 15-percent
creditable withholding tax, if his gross income for the current year exceeds P720, 000;
otherwise, the fees are subject to 10-percent creditable withholding tax.
Aside from the issue on the applicable withholding-tax rates on directors fees, there is
also the question on whether such fees are subject to value-added tax (VAT).
Apparently, the Tax Code imposes VAT upon any person who, in the course of trade or
business, sells, barters, exchanges, leases goods or properties, renders services and
any person who imports goods.
There is no doubt that directors fees are not subject to VAT if the director is also an
employee of the corporation. The Tax Code specifically exempts from VAT services
rendered by individuals pursuant to an employer-employee relationship.
The issue is magnified in case the director is not an employee of the corporation. In
RMC 34-2008, the BIR initially articulated that directors who are not employees of the
corporation are considered sellers of services and are, therefore, liable to pay the 12-
percent VAT or the 3-percent percentage tax, in case they fail to meet the VAT
threshold.
Recently, however, the BIR reversed its previous position in RMC 34-2008 and issued
RMC 77-2008, which specifically provides that fees paid to directors who are not
employees of the corporation are not subject to VAT or percentage tax. According to the
BIR, the VAT only applies to persons whose undertakings are intended to be pursued on
a going-concern basis where the end view is to realize unrestricted amounts of
pecuniary gains/profits from those who may avail themselves of the goods they sell or
the services they render. Such is not the case for directors who are not employees of the
corporation.
First, a director does not freely offer his services to any corporation since to be elected
as such, he must own at least one share of the capital stock of the corporation. Second,
the services of a director cannot be considered as on a going-concern basis because the
Corporation Code limits his term to only one year until his successor is elected. Last, a
director may not be said to earn unrestricted amounts of profits because his
compensation is subject to a certain limitation.
It is hoped that with the recent issuance of RMC 77-2008, the tax treatment of directors
fees will now finally be resolved.