In this article, we will explain the tax implications of director’s remuneration as a mean of extracting profits from an owner-managed company.
Types of directors
In principle, there are two types of directors, executive and non-executive. Both types represent office holders owing the same legal duties and responsibilities but differing in their business participation and the way their remuneration is taxed.
Executive directors have an active, leadership role in the day-to-day business and usually perform operation or strategic business function (managing director, finance director, marketing director etc.). Non-executive directors have a monitoring and supervisory role and are not involved in day-to-day management.
Directors, as mentioned at the outset, are office holders; however, executive directors due to their close involvement with the day-to-day operation of the business are perceived to provide a contract of service, making them also an employee. Non-executive directors, on the other hand, work under a contract for service and could simply be regarded as self-employed.
Taxation of executive directors
In most SMEs and single director companies, the owner will be the director, shareholder and acting manager.
The remuneration of executive directors is taxed in the same way as that of an employee. They pay 6.8% from their insurable earnings to the social funds as well as PAYE (Pas As You Earn) according to their progressive tax rate. The 2011 progressive tax rates on personal income are:
0% from €0 up to €19,500
20% from €19,501 up to €28,000
25% from €28,001 up to €36,300
30% over and above €36,301
Taxation of non-executive directors (NEDs)
In other instances, a business owner may decide to stand back from the daily operations and mainly supervise/monitor and contribute to the development of the company’s strategy. It is also possible, that a member of the family, a co-founder or a close business associate is appointed as NED.
Taxation of NED’s remuneration, which may comprise of directors fees, benefits in kind and other payments, is based on the progressive tax rates as in the case of executive directors. However, NED’s remuneration is not subject to social fund contributions for both, the director (6.8%) and the company (10.5%).
The impact of directors’ remuneration to the company
The biggest tax saving for a company paying remuneration to NEDs as apposed to executive director is the 10.5% social contributions. Salaries, fees and benefits paid to either executive or non-executive directors are a deductible expense for the company, reducing the tax base and resulting in lower corporate tax.
For example, two directors, one executive and the other NED, receive €20,000 each per year in remuneration. After deduction of social insurance and PAYE, the executive director will receive €18,640 whereas the NED will receive €19,900. Furthermore, the company will bear the social contribution cost of €2,100 in the case of executive director and nothing for the NED.
Finally, the tax efficiency of drawing funds from your company in the form of director’s fee or remuneration could become even more advantageous when a NED is not tax resident of Cyprus or in certain cases when directorship is provided within a package of services from a Personal Service Company (PSC).