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Directors’ functions: direct tax, governance, and VAT considerations

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Michel Lambion and Frederic Scholtus of Deloitte Luxembourg consider the concept of independence for governance and tax, including the implications of a future CJEU ruling on whether directors act independently from a VAT viewpoint.

Good governance plays an important role in navigating an organisation to success. This explains the increasing demand for professionalised boards of directors in the market.

To meet this expectation and to prepare for future regulatory changes, it is crucial that boards use their authority to establish a functioning organisation and secure remuneration packages. These changes may include limits on the number of mandates a director can hold and a requirement for independent directors.

To ensure an adequate remuneration structure, it is important to determine directors’ income tax and VAT status.

In Luxembourg, income tax status is defined in articles 91 and 95 of the Luxembourg Income Tax Law (LITL). It is also determined by a director’s mission and responsibilities. Moreover, the LITL refers to the Law on Commercial Companies (LCC) to define the roles of non-executive directors (NEDs), described in Article 59 of the LCC, and executive directors (EDs), described in Article 60 of the LCC.

Proper interpretation of the LITL and LCC is necessary as boards nominate individual directors. Applicable tax obligations may include withholding tax requirements and the ability to deduct directorships’ costs. Failing to handle the tax obligations related to directors’ fees properly may result in tax penalties for the parties involved.

The changing face of boards of directors

Other important developments in corporate governance are on their way. It is important to note that the promotion of good corporate governance is not self-explanatory.

To mobilise new resources, boards of directors need to realign with a mix of EDs, NEDs, and a sufficient number of independent non-executive directors (iNEDs). Additionally, iNEDs have become a critical element of board diversity; therefore, independent and transparent recruitment processes that prioritise gender balance are needed.

This trend can be observed in regulated industries, specifically in the banking sector, where iNEDs’ presence is mandatory on boards, and in the fund industry, where iNEDs’ presence is strongly encouraged by the regulatory authority. Present trends, such as creating room for more diversity on boards, can have a positive effect on governance procedures and future expected changes.

Independence also plays a key role in determining the VAT-able status of directors, but this concept may vary from the independence criteria used for corporate tax and governance purposes. The Court of Justice of the European Union (CJEU) has ruled that the EU VAT Directive does not necessarily have a link with other directives.

CJEU cases

The question of whether a director acts independently has recently been referred to the CJEU (C-288/22, the ‘TP’ case) as a result of a Luxembourgish NED who refused to pay VAT on his directors’ fees.

The director argued that he does not act independently because he is a member of the “organ” – i.e., the board of directors – that represents the company. Therefore, he personally does not bear the economic risks related to his activity or any personal obligation or liability towards the company or third parties.

One exception to this rule is when a director clearly exceeds the limits of acceptable conduct, which is a wrongful act separable from the function of director. This argument reflects the opinion of the CJEU in the ‘IO’ case (C-420/18, June 13 2018), which held that a natural person who was a member of the supervisory board of a Dutch foundation was not a VAT-able person because the person did not act independently and bore no economic risk.

The Luxembourg VAT authorities, on the other hand, argued in the TP case that a director acts independently because, unlike an employee, they organise their activity independently and their position is revocable without delay. Therefore, third parties could find the director responsible for failure to pay VAT.

Potential impact of the CJEU decision

Should the CJEU decide that a director is not a VAT-able person, the decision will have an effect on any EU member state that considers directors to be taxable. It will also reduce or eliminate the administrative obligations of directors and the non-deductible VAT of companies such as banks or holding companies.

Ultimately, it is in directors’ best interests to promote a board’s independence, diversity, and transparency, thereby better preparing themselves for future challenges, fully contributing to the next level of resource requirements, and seizing new opportunities.

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