Introduction

Many Malaysian companies remunerate their directors through a mixture of monthly salaries and director fees. While this is common practice, the tax treatment is often misunderstood, particularly when the director is both a shareholder and part of management.

The Court of Appeal’s recent decision in Datuk Oh Chong Peng v Inland Revenue Board [2024] 2 ILR509 now provides welcome clarity on how director salary and director fees should be classified for tax purposes. This article explains the distinction and what companies should do to remain compliant.

1. Director Salary vs Director Fees – What Are They?

A director salary is typically paid to an executive director who takes part in daily management, supervises teams, makes operational decisions and functions like a senior employee. Because of the employer–employee relationship, a director salary is treated as employment income, subject to PCB, EPF, SOCSO and EIS, and must be reported in Form EA.

Director fees, however, are payments made for services performed in a board capacity, such as attending meetings, reviewing papers, or sitting on committees. These fees must be approved by shareholders at the AGM and may be paid to both executive and non-executive directors.

Importantly, director fees become taxable at the point they become receivable, which is the moment the shareholders approve the fees (usually during the AGM), even if payment is only made later.

2. The Legal Framework Under the Income Tax Act (Section 4(a) vs 4(b))

The Income Tax Act 1967 places great emphasis on the nature of the relationship between the individual and the company.

Classes of income on which tax is chargeable

4. Subject to this Act, the income upon which tax is chargeable under this Act is income in respect of—

(a) gains or profits from a business, for whatever period of time carried on;

(b) gains or profits from an employment;

…

Section 4(b) governs employment income, which covers salary, remuneration and any payment arising from an employer–employee relationship. Executive directors fall squarely within this category because they perform day-to-day operational roles and are subject to employer control.

Section 4(a) deals with professional, vocational or business income, which applies when a person provides services independently and not under an employment relationship.

This distinction is crucial because the classification determines not only how the income is taxed, but also whether the recipient may deduct business expenses, claim capital allowances, file CP500 instalments and carry forward business losses.

3. The Oh Chong Peng Case — Clarifying Director Fees

The turning point came when the Court of Appeal ruled in Oh Chong Peng v Inland Revenue Board that an independent non-executive director is not an employee, and therefore the director fees he received were properly classified as business income under Section 4(a).

The Court reasoned that independent directors do not engage in management, do not report like employees and are not under employer control. Their role is advisory and supervisory, not operational.

The Court also confirmed the opposite scenario: an executive director, even if paid “director fees”, remains an employee in substance. The title of the payment does not change its nature. Any director fee paid to an executive director is still treated as employment income under Section 4(b). This decision creates a clear and practical distinction between the two categories.

Conclusion

The classification between Section 4(a) and 4(b) has real practical implications. Executive directors must be placed on normal payroll, their remuneration (including any director fees) must be subject to PCB and statutory contributions, and no business deductions are allowed in their personal tax filings. Independent non-executive directors, however, may treat their director fees as professional income, deduct relevant business expenses, claim capital allowances and manage tax instalments under CP500.

Equally important is the timing of taxation. For both executive and independent directors, director fees are taxable when they become receivable, which is the date the shareholders approve the payment. Many companies mistakenly tax director fees only when actually paid, exposing themselves to unnecessary compliance risks.

Understanding these rules helps companies avoid audit issues, prevent misclassification, and design remuneration structures that comply with the law while supporting good governance.

The contents herein are for general guidance and should not be relied upon as legal or tax advice without professional consultation.