Director remuneration can be categorized as salary or business income, depending on the director’s engagement with the company. Executive directors, actively involved in company operations, are considered employees and receive salaries, taxed under “Income from Salaries” with TDS under Section 192. In contrast, non-executive and independent directors provide strategic guidance without direct employment, and their income is categorized under “Profits and Gains from Business and Profession,” attracting TDS under Section 194J.
Key legal cases highlight the distinction between employment and professional services. The ITAT Mumbai in Red Chillies Entertainment Pvt Ltd vs. ACIT ruled that a production manager’s salary fell under income from salaries due to an employer-employee relationship. Conversely, Jayram Rangan vs. ACIT recognized consultancy fees as professional income due to contractual service agreements and invoicing patterns.
Determining employment status involves factors such as control, contract type, and benefits received. If classified as professional fees, GST may apply under the reverse charge mechanism. Independent directors are always subject to GST, while whole-time directors may be exempt if classified as employees.
Correct classification is critical for taxation and compliance, impacting deductions and tax obligations. Misclassification, such as deducting TDS under Section 192 for independent directors, may lead to tax disputes. Companies must assess agreements carefully to ensure proper tax treatment.
Introduction
As we all know, a director is an individual who is appointed to manage, oversee, and make strategic decisions for a company as an agent. Directors can be broadly classified into executive or whole-time employee directors and non-executive or independent director which is totally based on their role, responsibility and level of involvement in the operations of the company.
Directors can generally be classified into two categories:
Executive directors
These directors are actively involved in the daily operations of the company and receive a salary or remuneration like an employee.
Non-Executive directors
These directors are not involved in daily operations but provide strategic guidance and oversight. They are usually compensated through sitting fees or commissions, while an Independent Director should not have been an employee, proprietor, or partner of the company in any of the three financial years before their appointment
The taxation issues for directors significantly differs from that applicable to professionals or non-executive directors who are earning income under “Profits and Gains from Business and Profession” and executive directors who are earning income under salary
There is a difference between “agreement for services” and “agreement to service”
“Agreement for services” is the standard term used to describe a contract where a service provider outlines the specific services they will provide to a client, including details like scope of work, timelines, pricing, and deliverables while, “Agreement to service” technically conveying the same idea, “agreement to service” might be interpreted as slightly more passive, suggesting that the client is “agreeing to receive” the services rather than actively engaging with the service provider.
Identifying whether an income source is classified as “Salary” or “Professional Fees” is essential, as the tax implications vary substantially.
When income is categorized under “Salaries“, the deductions are limited to standard deductions and a few specified allowances. However, if the income falls under “Profits and Gains from Business and Profession“, individuals can claim a variety of expenses incurred in earning that income. Furthermore, under presumptive taxation (Section 44ADA), professionals can declare 50% of their gross receipts as taxable income, simplifying compliance.
Why I chose this topic for article
I was giving a webinar, on a topic related to salaries, then a person asked me this question, “whether director’s renumeration will be charged under salary or Business income?” My answer to it was, as director gives an independent professional service to a company as it’s agent and Taxability under head salary clearly states the importance of employer-employee relationship, hence is very important for taxation purposes, and even for corporates whether TDS shall be deducted under section 192 i.e. salaries or 194 J i.e. fee for professional services.
Employer-Employee Relationship and Tax Implications
As we discussed, for income to be categorized as “Salary,” there must be an employer-employee relationship. Employees work under the direct supervision and control of the employer, distinguishing them from independent professionals who maintain a principal-agent relationship with their clients.
Case Law: Red Chillies Entertainment Pvt Ltd vs. ACIT (ITA No. 6655/Mum/2014)
The Income Tax Appellate Tribunal Mumbai ruled that remuneration paid to an individual as a “Production Manager” constituted salary income due to the presence of an employer-employee relationship.
This was because the contract of employment explicitly stated that the individual was appointed as an employee with assigned duties, Independent professionals are engaged for specific assignments, whereas employees undertake duties that are not strictly defined in advance, The remuneration was a fixed monthly salary with no escalation based on workload, Additional benefits, such as a company-provided car and mobile phone, indicated full-time employment, The absence of provident fund, bonus, or gratuity payments was not considered conclusive proof of an independent professional relationship.
Based on these factors, the tribunal upheld the revenue’s stance that the remuneration was “Salary,” leading to taxation under the “Income from Salaries” head.
Independent Professional Services and Tax Implications
Professionals who render services independently and are not under direct supervision typically fall under “Profits and Gains from Business and Profession.” Professionals can claim business-related expenses and may opt for presumptive taxation under Section 44AD.
Case Law: Jayram Rangan vs. ACIT (ITA No. 1770/Chny/2019)
The ITAT Chennai ruled in favour of the taxpayer, treating consultancy fees as professional income rather than salary.
Here, the taxpayer had a contractual agreement for professional services, receiving payments through professional fee invoices rather than a fixed salary, Service tax (now replaced by GST) was charged on the invoices, indicating a business transaction, The taxpayer maintained books of accounts and underwent tax audits under Section 44AB, The designation of “Managing Director” was not, by itself, sufficient to establish an employer-employee relationship.
The tribunal held that the nature of the contract, invoicing method, and tax deductions under Section 194J (Professional Fees) confirmed the professional status of the taxpayer.
How to determine employment vs. independent services
Employees work under direct control, while independent professionals have autonomy, also salaries indicate employment, whereas fee-based payments for specific assignments favour professional status, employment contracts specify ongoing responsibilities, while professional agreements define assignments, employees receive perks such as insurance, PF, and allowances, which are typically absent for independent professionals.
Also in case the remuneration is classified as professional fees, companies may need to pay GST under reverse charge, one of the case I saw practically that GST was charged under reverse charge but TDS was deducted as per section 192 i.e. salaries, which was a completely wrong approach and may attract income tax notices.
Applicability of GST in director renumeration
Under the GST framework, the applicability of tax on a director’s remuneration depends on whether they are classified as an employee of the company. Independent directors are not considered employees, hence, their services do not fall under Schedule III of the CGST Act, which exempts employer-employee relationships from GST. Instead, their remuneration is treated as a supply of service and is taxable under reverse charge in the hands of the company.
For whole-time directors, Section 2(94) of the Companies Act states that they may or may not be employees of the company. Therefore, determining GST applicability requires examining the nature of services provided and how their remuneration is recorded in the company’s accounts. If a whole-time director is classified as an employee, their salary is covered under Schedule III and is not subject to GST. However, if they are not treated as employees, their remuneration may be taxable under the reverse charge mechanism, similar to independent directors.
Conclusion
The classification of director’s fees as salary income or business/profession income totally depends on the nature of the director’s engagement with the company. If the director is employed by the company under a contract of service, as an executive director, and is receiving a fixed remuneration that includes benefits like provident fund, gratuity, and leave encashment, then such remuneration is treated as salary income under the head “Income from Salary” as per the Income Tax Act. In such cases, the company deducts TDS under Section 192, which applies to salaries.
However, if the director is an independent director or non-executive director, who is not an employee but provides professional services, then the fees or commission received for their services is treated as income from business or profession under Section 28 of the Income Tax Act. The company deducts TDS under Section 194J on such payments, as it is considered a fee for professional or technical services.
This classification is crucial for tax purposes, as salary income allows for deductions under Section 16 (such as standard deduction and professional tax), whereas professional income permits deductions for expenses incurred in earning such income under Section 37(1). Therefore, whether director’s fees are treated as salary or PGBP income depends on the director’s employment status and the nature of their engagement with the company.
***
Author can be contacted at aman.rajput@mail.ca.in
Author Bio
