Managerial Remuneration under Companies Act, 2013- Simplified

Foreword:

In this article, there is an effort put forward to enlighten the concept of managerial remuneration and computation of managerial remuneration to be adopted by a company in various circumstances. The Companies Act, 2013 has comprehensively provided the provisions for managerial remuneration to be implemented by the organizations.

To start with, lets understand who all are considered or are eligible for receiving managerial remuneration. The word managerial is associated with the words such as, management, administration, organizational, etc.

Therefore, it can be comprehended that,

• personnel who all manages the affairs of a company, and/or
• has command over the administration of the day-to-day affairs of an organization, are given or compensated by money and/or kind and/or perquisites, for the services provided or offered by them towards such company.

Such personnel generally are the directors and managers of a company.

As we all know, there are various categories of directors prevailing in organizations such as, Managing Director, Whole-time Director, Executive Director, Non-executive Director, Promoter Director, Nominee Director, Independent Director, Women Director.

Now, let’s discuss the meaning of remuneration. The Companies Act, 2013 has specifically defined the meaning of remuneration. As per sub section 78 of Section 2 of the Companies Act, 2013, “remuneration” means any money or its equivalent given or passed to any person for services rendered by him and includes perquisites as defined under the Income-tax Act, 1961.

In view of the above, it is evident that, managerial remuneration is paid to the above-mentioned categories of directors and manager of a company.

Now, the question arises how to determine the extent of managerial remuneration to be paid?

Section 197 of the Companies Act, 2013 provides for the payment of overall managerial remuneration to be paid on certain circumstances by a company. 

 Scenario-I: When a company has profit.

Section 197 of the Companies Act, 2013 provides that, when a company has adequate profit then, the maximum managerial remuneration in respect of a financial year shall be paid by a company is 11% of the net profit of the company for that financial year in which the remuneration is payable.

However, the Act has stated various conditions on this overall 11% of the managerial remuneration on different situations.

Situation-A under Scenario-I: when there is only 1 managing director or whole-time director or manager in a company:

Then the remuneration payable to such 1 managing director or whole-time director or manager shall not exceed 5% of the net profits of the company.

Situation-B under Scenario-I: when there is more than 1 managing director or whole-time director or manager in a company:

The remuneration shall not exceed 10% of the net profits to all such Directors and manager taken together.

Situation-C under Scenario-I: remuneration payable to other categories of directors who are neither managing directors nor whole-time directors:

• The remuneration payable to such directors shall not exceed 1% of the net profits of the company if there is 1 managing or whole-time director or manager.
• 3% of the net profits in any other case. That means, if there is no managing or whole-time director or manager in a company then the maximum managerial remuneration payable to other categories of directors shall not exceed 3% of the net profits of a company.

Scenario-II: When a company has inadequate profit or is in loss.

When a company is incurring losses or has inadequate or insufficient profit during a financial year, then the company must follow the provisions and conditions prescribed under Schedule V of the Companies Act, 2013 for payment of managerial remuneration.

Before we jump into the provisions of Schedule V of the Companies Act, 2013, and mug up the conditions specified therein, we must understand that what happens when a company suffers loss or has inadequate profit?

When a company suffers a loss or has inadequate profit, it can have various implications for its financial health, operations, and stakeholders. If the company has borrowed money, it may struggle to meet its debt obligations. This could lead to credit downgrades and increased borrowing costs. Continuous losses can erode the company’s capital, making it challenging to fund operations, investments, and debt repayments. Suppliers and creditors may become concerned about the company’s ability to meet its obligations, impacting relationships.

With the intention of providing an opportunity to a loss-making company, the Government has stipulated that such loss-making company shall pay managerial remuneration based on its effective capital.

Now, what is effective capital? Let’s understand first the meaning of the word effective.

The term “effective” generally means producing the intended or desired result; it refers to something that is successful in achieving its purpose. Effectiveness is often associated with efficiency and the ability to accomplish goals or objectives.

In the context of effective capital, it would mean the capital that is successful and efficient in achieving its purpose, which is typically related to funding productive activities and generating returns. The effectiveness of capital is assessed by considering factors like debt, equity, and financial obligations to determine the actual resources available for investment or operational needs.

Effective capital typically refers to the capital that a business or individual has available for productive use after considering various factors such as debt, equity, and other financial considerations. It is a measure of the actual financial resources that can be deployed for investment, operations, or other purposes.

In a business context, effective capital may include both equity capital (such as common stock) and debt capital (such as loans or bonds), adjusted for factors like interest expenses, taxes, and other financial obligations. The goal is to understand the true financial capacity of a business to fund its activities and generate returns.

Hence, in this situation, as provided by the Schedule V of the Companies Act, 2013, the managerial remuneration shall not exceed the higher limit of the following:

Provided that the remuneration in excess of above limits may be paid, if the resolution passed by the shareholders, is a special resolution.

Explanation as per Schedule V of the Companies Act, 2013— “effective capital” means the aggregate of the paid-up share capital (excluding share application money or advances against shares); amount, if any, for the time being standing to the credit of share premium account; reserves and surplus (excluding revaluation reserve); long-term loans and deposits repayable after one year (excluding working capital loans, over drafts, interest due on loans unless funded, bank guarantee, etc., and other short-term arrangements) as reduced by the aggregate of any investments (except in case of investment by an investment company whose principal business is acquisition of shares, stock, debentures or other securities), accumulated losses and preliminary expenses not written off.

Key points to be noted:

1. This section is applicable only for public companies and not for private companies.

2. Managerial remuneration shall be computed only on the basis of net profit and not on gross profit.

3. The process of computation of net profit is stated in Section 198 of the Companies Act, 2013.

4. Section 197 of the Companies Act, 2013 provides only for the maximum managerial remuneration shall be paid by a company during various circumstances.

Conclusion: The Companies Act, 2013, provides a structured framework for the payment of managerial remuneration, highlighting the importance of aligning compensation with corporate profitability and governance standards. The act distinguishes between scenarios of profit and loss, prescribing specific caps on remuneration based on the company’s net profits and its effective capital, thereby ensuring that remuneration practices are both fair and sustainable. For companies, adhering to these guidelines is not merely a legal mandate but a step towards robust corporate governance and ethical management practices. As companies navigate through varying financial landscapes, the act’s provisions serve as a beacon, guiding them in rewarding managerial efforts appropriately while safeguarding the interests of all stakeholders. Ultimately, the act underscores the principle that managerial remuneration should be reflective of the company’s financial health and operational realities, promoting a culture of accountability and excellence in corporate India.

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