Goods and Services Tax Act (‘GST’) was introduced in India from July 1, 2017 and is a single unified tax created by amalgamating provisions from erstwhile taxes like VAT, Service Tax, Excise etc. One of the legacy provisions which is included under GST from Service Tax is the concept of Reverse Charge mechanism (‘RCM’) wherein the receiver of service is liable to deposit tax with the Government Treasury for services received from service provider.
Legal Reference
As per Entry No. 6 of 13/2017-CTR issued u/s 9(3) of the Act, 2017 Services supplied by a director of a company or a body corporate to the said company or the body corporate is liable for GST and shall be paid on reverse charge basis by the recipient of the such services.
However as per schedule III of CGST Act 2017 Services by an employee to the employer in the course of or in relation to his employment neither treated as supply of Goods or nor supply of services.
The Rajasthan AAR through ruling No. RAJ/AAR/2019-20/33 dated 20th Feb 2020, ruled that consideration paid to the Directors is for the supply of services provided by them and will attract GST under entry no. 6 of N/No. 13/2017 Central Tax (Rate).
The Karnataka AAR through ruling No. KAR ADRG 30/2020 dated 4th May 2020, clearly differentiate the service provided by Executive director (whole-time director) under employment and service provided by Non-Executive Director. The said ruling gives a counter to earlier ruling given by AAR, Rajasthan in case of clay craft India P Ltd.
Now the question arises where a director of the company can be an employee of the company.
Managing Director
Section 2(54) of the Companies Act, 2013, defines ‘managing director’. It stipulates that a “managing director” means a director who, by virtue of the articles of a company or an agreement with the company or a resolution passed in its general meeting, or by its Board of Directors, is entrusted with substantial powers of management of the affairs of the company and includes a director occupying the position of managing director, by whatever name called.
Whole Time Director
Section 2 (94) of the Companies Act, 2013 defines “whole-time director” as a director in the whole-time employment of the company.
Managing Director/Whole-time Director or Executive Director is appointing by the Board and entrusted with several administrative role and responsivities.
Accordingly, as per section 197 of the Companies Act 2013 the directors are remunerated for the same through salary approved by the board.
However other director like independent director, nominee director and non-executive director is entitled for sitting fee, commission or services in professional capacity.
Here we need to understand the difference between the services performed by Director under the employment and other services.
However, it is pertinent to note that a Managing Director/Whole-time Director or Executive Director can be remunerated for services which he is provide in independent capacity like sitting fee, commission or professional fee which will not come service under employment.
Following are few case laws which ruled that a Managing Director or Whole-time director is employee of the company.
M/S. MAITHAN ALLOYS LTD. Vs CCE & ST, BOLPUR – 2018 ACR 927 CESTAT Kolkata
A whole-time director refers to a director who has been in employment of the company on a fulltime basis and is also entitled to receive remuneration. The position of a whole-time director is a position of significance under the Companies Act. Moreover, a whole-time director is considered and recognized as ‘key managerial personnel’ under Section 2(51) of the Companies Act. Further, he is an officer in default [as defined in clause (60) of section 2] for any violation or non-compliance of the provisions of Companies Act.
Thus, the whole-time director is essentially an employee of the Company and accordingly, whatever remuneration is being paid in conformity with the provisions of the Companies Act, is pursuant to employer– employee relationship and the mere fact that the whole-time director is compensated by way of variable pay will not in any manner alter or dilute the position of employer – employee status between the company assessee and the whole-time director. When the very provisions of the Companies Act make whole time Director (as also in capacity of key managerial personnel) responsible for any default / offences, it leads to the conclusion that those directors are employees of the assessee company.
Allied Blenders and Distillers (P.) Ltd. Commissioner of Central Excise & Service Tax, Aurangabad – (2019) 101 taxmann.com 462 (Mumbai – CESTAT)
Directors for managing day-to-day affairs of company and made necessary deductions on account of Provident fund, Professional Tax and TDS as applicable and declared these Directors to all statutory authorities as employees of company, remuneration paid to Directors was nothing but salary and assessee was not required to discharge service tax on remuneration paid to Directors
Section 66 of the Finance Act, 1994 – Levy and collection of tax – Period July, 2012 to March, 2015 – Assessee-company paid remuneration to its four whole time Directors for managing day-to-day affairs of company and made necessary deductions on Account of Provident Fund, Professional Tax and TDS as applicable – Adjudicating Authority held that assessee was required to discharge service tax, under reverse charge mechanism, on remuneration paid to Directors
AGGARWAL ZARDA FACTORY PVT. LTD. Vs COMMISSIONER OF CENTRAL EXCISE & S.T., MEERUT – 2018 (12) TMI 1361 – CESTAT ALLAHABAD
For the above consideration as Salary being paid to an employee what is essential is the recognition of the employee and employer relationship between the Director and the company. For this we need to understand the circumstances, facts and conditions when such employer and employee relationship can understand and has been judicially accepted.
As per the Companies Act 2013
Section 2(94): “managing director” to mean a director who, by virtue of an agreement with the company or of a resolution passed by the company in general meeting or by its Board of Directors or by virtue of its memorandum or articles of association, is entrusted with substantial powers of management which would not otherwise be exercisable by him, and includes a director occupying the position of a managing director, by whatever name called.
The proviso to that section provides that a managing director of a company shall exercise his powers subject to the superintendence, control and direction of its Board of Directors.
From the Layout and design provided by the Companies Act 2013 we see two layers of the Management, the Supervisory and Controlling (Board of Directors) not involved in day to day managing of the business and Second the actual Day to Day Management of the company under the Supervision and direct Control of the Board of directors and such other person could also be a director and in such case, under the contractual relationship with the company, undertakes the additional duties of day to day management of the company operations and thus in such capacity becomes a servant of the company i.e. Employer and Employee Relationship is Created.
Few other decisions where the Managing Director was held to be Employee of the Company.
Ram Prasad vs. CIT – (1972) 86 ITR 122 (SC).
A director of a company, as such, is not a servant but an agent in as much as the company cannot act in its own person but has only to act through directors who qua the company have the relationship of an agent to its capacity. Whether or not a managing director is a servant of the company apart from his being a director can only be determined by the articles of association and the terms of his employment. The assessee was appointed as Managing Director for 20 years and was also a major shareholder. The Hon. Supreme Court in this decision has recognized the dual capacity of being engaged by the company – As a director for stewardship and as an employee for actually managing the Company.
CIT vs. L. Armstrong Smith (1946) 14 ITR 606 (Bom)
Salary—Employer-employee relationship—Remuneration of chairman and managing director—Assessee, director of a company holding almost all the shares, working as a chairman and managing director and getting remuneration as provided by articles of association of the company—There is a contractual relationship between the company and the assessee of employer and employee—Remuneration received by assessee is, therefore, chargeable under s. 7 as salary
Kothandaraman vs. CIT (1966) 62 ITR 348 (Mad)
Salary—Accrual—Assessee is managing director of a company—Agreement invested assessee with extensive powers of management subject to superintendence, direction and control of board of directors and subject also to provisions of memorandum and articles of association—Relationship between the company and assessee is that of an employer and employee—Agreement was a contract of service—Therefore, monthly remuneration credited to assessee represented his salary—Company debited the whole of salary following a resolution of board of directors—Agreement did not provide for such stopping payment of remuneration—Further, entries in the books of the company did result in accrual of salary from month to month—Denial, withdrawal or waiver, if at all, occurred subsequent to assessment year—Remuneration rightly brought to tax
Employer Employee Relationship Establishment is Must
From the decisions finding favour with the employee employer relationship between the director and the company is certain underlying document/support from contractual relationship, Articles of Association etc. where such director has been given the executive power to manage the company on day-to-day basis under the supervision and guidance of the Board of Directors and can be removed if does not perform well. In addition, there are umpteen documents and communication with various statutory authorities that provide for reporting of such director as an employee. However, the same would not be true for a director who attends to only the Board Meetings for providing guidance and is not an Executive Director. It is possible that such person may also be given and furnished Salary Certificate in Form 16 and the Director Remuneration be so disclosed, but the same may not find acceptance based on the facts and documents evaluation by the Higher Appellate Authorities. The same may also not find a favour by the Income Tax Department for being taxed as Income from Salary. Adequate care needs to be taken in such cases.
Analysis
In the light of the above it is inference that the services performed by Managing Director/whole time director/Executive Director under the employment will fall under schedule III of CGST Act 2017 and will neither treated as supply of Goods or nor supply of services.
Services performed in professional capacity, sitting fee, commission and services performed by other Director such as independent Director or nominee Director etc will fall under Entry No. 6 of 13/2017-CTR issued u/s 9(3) of the Act, 2017 and RCM will be applicable on the same.
Further AR is applicable only for the person who has made an application, and we should not take any inference from outcome of AR unless there is any amendments in statute
Accordingly, it is clarified that the part of Director’s remuneration which are declared as “Salaries‟ in the books of a company and subjected to TDS under Section 192 of the IT Act, are not taxable being consideration for services by an employee to the employer in the course of or in relation to his employment in terms of Schedule III of the CGST Act, 2017.
It is further clarified that the part of employee Director’s remuneration which is declared separately other than “salaries‟ in the Company’s accounts and subjected to TDS under Section 194J of the IT Act as Fees for professional or Technical Services shall be treated as consideration for providing services which are outside the scope of Schedule III of the CGST Act, and is therefore, taxable. Further, in terms of notification No. 13/2017 – Central Tax (Rate) dated 28.06.2017, the recipient of the said services i.e., the Company, is liable to discharge the applicable GST on it on reverse charge basis (Circular No. 140/10/2020-GST dated 10 June 2020).
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