RAJASTHAN AAR RULING IN THE MATTER OF CLAY CRAFT INDIA PVT LIMITED – REGARDING TAXABILITY OF REMUNERATION PAID TO DIRECTORS UNDER REVERSE CHARGE MECHANISM – REF NO. RAJ/AAR/2019-20/33 dated 20.2.2020
Till now the interpretation done by all was that if the Director is an employee of the Company and being paid remuneration, then the services provided by the Director are in the nature of Employee Services and are not exigible to GST. Only if the Director is not an employee and commission / sitting fee etc are being paid then the Company is liable to pay GST on Reverse Charge Mechanism (RCM).
However, a recent ruling of the AAR of Rajasthan in the reference of CLAY CARFT INDIA PRIVATE LIMITED has ruled that the Notification No. 13/2017 dated 28.6.2017 is applicable that is the Director payments even if it is on employment services because the words used in the Notification are payments for consideration of services rendered and hence the Company is liable to pay GST on Salaries paid to Directors on Reverse Charge Basis.
While the AAR is applicable and binding on the applicant, there is a possibility that GST officers may rely on the same and look for GST payment on RCM by companies in respect of salaries paid to the Directors.
ANALYSIS OF THE DECISION OF THE AAR
It seems that the AAR has treated the Contract of the Company with the Directors as a Contract for Service and not a Contract of Service. A contract of service is different from a contract for service. In a contract of service, the employer normally enjoys the power of control over the work of the servant and the servant is bound to obey the orders/instructions of the master. In a Contract for Service, an independent contractor undertakes to produce the required result but is not under the order or control of the person for whom he executes the work.
CONTROL TEST
For distinguishing between an independent contractor and a servant, the test would be whether or not the employer retains the power not only of directing what work is to be done but also of controlling the manner of doing the work. If a person can be overlooked, beholden and directed in regard to the manner of doing his work, that person is not a contractor and it makes no difference that his work is piece work.
In Shivnandan Sharma v. Punjab National Bank Ltd. Supervision and Control was held to be the crucial point for determining the relationship whether the person is an employee or an independent contractor. In Dhrangadhra Chemical Works Ltd. v. State of Saurashtra, the Supreme Court held that the test of supervision and control may be taken as prima facie test for determining the relationship of employment. Since the nature or extent of control varied from business to business it became impossible to precisely define the extent of control and supervision. The judicial dicta therefore suggested that correct method of approach, would be to consider whether having regard to the nature of work, there was due control and supervision by the employer. It means the greater the amount of direct control exercised over the persons rendering services by the persons contracting for them, the stronger would be the logic for holding it to be a contract of service
Qua the Director, the Director undertakes to produces the required results but is not under the order or control of anybody. The Board of Directors (“Board) of which the Director is also a member is the body entrusted with the control of the operations of the Company and does not take orders or is under the control of anybody except of course the Shareholders in General Meeting in respect of certain matters. I think this is the difference that the AAR has considered and held that the Contract with the Director is a Contract for Service and hence is not qualified to be called as Employee because Employment is a contract of Service.
Contract of service is an agreement (whether orally or in writing) binding on parties who are commonly referred to as “employer” and “employee”. In contrast, a contract for services, such a contract refers to a relationship akin to an agency. The Directors collectively as Board and individually are agents of the Company and hence the Contract with them is a Contract for Service and not Contract of Service.
INTEGRATION TEST
The Integration Test looks at whether the person performing the services is an integral part of the Company or whether they conduct business similar to someone performing services as a Contractor. The basis of Integration Test is that under a Contract of Service or employment, a man is employed as part of the business and his work is done as an integral part of the business; whereas a contract for service although the service is done for the business is not integrated into it but is only accessory to it.
If we apply this test to the Directors – the Directors are an accessory to the business and not part of it. When we look at the word Director, we look at the position of Director and not whether he is employed or not. Directors are agents of the Company responsible for control of the activities of the Company.
POSITION WITH REFERENCE TO COMPANIES ACT, 2013
Section 179 of the Companies Act specifies the Powers of the Board of Directors and reads as under:
179. (1) The Board of Directors of a company shall be entitled to exercise all such powers, and to do all such acts and things, as the company is authorised to exercise and do:
Provided that in exercising such power or doing such act or thing, the Board shall be subject to the provisions contained in that behalf in this Act, or in the memorandum or articles, or in any regulations not inconsistent therewith and duly made thereunder, including regulations made by the company in general meeting:
Provided further that the Board shall not exercise any power or do any act or thing which is directed or required, whether under this Act or by the memorandum or articles of the company or otherwise, to be exercised or done by the company in general meeting.
Similarly, Section 166 of the Companies Act, 2013 specifies the duties of the Directors which reads as under:
166. (1) Subject to the provisions of this Act, a director of a company shall act in accordance with the articles of the company.
(2) A director of a company shall act in good faith in order to promote the objects of the company for the benefit of its members as a whole, and in the best interests of the company, its employees, the shareholders, the community and for the protection of environment.
(3) A director of a company shall exercise his duties with due and reasonable care, skill and diligence and shall exercise independent judgment.
(4) A director of a company shall not involve in a situation in which he may have a direct or indirect interest that conflicts, or possibly may conflict, with the interest of the company.
(5) A director of a company shall not achieve or attempt to achieve any undue gain or advantage either to himself or to his relatives, partners, or associates and if such director is found guilty of making any undue gain, he shall be liable to pay an amount equal to that gain to the company.
Further, if we look at the method of appointment of Directors, there are four methods by which they can be appointed:
- By virtue of an agreement with the Company
- By virtue of a resolution passed by the Company in General Meeting
- By virtue of a resolution passed by the Board of Directors
- By virtue of the Memorandum or Articles of Association of the Company
Therefore, appointment by means of appointment letter by the Company is only one of the means and is not the only means for appointment of Director. Therefore, the appointment letter per se does not define the employee – employer relationship of Director Vs Company.
Managing Director as an Employee
In Ram Prashad Vs CIT (1972) 43 Com Cases 544, 549; AIR 1973 SC 637, the Supreme Court laid down the test as to whether or not a Managing Director is an employee of the Company in the following words:
Though an agent as such is not a servant, a servant is generally for some purposes his master’s implied agent, the extent of the agency depending upon the duties or position of the servant. It is again true that a director a company is not a servant but an agent in as much as the company cannot act in its own person but only act through the Directors who qua the company have the relationship of an agene toto its capacity. A Managing Director may have a dual capacity – as an employee and as an agent. 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 terms of his employment.
In the case of Anderson Vs James Sutherland (Peterhead) Ltd 1941 Scottis Cases 203, 218 the Scottish Court in Session held that the Managing Director has two functions and two capacities. Qua Managing Director he is a party to the contract with the company and this contract is a contract of employment, more specifically I am of the opinion that it is a Contract of Service and not Contract for Services. There is nothing anomalous in this, indeed it is a common place of law that the same individual may have two or more capacities, each including special rights and duties in relation to the same thing or matter or in relation to the same persons.
In Boultring Vs Association of Cinematograph, Television and Allied Technicians (1963) 1 All ER 716; (1963) 33 Com Cases 475 it was observed: “True it is as directors they are not employees, but it cannot, I think, be doubted that a managing director may for many purposes properly be regarded as an employee”
In PALMER’S COMPANY LAW pp. 8065-66 (25th Edition 1992) it was specified as follows:
It follows from this case that in modern company practice a managing director, in the great majority of cases, combines the position of director and of the employee and that, as has been observed earlier, the validity of his appointment and the scope of his duties have to be gathered from the provisions of the articles and the terms of his contract with the company. The view that a director may be an employee of the company is further supported by cases such as Lee Vs Lee’s Air Farming Ltd (1961) 31 Com Cases 233 etc.
Thus, the Directors of the Company are kept in Fiduciary relationship with the Company
Directors are agents of the company – they are special and not general agents. Their powers are vested in them by the Memorandum and Articles of Association. They are also the Trustees of the Company’s Properties in a limited sense.
Directors as such are not employees or servants of the Company whose affairs they direct. But where any director, besides being a director, is also in the service or employment of the company then they may be treated as an employee. A director of a company only by reason of that capacity is not a servant of the company.
Where a director holds a salaried employment in addition to his being a director, he would in respect of such office or employment, be certainly an employee and entitled to claim the rights given to employees as such, but his directorship and rights relating thereto, such as the right to sitting fee in respect of Board and Committee meetings attended by him, are distinct and separate and will not entitle him, in respect thereto, to the privileges granted to employees.
In Parsons & Sons Vs Albert J Parsons Ltd (1979) IRLR 117 the decision of the Court of Appeal in UK emphasizes the need for clarity on the question whether the remuneration of a director is paid to him as salary and allowances like other employees or as for services rendered in his capacity of director and in this connection the manner of treatment of the same in the books of accounts of the company will also throw light. Where the Director was paid annual remuneration as voted by shareholders in general meeting and the accounts showed the payments to director separately as Directors Remuneration and not treated in the same way as Salaries and Wages paid to other employees, the Director was not be treated as an Employee but only as a Full Time Director receiving remuneration for services as Director
Further, the following points also need to be considered:
1. Appointment of Managing Director, Whole Time Director is regulated by the Companies Act, 2013 under Section 196. They cannot be employed or removed as regular employees of the Company.
2. Remuneration payable to managerial personnel of a Public Limited Company is subject to the provisions of Section 198 of the Companies Act. In respect of Listed Companies certain separate disclosures have to be made with regard to the remuneration payable to the Managerial Personnel
3. Section 198(16) reads as under:
The auditor of the company shall, in his report under section 143, make a statement as to whether the remuneration paid by the company to its directors is in accordance with the provisions of this section, whether remuneration paid to any director is in excess of the limit laid down under this section and give such other details as maybe prescribed.
From a reading of this sub section, it is clear that the remuneration paid to the managerial personnel is in respect of the services rendered by them as such Managerial Personnel and not as employees.
4. Similarly, under CARO 2016, under clause (xi) the Auditor is supposed to report as follows:
whether managerial remuneration has been paid or provided in accordance with the requisite approvals mandated by the provisions of section 197 read with Schedule V to the Companies Act? If not, state the amount involved and steps taken by the company for securing refund of the same;
This is also indicative of the intention that the remuneration paid to Directors is not employees but for services rendered as Directors.
Based on the above discussion, it can be inferred that the AAR has treated the remuneration paid to Directors as payment for Services rendered and not as salaries and treated the Directors as Providers of Service and not as employees serving the Company.
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