GST under reverse charge mechanism (RCM) on fees or remuneration paid to the director
1. Background
There has been a lot of confusion concerning the taxability of payment made by the company to its director, whether payable on reverse charged by the company or not.
The author of this article has attempted to bring some clarity on the aspects of the taxability, and applicability of RCM on payments made to its directors by the company. The author has also thrown some light on the Circular 140 issued by the department.
2. Types of payments made to directors
Taxability of amount paid to directors: The different amount paid to directors can be categorized as below:
Directors’ capacity
> As Salary [director as an employee] – Paid in the form of salary and TDS u/s 192 of Income Tax Act is deducted.
> As other fees [director not an employee] – Paid in the form of other professional fees and TDS u/s 194J of the Income-tax Act is deducted.
Individual capacity
> Payment made to director against supply made by him in an individual capacity to the company (such as renting of the commercial premises to the company by him).
3. Taxability – Provisions and analysis thereof
A. Schedule III – Activities or transactions which shall be treated neither as a supply of goods nor a supply of services –
1. Services by an employee to the employer in the course of or in relation to his employment.
The above Schedule provides that, where, if there exists an employer-employee relationship, then as per Schedule III of the CGST Act 2017, any services provided by an employee to the employer in the course of employment is not a supplyand hence , no taxability can arise in such cases.
In a similar case, it was held that , where directors are shown to be employees by the appellant, remuneration paid to directors was nothing but salary, and the company was not required to discharge service tax on remuneration paid to directors – Section 65B(44)(b) of Finance Act, 1994. [Paras 15 and 16] Allied Blenders and Distillers Pvt. Ltd.[1]
Further, the following was held in the case of M/s Bengal Beverages Pvt Ltd[2] that in case of a whole-time director –
> Section 2(94) of the Companies Act, 2013, defines ‘whole-time director’ to include a director in the whole-time employment of the company.
> A whole-time director refers to a director who has been in the employment of the company on a full-time basis.
> Any violation or non-compliance of the provisions of the Companies Act in such a director is held responsible as he is recognized as an employee as well as KMP of the company
> The mere fact that the whole-time director is compensated by way of variable pay will not in any manner alter or dilutes the position of employer-employee status.
> Therefore, the amount paid by the company to its employee is not liable to service tax.
Therefore, where, when a company pays an amount to its director in the form of salary and TDS u/s 192 of the Income Tax Act is deducted, i.e., they are in the payroll of the companies, then, the salary or the consideration paid by the companies to the directors would not be taxable under GST as they are supplying the services in the course of their employment; consequently, no GST is required to be paid, neither in the hands of the director nor in the hands of the company.
When to consider that there is an employee-employer relationship?
There is no definition of the term “employee” or “director” in the GST Laws. The term director is defined in Sec 2(34) of the Companies Act, 2013, as a director appointed to the Board of a company.
The Hon’ble Supreme Court in the case of Apex Engineering[3],while considering the question of whether the managing director was an employee of the company in the context of the definition of employee in the Employees State Insurance Act, 1948 observed the following-
A Managing director may have a dual capacity. He may both be a director as well as employee, depending upon the nature of his work and the terms of his employment. 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.
In simple words, the Supreme Court held that the managing director of the company is an employee of the company for the provisions of the Employees State Insurance Act, 1948.
In my considered view, while determining whether a director is an employee or not, we need to analyze the terms of the contract. In case where he is a director and provides services in the capacity of an employee, then there is no need to pay GST as it would be squarely covered under Schedule-III as neither supply of goods nor supply of service.
B. RCM notification
Notification 13/2017-Central Tax (Rate) dated 28.06.2017 (‘RCM notification’) issued under Section 9(3) of the CGST Act, 2017 provides for payment of GST under reverse charge mechanism for services provided by a director of a Company to the said Company. More specifically, the said entry under the notification reads as under –
| Sl. No. | Category of Supply of Service | Supplier of Service | Recipient of Service |
| 6 | Services supplied by a director of a company or a body corporate to the said company or the body corporate. | A director of a company or a body corporate | The company or a body corporate located in the taxable territory. |
Analysis
> It is to be noted that the RCM Notification does not use the phrase ‘services provided by any person to a Company, who is a director in the said Company’. Instead, it uses the phrase ‘services supplied by a director of a Company’. Hence it is clear that the said notification covers only those services which are provided in the capacity of a director.
> Further, the entry emphasizes the services provided by a director of a company to the said company which makes it clearer that this entry is attracted only when the director provides services to the company that has appointed him as director.
> The RCM notification does not appear to cover services that are provided in the independent capacity of the director, as it would not form part of the remuneration paid to the director in the said capacity.
> Also, under entry no. 6 of the RCM notification, the supplier of service should be a director of the said Company. A ‘director’ by itself is not a person, but a position in the Company that is held by a person.
4. Advance ruling in Clay Craft India Pvt Ltd[4] – controversy
The applicant was paying salary to its director and it is also booked under “Income from Salary” by the Directors in their personal Income Tax returns;
AAR observed that the consideration paid to the Directors is against the supply of services provided by them to the applicant company and are not covered under Schedule III to the CGST Act, 2017 as the Directors are not the employee of the Company.
AAR held that director is the supplier of services and the applicant company is the recipient of the services. So, it is very clear that the services rendered by the director to the company for which consideration is paid to them in any head are liable to pay GST under RCM. The Authority for Advance Ruling (AAR) at Karnataka, in the case of Alcon Consulting Engineers[5], had taken an identical view, on the same grounds relying on the aforesaid rulings.
Comments:
> The advance ruling authority simply held that the directors were not employees of the company.
> The ruling issued by AAR above was incorrect and not in accordance with the provision of the GST law as it failed to interpret the relationship of the director (say whole time director being an employee) with a company (employer).
> AAR did not examine the terms and conditions of employment of the persons who are appointed as directors of the company,
> AAR relied only on the wording of the notification
> AAR would be binding only on the department and the applicant.
> The principle of ‘Stare decisis’ does not apply to AAR orders issued which means AAR has the liberty to give no reasons as to why the previous settled decision was not followed even when referred by the applicant. Stare decisis is a principle of law that has a binding force on lower courts and should be followed in similar cases, it gives certainty to the law and guides people to their affairs accordingly.
Post this advance ruling, CBIC had to come out with the Circular 140/2020 to clarify certain aspects, which are discussed below:
5. Circular 140/2020 [6] issued by dept on directors remuneration and RCM
The circular has clarified the following issues-
(i) The leviability of GST on remuneration paid by companies to the independent directors defined in terms of section 149(6) of the Companies Act, 2013 or those directors who are not the employees of the said company.
Clarification
> The remuneration paid to such independent directors, or those directors, by whatever name called, who are not employees of the said company, is taxable in hands of the company, on a reverse charge basis.
(ii) Leviability of GST on remuneration paid by companies to the whole-time directors including the managing director who is an employee of the said company.
Clarification
> director’s remuneration which is declared as “Salaries‟ in the books of a company and subjected to TDS under Section 192 of the IT Act is not taxable in terms of Schedule III of the CGST Act, 2017.
> 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 is taxable under RCM in the hands of the company.
The Circular has failed to bring clarity on the aspect that whole time director is an employee of the company and it has failed to differentiate between the nature of payments done to director i.e., the payment arising to the director on account of his services in directors’ capacity and payment arising to him on account of any other services supplied in directors’ individual capacity such as renting of the commercial premises to the company done by him.
It is specifically noted that the said Circular has emphasized the words ‘director’s remuneration’ and it is abundantly clear that the Circular covers the aspect of remuneration paid to a director, in his capacity as a director. This aspect also supports the view that the services which are provided in the capacity of a director would only be covered under the reverse charge mechanism.
Whether one needs to follow department circular mandatorily?
It was held by the Hon’ble Supreme Court in the case of Minwool Rock Fibres Ltd[7] that the circulars/instructions issued by CBE&C are merely their understanding of statutory provisions and are not binding on Assessee, Quasi-Judicial authorities, and courts.
Thereby, the said clarification could be adopted when it is favorable to the assessee. In my view, the circular does not bring clarity on major aspects, however, it could be adopted on the lines of words ‘director’s remuneration’ discussed supra.
Based on the above discussion, where any amount paid in any form of Remuneration/sitting fees/commission, if paid like professional charges, then the payment for providing such services to the directors would be liable to be GST and to be paid under RCM by such company.
6. Whether services provided in the individual capacity is liable to be paid under RCM?
Where a director is not serving as an employee of the company, services provided by him would not be covered by Schedule III of the GST and would be liable to GST under forward charge.
In terms of Section 197(4) of the companies Act 2013 Services provided by the director would not be included in remuneration (salary) if provided in other capacity, such as –
(a) The services rendered are of a professional nature; and
(b) In the opinion of the Nomination and Remuneration Committee (if applicable), or the BOD (other cases), the director possesses the requisite qualification for the practice of the profession.
Therefore, there is no restriction that the director cannot provide any services in his own individual capacity to the company in professional nature.
There are certain supplies of goods/services provided by the director in his own individual capacity to the company which is as follows:
> Renting of property owned by the director to the company
> Sale of goods
> Providing services as a tax consultant
> Commission paid for inducing investments etc for the company
> A guarantee is given by the director to a financial institution for a term loan or cash credit facility which is enjoyed by the company in place of a guarantee commission paid to the director
The question here arises, whether all services provided by the director would be covered under RCM payable by the company?
The RCM notification does not appear to cover services that are provided in the independent capacity of the director, as it would not form part of the remuneration paid to the director in the said capacity.
Also, under entry no. 6 of the RCM notification, the supplier of service should be a director of the said Company. A ‘director’ by itself is not a person, but a position in the Company that is held by a person.
When the services are provided in the independent capacity of an individual, it cannot be said it is the director who has provided the said service. For instance, say, when a director provides his commercial property for rent to the Company, it cannot be construed that it is a service provided by the director in his capacity as a director of the Company. In fact, it is a service provided in the individual capacity of the director (i.e., as a third party), on which consideration is paid for the property provided on lease.
Such services would be liable to be paid under forward charge by directors [if liable for registration i.e., Section 22 of the CGST Act, 2017 provided that every supplier would be liable to be registered in the State or Union territory, from where he makes a taxable supply of goods or services or both if his aggregate turnover in FY exceeds Rs. 20 lakhs (Rs. 10 lakhs in the case of special category States)]
Hence, the test would be to determine whether the service is provided by a person to the Company, in his capacity as a director or otherwise. The requirement to pay GST under RCM would arise only when it is provided in the capacity of a director. The exclusion of employer-employee relationships under Schedule III of the CGST Act, 2017 shall be evaluated in case of such transactions.
7. Whether RCM is payable on renting of property owned by the director to the company?
Renting services is provided by the director in his capacity (not as a director but as a distinct capacity) to the company. Consequently, Company is not liable to pay tax under reverse charges; tax would be paid under forward charge by the director.
In my considered view, the reverse charge should only be applicable for payments arising to the director on the account of his services supplied in the capacity of the director [other than in the capacity as an employee of the company or in the capacity of an individual].
8. Whether RCM is payable on a Guarantee given by the director which is enjoyed by the company in place of a guarantee commission paid by the director?
Generally, directors of the company execute personal guarantees given to a financial institution for the term loans/cash credit facilities to be enjoyed by the company or as a pre-condition for providing financial assistance, and for such guarantee directors charge a fee to the company.
A ‘contract of guarantee’, as defined in Section 126 of the Indian Contract Act, is a contract to perform the promise, or discharge the liability, of a third person in case of his default. The assumption of personal liability is a necessary element in a contract of guarantee.
In the case of Suessen Textile Bearings[8] it was held that the guarantee commission payable to a director is not remuneration for the services rendered in the capacity of the director instead it is towards commission for the pledge of his credit.
The guarantee given by the director against his assets is in his individual capacity and not as a director of the company. Consequently Company is not liable to pay tax under reverse charges; instead, tax would be paid under forward charge by the director.
9. Summary
In Directors’ capacity
a. As Salary [director is an employee] – Paid in the form of salary and TDS u/s 192 of Income Tax Act is deducted
Remuneration paid could get covered under Schedule III and consequently not liable under GST.
b. As other fees [director is not an employee] – Paid in the form of other professional fees and TDS u/s 194J of the Income-tax Act is deducted
Remuneration paid like professional charges,where the company is paying consideration for providing services to directors and TDS under S. 194J of the Income Tax Act, 1961, such services received by the company would be taxable under RCM.
In Individual capacity
c. Paid to director against supply made by him in an individual capacity to company [such as renting of the commercial premises to the company done by him]
The GST would not be payable under RCM by the company when the director is providing services other than the capacity of a director such as renting immovable property.
10. Conclusion
The drafting of the RCM notification has placed absurd interpretations. Though Circular 140 discussed supra has clarified few aspects, however, its failure to bring some clarity on services provided by the director in his capacity to the company not liable under reverse charge has left Pandora’s Box open unattended.
It is hoped that the representations made are considered and this provision is made clear to avoid litigation.
Publication Link:
[1] Allied Blenders and Distillers Pvt. Ltd. vs C.C.E. & S.T.,2019 (024) GSTL 0207 Tri.-Bom
[2] M/s Bengal Beverages Pvt Ltd vs CGST and CE [2020-TIOL-1626-CESTAT-KOL]
[3] Employees State Insurance Corp vs Apex Engineering Pvt Ltd Civil Appeal No 3411/1996
[4] Advance Ruling No. RAJ/AAR/2019-20/33, dated 20-2-2020
[5] Advance Ruling No. KAR ADRG 83/2019, dated 25-9-2019
[6] Circular 140/10/2020-GST dt 10.06.2020
[7] Comm of CE vs Minwool Rock Fibres Ltd (2012) 278 ELT 581 (SC)
[8] Suessen Textile Bearings Ltd. vs Union of India and Ors. on 14 November, 1983
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