The issue relating to leviability of tax on remuneration paid to directors has been a matter of debate very since August 07, 2012 when reverse charge mechanism (‘RCM’) in respect of services provided by directors was first introduced under Service Tax laws vide Notification No. 45/2012-ST dated August 07, 2012. RCM provisions were also built-in under the Goods and Services Tax Act, 2017 (‘CGST Act’) and were notified through the Notification Number 13/2017-Central Tax (Rate) dated June 20, 2017 issued under Section 9(3) of the CGST Act. So, the debate relating to the taxation of remuneration paid to Directors was being carried over from service tax laws to the GST Laws as well.
Now, this debate has further been given some more air to the issue by the ruling pronounced by Hon’ble Rajasthan Authority for Advance Ruling (‘Authority’) in the case of M/s Clay Craft India Private Limited wherein it has been held by the Authority that the remuneration paid to directors is a consideration in respect of services supplier by them to the company and hence, is not covered by the Para 1 of Schedule III appended to the CGST Act i.e. such services are not in the course of their employment and accordingly cannot qualify to fall within the said para of Schedule III. Accordingly, since such services are not covered within Para 1 of Schedule III to the CGST Act, the same shall be treated as supply of services in accordance with Section 7 of the CGST Act and hence be chargeable to tax as taxable supply of services.
Further, in terms of Entry 6 of the Notification No. 13/2017-Central Tax (Rate) dated June 28, 2017 (‘RCM Notification’), such supply shall attract mechanism of reverse charge (‘RCM’) wherein the recipient (i.e. the Company or the body corporate located in taxable territory) should be paying tax at applicable rates under RCM provisions.
With the above background, through this article, an attempt has been made to understand the provisions relating to the taxability of payments made to directors under GST laws. Further, relevant provisions of Companies Act, 2013, Income Tax Act, 1961, Finance Act, 1994 (Service Tax Laws) and related judgements have also been incorporated into the same so as to appropriately appreciate and understand the provisions to arrive at a conclusion.
Before the Hon’ble Authority, there were two questions raised by M/s Clay Crafts India Private Limited (‘Applicant’). These questions were as under;
It was submitted by the Applicant that directors are being paid compensation regularly by way of salary and other allowances in terms of the policy of the Company and in terms of their employment contract. It was also stated that directors are being treated at par with other employees as far as their employment is concerned. Further, the company is also deducting TDS on their salary and relevant labor laws (like EPF laws) are also being complied with in respect of these directors along with all the benefits given to them as per the policy decided by the company for its employees. Therefore, for all practical purposes, these directors are the employees of the company and working as such beside being directors of the company. Hence, it was submitted by the Applicant, that services provided by the directors in terms of their employment contract are in the nature of services performed by the employee for their employer and accordingly should be covered within the ambit of Para 1 of Schedule III appended to CGST Act, treating it neither supply of goods nor supply of services.
The Authority stated that directors are not to be treated as employee of the company and hence, services provided by such directors should be chargeable to tax under GST. It was held that in the present case, directors should be treated as supplier of services and the company shall be considered as recipient of services. Accordingly, in terms of RCM notification, such services should be taxed on reverse charge basis and company shall be liable to pay tax being recipient of services.
Similar views were given by Hon’ble Karnataka Authority for Advance Ruling in the case of M/s Alcon Consulting Engineers (India) Private Limited wherein it was held by the Authority that services provided by the directors of the company are not covered within Para 1 of Schedule III of CGST Act, as the director is not an employee of the company. The consideration paid to the director is in relation to the services provided by the director and recipient of such services is the company in terms of section 2(93) of the CGST Act and director is the service provider. Such services shall be chargeable to tax in terms of RCM notification and recipient in this case (the company) shall be required to pay applicable taxes under reverse charge.
In both the rulings as mentioned above (i.e. M/s Clay Craft India Private limited and M/s Alcon Consulting Engineers (India) Private Limited), Authorities failed to appreciate the fact that there exists a relationship of an employer and employee between a company and a director. Such authorities only considered the RCM implications on the remuneration paid to the director and the fact that a director is an employee of the company was outrightly denied.
In order to appreciate various provisions of other laws which inter alia include Companies Law, Income Tax laws, it is important to analyze them one by one.
Provisions under Companies Act, 2013
Section 2 (34) of the Companies Act provide that ‘director’ means a director appointed to the Board of a company. A director is a person appointed to perform the duties and functions of director of a company in accordance with the provisions of the Companies Act, 2013.
In certain cases, directors are nominated by any financial institution/investors/foreign collaborators etc., in pursuance of any law for the time being in force, or of any agreement, or appointed by any Government or any other person to represent its interest.
In terms of Section 2(94) of the Companies Act, a whole-time director means a director, who is in whole-time employment of the company. In terms of Section 2(54) of the Companies Act, ‘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. In the case of Employees State Insurance Corporation vs. Apex Engineering Private Limited, the Hon’ble Supreme Court held that managing director of the company shall also be termed as an employee since he is in whole time employment. Similar views were expressed by this court in case of Commissioner of Income Tax vs. B.P. Dalmia and it was held that managing director is to be treated as employee of the company.
In terms of Rule 2(1)(k) of Companies (Specification of Definitions Details) Rules, 2014, an executive director means a whole-time director as defined in section 2(94) of the Companies Act, 2013. Accordingly, tax implications which are applicable in case of remuneration paid to whole-time director shall also be applicable in case of executive directors. Non-executive directors have not been defined in the law and hence, they should be considered as the one who are not executive director. In other words, non-executive directors are from outside the company and they do not take part in day to day operations of the company as they are not in knowledge of regular and routine operations of the company. They are appointed only to attend board meetings and work otherwise than on routine basis. Hence, it can be considered that non-executive directors are not employees of the company.
In terms of Section 149(6) of the Companies Act an independent director is the one who is not a managing director or a whole-time director or a nominee director. An independent director is the one who is independent of the company’s management and is appointed by the Board. An independent director is required to possess certain prescribed skill and knowledge in terms of the Companies law. Such director does not work under the supervision and control of the company and accordingly, it can be viewed that these types of directors are not employee of the company.
Remuneration in terms of Section 2(78) of the Companies Act, 2013 would 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. Hence, any money or its equivalent paid to the directors for services rendered by him shall qualify to be remuneration in respect of such services rendered. In few cases, directors are also paid sitting fees for attending the board meetings or committee meeting. As regards sitting fee, this fee is normally paid to non-executive directors and is not generally paid to whole-time director or a managing director. In case such fee is paid to whole-time or managing director, such fee is included in the value of allowance and is treated as part of salary for the purposes of computation of ceiling amount to be paid as salary in terms of the provisions of the Companies Act, 2013. Further, in case of sitting fee being paid to non-executive directors, as these directors are not employees of the company, such sitting fee paid shall not be regarded as salary/remuneration in the course of employment and shall not be covered within Para 1 of Schedule III to the CGST Act.
Provisions under Income Tax Act, 1961
The most important requirements in relation to an income be considered as salary under taxation laws, is the existence of an employer-employee relationship. Unless there is an employer-employee, master-servant relationship, consideration paid cannot be taxed under the head salary.
Further, to determine the existence of an employer-employee or master-servant relationship, following tests as laid down by Hon’ble Supreme Court can be applied. If the test as laid down are satisfied, it can very safely be concluded that there exist an employer-employee relationship and remuneration paid is in the course of employment and shall be treated as salary. Where there exists a right of the master to supervise and control the work done by the servant which is not limited to the direction of what work is to be done, but including how that work is to be done. Further, who is the appointing authority, who pays the remuneration, who can dismiss, the extent of control or supervision, the nature of job, nature of establishment, right to reject etc. should also be important to determine the nature of relationship.
Hence, if a person has to work under direct supervision and control of a person and has no discretion of his own in performing the work, he shall be considered as an employee and remuneration paid to him shall be treated as salary. Where the person exercises only supervisory role in respect of work given and person doing it has his own discretion in the execution of work assigned, it can very well be presumed that there exist no relationship of employer and employee. The relationship is this case would be on principal to principal basis and remuneration paid under this scenario shall be treated as ‘Profits and gains of business and profession’ for the person receiving such remuneration.
In case of a director, the nature of employment may be determined by the Articles of Association (‘AOA’) of the Company or the service agreement entered into between the director concerned and the company, if any. In order to determine that a director is an employee of the company, tests as laid down by the Hon’ble Supreme Court as discussed in preceding paragraph may be referred to and relationship may be determined in accordance with the same.
Provisions under erstwhile Service Tax Laws
In terms of the provisions contained under Service Tax laws vide Finance Act, 1994, services provided by an employee in the course of or in relation to his employment were out of the service tax net and hence, no service tax was paid in respect of remuneration paid in respect of work assigned in relation to employment. Any activity done in independent or professional capacity was treated as consideration paid for professional or consultancy services and was accordingly charged to services tax subject to the provisions contained in the regulations in so far as those regulation relate to taxation of services.
In the case of M/s Allied Blenders and Distillers Private Limited vs. Commissioner of Central Excise and Service Tax, Mumbai CESTAT held that where the remuneration is paid by a company the its whole-time director for engaging himself in day-to-day operations of the organization, compliance in relation to provident fund laws, professional tax and tax deduction in terms of Income Tax laws were made and complied with and were appropriately reflected in the returns/statements filed under the relevant laws, such remuneration paid shall be treated as salary and accordingly, service tax chargeability cannot be invoked on the same.
In the case of NRB Industrial Bearings Private Limited vs. Commissioner of Central Excise and Service Tax, Mumbai CESTAT held that where no evidence was produced by the Department that remuneration paid to the Managing director, in terms of the Memorandum of Association and Article of Association, is in relation to consultancy work and not in relation to routine work, such amount paid shall be treated as salary and hence, shall not be chargeable to tax under service tax provisions.
Reference to the circular 115/09/2009-ST dated July 31, 2009 is also worth mentioning here. In the said circular, it was clarified by Central Board of Excise and Customs (‘CBEC’) (now Central Board of Indirect Tax and Customs (‘CBIC’) that remuneration paid to managing director or directors of the company, whether whole-time or independent, when compensated for their performance as managing director or director would not be liable to service tax. This also indicates that remuneration paid in relation to the employment is not leviable to service tax.
Taxation of remuneration paid to various types of directors can be summarized as under:
|S. No.||Type of Director||Taxability under GST|
|1||Whole-time director||Since the whole-time director is in the whole-time employment of the company and performs his services in relation to day-to-day activity of the company, remuneration paid to such director shall be treated as salary and shall not be chargeable to GST by virtue of Para 1 of Schedule III to the CGST Act.|
|2||Managing director||By virtue of decision of the Hon’ble Supreme Court in the case of Employees State Insurance Corporation vs. Apex Engineering Private Limited, it has been held that managing director shall be treated as employee of the company as he is in the whole-time employment of the company and is engaged in the day-to-day routine activities of the company. Hence, remuneration paid to such managing director should be treated as paid in the course of employment and is covered within Para 1 of Schedule III to the CGST Act.|
|3||Executive director||Since, an executive director has been assigned as the same meaning as that of a whole-time director, tax treatment of remuneration paid to such executive director shall be same. Accordingly, it shall be outside the purview of GST.|
|4||Non-executive director||Such directors are not to be treated as in the employment of the company and they provide their services as independent professionals. Hence, remuneration paid to them shall be chargeable to GST.|
|5||Independent directors||Services performed by independent directors are separate from that of the director serving under the employment agreement. Services from independent director are not to be treated as performed under any employment agreement and hence, shall be outside the purview of Para 1 of Schedule III and accordingly be taxable.|
|6||Nominee director||Nominee director, though not employed by the company but by the institution/foreign collaborator/Government etc., can be treated as performing his duties in the course of or in relation to his employment and accordingly, remuneration paid to such director shall be outside the ambit of GST net by virtue of Para 1 of Schedule III to the CGST Act.|
Based on the provisions relating to Companies Act, 2013, Income Tax Act, 1961, erstwhile Service Tax Laws and principles given in various rulings, circulars and clarification from the Department, as discussed above, it can be concluded that remuneration paid to directors which is in the course of or in relation to their employment shall be regarded as salary and shall be governed by Para 1 of Schedule III appended to the CGST Act. Accordingly, the same shall be outside the purview of the taxation in terms of provisions contained under GST laws. The fact that whether the services performed by the director concerned is in the course of or in relation to the employment is to be determined on case to case and on the basis of the facts of the case. Tests to determine the existence of employer-employee relationship could be used to determine the true nature of services performed by the director concerned.
It can further be concluded, that Hon’ble Rajasthan Authority for Advance Ruling has incorrectly interpreted the law relating to taxation of remuneration paid to the directors for their services rendered to the companies. Due to this ruling, it is likely that the Tax department or other Authorities may frame a view and take the same position under the law in future as well which may result in un-called litigation in the times to come.
Disclaimer: Views expressed in this article are personal views of the author and are for guidance purposes only. It is advised that the same should not be treated as legal advice and should not be acted upon in business scenarios. It is further advised that appropriate legal/professional advice is taken prior to acting upon the above while undertaking business transactions.