Is the word Director becoming a big reason to worry for Companies?
Directors are appointed to a Company to manage the day-to-day business activities, finances and to ensure all statutory filing obligations are met. They act lawfully and honestly while making decisions for the benefit of the company and its members. In nutshell, it can be said that the Directors play a key role in the success of any Company.
But recently it has been observed that Companies are being softly targeted through its directors. In a very recent decision of Clay Craft India P Ltd  116 taxmann.com 114 the Hon’ble AAR-Rajasthan has held that GST is payable by the company under reverse charge mechanism on remuneration/salary paid to whole-time/executive directors. In that decision intent of legislature has been ignored purely and an attempt to unsettled the settled position of earlier laws (though the same is not in existence after GST) has been made unnecessarily.
Taxability of services provided by directors in GST:
As per the provisions of section 9(3) of CGST Act, some notified services and goods would be liable to GST under Reverse Charge Mechanism (RCM) and for the same Notification No. 13/2017 – Central Tax (Rate) has been issued on dated 28.06.2017 which provides a list of goods and services for which GST to be paid on RCM basis by the recipient. In entry number 6 of said notification, services supplied by directors to Company has been notified as RCM services on which GST needs to be paid by Company/Body Corporate.
As per the above notification, all the services provided by Directors to Company are subjected to GST under RCM but services provided by the director in the capacity of an employee is not subjected to GST on the basis of the provisions of the Schedule III of CGST Act, 2017 where it is clearly mentioned that services by an employee to the employer in the course of or in relation to his employment are NOT to be considered as a supply of services.
As per the provisions of the GST law, it is clear that if the employer-employee relations are existing then service provided by the employee to his employer is not subjected to GST but services provided director in any other capacity other than employee are subjected to GST under RCM and the recipient Company is liable to pay GST on the said services. Example of the same are like Sitting Fees, Guarantee Commission and any specific technical services etc.
Though it is clear that service provided by the director to Company is subject to GST under RCM except to the service which has been provided in the capacity of the employee. But there are some issues have been emerged related to services provided by the director to Company by way of giving their personal guarantee for the loan extended by banks or financial institutions to the Company. Following are the issues which need attention:
1. Valuation of personal guarantee given by directors to banks for the loan extended by Banks to the Company.
2. Quantum of guarantee valuation with respect to directors.
As per the provisions of section 7(1)(c) read with para 2 of Schedule – I of CGST Act, 2017 supply of services between related persons or between distinct persons as specified in section 25 shall be treated Supply even if made without consideration hence the transaction of providing guarantee by directors to banks for the Company is taxable transaction but the valuation of the same is a difficult task as the director gives the same without consideration.
For the purpose of determination of guarantee valuation, we have to refer valuation rules number 28 where it is prescribed that value of supply of services between distinct or related persons will be the open market value of such supply. The open market value of such guarantee transaction is not available in the open market as while giving guarantee to bank director cannot charge any commission on the said services as it is a precondition of banks for providing loan facility that director will not charge any guarantee commission on the guarantee provided by them.
Now the question arises that if in the open market such kind of transactions is not available then what value should be adopted. In such case, it can be said that though exact transaction related to director guarantee is not available but similar kind of transaction available in the open market like guarantee commission charged by the bank while giving guarantee for its customer can be considered. These transactions can be the decider of the arm’s length price. Generally, while giving guarantee by banks for its customer’s bank charge 1% to 2% commission of guarantee value. Hence in case of guarantee given by directors to the bank for extending loan to the Company value of supply can be considered 1% to 2% of the guarantee amount.
After discussing the valuation of guarantee transaction one more issue arises that what should be the quantum of guarantee amount. To understand the quantum issue, have a look at the example given beneath:
Ex. M/s Sunrise Textile Pvt Ltd (‘STPL’) has taken Rs. 500 lacs loan from Bank of Baroda (‘BOB’) and the Company is having two directors Mr. A and Mr. B on its board. As per the preconditions of loan apart from taking collateral bank as has taken personal guarantee of both the directors. Mr. A’s personal assets valuation comes to Rs. 600 lacs and Mr. B’s assets valuation comes to Rs. 800 lacs.
Question 1 : What will be the quantum of guarantee amount for Mr. A and for Mr. B?
Question 2 : What will be the quantum of guarantee amount if the value of personal assets of Mr. A is Rs. 300 and of Mr. B is Rs. 500 lacs?
The answer to the above questions is very difficult as noting has been prescribed in the valuation rules regarding this kind of situation. At present (i.e. while giving guarantee at the time of taking a loan) no one can say that in case of default in repayment of loan by the company how much amount will be recovered from Mr. A and from Mr. B.
To avoid any future dispute if the Company take a stand that quantum of guarantee should be to the extent of personal asset valuation of director then it may be possible that collectively the said amount may go beyond the actual loan amount which is highly impractical and an argument that whatever GST the Company will pay under RCM would become Input Tax Credit the Company is not tenable for those entities which are under Inverted Duty Structure.
Hence at the time of giving guarantee what quantum should be taken for valuation purpose, it is a matter of dispute which needs clarification from the Government to avoid unnecessary dispute. A specific rule for such kind of transaction should be made so that at the time of assessment, taxpayers are not at the mercy of tax officer.