Director’s remuneration and GST – analying the complex relationship

Analysis by CA. Gaurav Gupta, Partner, MGS & Co.

Advance Ruling (Download) in the case of Clay Craft (P) Ltd. (“Company” or “Applicant”) has created ripples all across.  The point under consideration before the Ld. Authority for Advance Ruling (“AAR”) was whether the remuneration of directors is exigible to GST and is company liable to pay such GST under reverse charge.  The facts of the case are as under:

• The Applicant declared the names of the members of board of directors
• It explained the work undertaken by the directors of the Company and stated that they are working as employee of the Company
• The Salary is paid to the directors and is shown under the head “Income from Salary” by the directors
• That the Applicant was paying GST on any amount other than Salary eg. Commission etc. being paid to directors

The Applicant further highlighted the decision of AAR, Karnataka IN RE : Alcon Consulting Engineers (I) Pvt. Ltd. wherein it was held that remuneration paid to the Director of the Applicant company is liable to tax under reverse charge mechanism under sub-section (3) of Section 9 in the hands of the Applicant company as it is covered under Entry No. 6 of Notification No. 13/2017-Central Tax (Rate), dated 28-6-2017. Further, provisions of Companies Act, 1956, Employee Provident Fund scheme, 1952, were highlighted by the Applicant to substantiate his case.

Ld. AAR, Rajasthan following the said decision without specifically disproving the submissions of the contentions held that Directors are not employees of the Company and GST should be paid under reverse charge on any payment to the directors.

At the outset, the above judgement is not a good precedent. Ld. AAR is acting in a quasi judicial capacity (the responsibility is not diluted in absence of a judicial member).  There is a huge responsibility which vests on this body as it is determines the fate of tax payable by an applicant.  Thus, like any other quasi judicial or judicial body, it should pass a reasoned order and not mere conclusion as to why the contentions of the Applicant is agreed or not agreed to.  Mere conclusion without a speaking order by AAR may not be accepted as a precedent by Courts in other cases.  In Tata Engineering & Locomotive Co. Ltd. v. Collector of Central Excise, Pune reported in 2006 (203) E.L.T. 360 (S.C.), the Hon’ble Supreme Court, held that it is not sufficient in a judgment, to give conclusions alone, but it is necessary to give reasons, in support of the conclusions arrived at.  The Apex Court had set aside the order of the Tribunal, holding that the findings recorded by the Tribunal therein, were cryptic and non-speaking.

We now move to discuss the exigibility of Director’s remuneration under GST.  Before entering the discussion, it is important to highlight some of the important definitions which are provided in of Companies Act, 2013, as relevant from current perspective are udner:

• 2 (34): Director means a director appointed to the Board of a company;
• 2(10): “Board of Directors” or “Board”, in relation to a company, means the collective body of the directors of the company;
• 2 (54): “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.

            Explanation.—For the purposes of this clause, the power to do administrative acts of a routine nature when so authorised by the Board such as the power to affix the common seal of the company to any document or to draw and endorse any cheque on the account of the company in any bank or to draw and endorse any negotiable instrument or to sign any certificate of share or to direct registration of transfer of any share, shall not be deemed to be included within the substantial powers of management;

• 2 (94): “whole-time director” includes a director in the whole-time employment of the company;

Understanding the relationship of persons in different capacities:

Section 149 of the Companies Act requires every company to have a Board of Directors consisting of individuals as directors.  Section 152 provides that every director shall be appointed by the company in general meeting.  Now, why does the General Meeting pf shareholders appoint directors.  Directors are appointed to constitute a Board whose powers are provided in Section 179 of the Companies Act.  Amongst others, the Board is entrusted with many powers, some of which are as under:

1. to make calls on shareholders in respect of money unpaid on their shares;
2. to authorise buy-back of securities under section 68;
3. to issue securities, including debentures, whether in or outside India;
4. to borrow monies;
5. to invest the funds of the company;
6. to grant loans or give guarantee or provide security in respect of loans;
7. to approve financial statement and the Board’s report;
8. to diversify the business of the company;
9. to approve amalgamation, merger or reconstruction;
10. to take over a company or acquire a controlling or substantial stake in another company;
11. any other matter which may be prescribed:

Thus, the directors are nothing but persons entrusted with the management of the Company.  Thus, as a director, a person is not liable for any other work other than being part of Board of Directors to manage the Company.  However, Board require further persons to execute its decisions.  Inline, the Board appoints Managing and Whole time directors.  Section 196 empowers the Board to appoint managing director, whole-time director or manager and the terms and conditions of such appointment and remuneration payable be approved by the Board of Directors at a meeting which shall be subject to approval by a resolution at the next general meeting. Accordingly, directors together as a Board further appoints persons into different executing positions in a Company.  Such persons are appointed under a different agreement and such persons can also be amongst the directors who constitute the Board and thus, the director has now assumed an additional role in the Company.

Thus, a person becomes a director and then in addition to being a director, he is given additional place of profits in different capacities and their relationship with the Company are under a different set of agreement and terms and such position is not a part of him being a director.  Also, we have to appreciate that the visualisation of the position can be different from different Acts.  Thus, we can now differentiate the relationships as under:

• Director: Director is a specific position who is a constituent of Board of directors which is entrusted with many powers as discussed above. Section 197 of the Companies Act provides that a person in the position or role of a Director may receive remuneration by way of fee for attending meetings of the Board or Committee thereof or for any other purpose whatsoever as may be decided by the Board.  Thus, a director does not get any consideration other than fee for attending meetings of the Board or Committee.  Thus, for his role as a director, a person gets a sitting fee. Such fees can have different names and ways of determination.  For his role as a director he is paid sitting fees, Commission on profits earned, ESOPs, etc.

• Whole Time director: A Whole time director is under an employment contract .  A whole time director is under the employment of the Company and thus, draws Salary as approved by the Board.  He may in this position as an employee, may get a monthly salary, ESOPs, Bonus, superannuation, Sweat Equities etc. All such amounts shall be exigible to TDS under Income Tax Act under the head ‘Payment of Salary’ and the Whole time Director shall also declare his income in his income tax return under the head  “Salary Income”.  The relationship of Whole time Director is examined in the case of Maithan Alloys Ltd. Vs CCE & ST, Bolpur [Appeal No. 75277 of 2016], wherein Hon’ble Tribunal observed as under:

“We further find that 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 a ‘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, in our view, 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. We are thoroughly convinced that when the very provisions of the Companies Act makes 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.”

• Managing Director: The nature of remuneration as a Managing Director shall be determined by the agreement between the Company and the Managing Director.  If the agreement is that of an employment as enunciated above, the remuneration shall be in form of Salary and allied emoluments.  The nature of emoluments then are of same nature as discussed in the case of whole time director above.  If the arrangement is in form of a consultant, the entire withdrawl shall be in form of consideration for provision of service as a professional / technical person.  Hon’ble Supreme Court decision in Ram Prashad v. CIT [1972] 42 Comp Cas 544 ; 86 ITR 122 observed that whether a Managing Director is an employee of the Company or not can be determined only by the articles of association and the terms of employment. The Supreme Court cited a passage from the judgment of the Scottish Court of Session in Anderson v. James Sutherland (Peterhead) Ltd. [1941] SC 203 at 218, where Lord Normand stated:

“‘…the managing director has two functions and two capacities. qua managing director he is a party to a contract with the company, and this contract is a contract of employment; more specifically I am of opinion that is a contract of service and not a contract for service.’”

The Supreme Court in ESI Corporation Vs. Apex Engineering (Pvt.) Ltd. (1998) 1 SCC 86 has held that a Managing Director by himself cannot be said to be the owner of the factory which belongs to the company and particularly when the Managing Director was to work under the directions of the entire body of Directors.  Hon’ble Allahabad High Court in the case of Sardar Harpreet Singh v. Commissioner of Income Tax – 1990 SCC Online All 929, submitted that merely on deduction of Income Tax at source cannot be considered that the Director and the Company has employer and employee relationship. It is the agreement between the employer i.e. company and the Director would reveal the exact relationship between them.

On employer-employee relationship, Organisation of Economic Cooperation and Development [OECD] Commentary on the  Model Tax Convention 2010 provides as follows:

“The nature of the services rendered by the individual will be an important factor since it is logical to assume that an employee provides services which  are an integral part of the business activities carried on by his employer. It will therefore be important to determine whether the services rendered by the  individual constitute an integral part of the business of the enterprise to  which these services are provided. For that purpose, a key consideration will be which enterprise bears the responsibility or risk for the results produced  by the individual’s work. Clearly, however, this analysis will only be relevant if the services of an individual are rendered directly to an enterprise. Where, for example, an individual provides services to a contract manufacturer or to an enterprise to which business is outsourced, the services of that individual are not rendered to enterprises that will obtain the products or services in question.”

The OECD Commentary has also laid down the following key factors for determining an employer-employee relationship:

• • Authority to instruct the individual regarding the manner in which the work is to be performed
  • Control and responsibility for the place of work
  • Remuneration of the individual is directly charged by the formal employer to the enterprise to which the services are provided
  • Provision of tools and materials to employee
  • Determination of the number and qualifications of the individual deputed
  • Right to select the individual to perform work and to terminate contractual agreements with the employee for that purpose
  • Right to impose disciplinary sanctions related to the work of that individual
  • Determination of holidays and work schedule.

Thus, every contract of Managing Director needs examination from above perspective to determine as to whether it falls within the terms of employment.  Deduction of TDS under Salary is only an indicative fact and not a deteremining fact.  It is also important to mention that different Acts can look at the above position from their perspective in different manner.

III.        GST on remuneration paid

The above relationships being established and understood, we now discuss the GST implications on remunerations received by the above categories.  Any remuneration received by a director in any capacity other than employee is exigible to GST.   Schedule III of CGST Act, 2017 interalia amongst others provides for employee services as transaction which are neither considered as supply of goods or supply of service.  Thus, various positions where a director draws remuneration for employee services are not exigible to the levy of GST, while in all other cases, it shall be exigible to GST.

Director

Since a person in the capacity of a director is not an employee of the Company, any remuneration received by such person shall be exigible to GST.  Thus, sitting fees, commission, ESOP etc all shall be exigible to GST and Company shall be liable to pay GST under reverse charge.

Whole Time director

Whole time directors are specifically are in an employee relationship and thus, their emoluments are in the nature of Salary and are outside the ambit of levy of GST.  Ministry of Corporate Affairs (MCA) vide Circular No. 24/2012 dated 09.08.2012 clarified as under:

“The Non-Whole Time Directors of the company are presently not covered under the exempted list and as such, the sitting fees/commission payable to them is liable to Service Tax. Service tax is payable on the commission/sitting fees payable to Non-Whole Time Directors of the company.”

Thus, MCA indirectly clarified that remuneration of Whole Time Directors of the company are not exigible to Service Tax (akin to GST in present scenario).  In the case of PCM Cement Concrete Pvt Ltd. vs. CCE, Siliguri 2018 (9) GSTL 391 (Tri-Kol) wherein the Tribunal observed that consideration paid to whole time directors would be treated as payment of salaries inasmuch as there would be employer – employee relationships and in such cases, there cannot be any levy of service tax.  In the case of Maithan Alloys Ltd. Vs CCE & ST, Bolpur [Appeal No. 75277 of 2016], it was held that demand of service tax on remuneration paid to whole time directors cannot be sustained (for reasons discussed above).

Managing Director

The treatment to be accorded to the receipts of the managing director shall be determined after review of its agreement.  If the agreement is in terms of employment, no GST shall be payable.  The position is upheld in the case of Allied Blenders And Distillers Pvt. Ltd. v C.C.E. & S.T., Aurangabad [2019 (24) G.S.T.L. 207 (Tri. – Mumbai)], wherein Hon’ble Tribunal held as under:

“16. Also, from the documents produced by the appellant it is crystal clear that the Directors who are concerned with the management of the company, were declared to all statutory authorities as employees of the company and complied with the provisions of the respective Acts, Rules and Regulations indicating the Director as an employee of the company. No contrary evidence has been brought on record by the Revenue to show that the Directors, who were employee of the appellant received amount which cannot be said as ‘ salary’ but fees paid for being Director of the company. The Income Tax authorities also assessed the remuneration paid to the said directors as salary, a fact cannot be ignored. The judgments cited by the revenue cannot be applied to the present case as the facts are different and the finding of Income tax authorities accordingly also different in the said case.”

However, if it is for engagement other than as an employee, his services shall constitute taxable supply and GST shall be applicable thereon. Similar observations were upheld in the case of Brahm Alloy Limited v Commissioner of CGST & C.Ex., Durgapur, wherein it was held as under:

“It is my considered view that to establish the employer-employee relationship for the purposes of the remuneration/salary, the Resolution of the company should cover both, “the terms of appointment/hiring of the services of the individual and similarly it should also cover that in case of nonperformance of the specified duties, the individual shall be fired and/or his appointment would be terminated”. In short, to establish the employer-employee relationship, the clause of hiring and firing are an essential ingredient without which it cannot be construed whether the individual is the Promoter/Director or an employee Director.”

Independent Directors

Independent directors are directors who are not related to the owners or persons having influential stakes in the company and thus, they are at par with Directors.  They draw sitting fees and other remuneration for attending meetings of the Board or Committee thereof.

Conclusion:

Services in the capacity of a director shall only be exigible to GST under reverse charge mechanism.  Services of a person in capacity of an employee shall be outside the ambit of GST.  A director can also rent his shop to Company but then this entry cannot cover that service also.  Since there are numerous services which a person can give to company including rental, right to use IPR, renting of tangible asset, etc. and thus, the terms services by a director cannot be presumed to include person’s other services.  Any other services of a person (who is a director) in a capacity other than director like rental etc may be chargeable to GST and that too under forward charge.  Trust the above discussion shall be useful in determination of the nature of different roles of a director and their exigibility under GST.