SERVICES OF NON EXECUTIVE DIRECTORS TO THEIR COMPNY.

[Mr. M. GOVINDARAJAN]

                        The Company cannot function on its own.  It functions through its Board of Directors.  The number of directors in a company may be as specified in the provisions of the Companies Act, 1956.   Only an individual shall be the director of the company and no body corporate or association or firm shall be appointed as director of a company under Section 253 of the Companies Act.  No company shall appoint or reappoint any individual as director of the company unless he has been allotted a Director Identification Number (DIN).  The directors are liable to be retired on rotation.   The company may have directors by whatever name they may be called ad also non executive directors.   Non executive directors are not involved in the day-to-day affairs of the company but they participate in the decision making process of the company.  

                        The whole time directors and executive directors are treated as employees of the company.   Section 310(4) of the Companies Act provides that a director who is neither in the whole time employment of the company nor a managing director may be paid remuneration either-

• By way of a monthly, quarterly or annual payment with the approval of the Central Government; or
• By way of commission if the company by a special resolution authorizes such payment.

The remuneration paid to such director, or where there is more than one such director, to all of them together should not exceed 1% of net profit of the company; if the company has a managing or whole time director or  a manager 3% of the net of the net profits of the company in any other case.   If this limit is exceeded then the Central Government’s approval is required to be obtained. 

                        The service tax regime witnessed a sea change by the introduction of negative list.  It was widely perceived that payments to directors would attract service tax because such payments were not specifically mentioned in the negative list.  The whole time directors and executive directors will not come under the service tax net since there is a relation of employer and employee between the company and such whole time director or executive director which is specifically not included in the definition of service.  The amendment brought to the Notification No. 30/2012-ST, dated 20.06.2012 vide Notification No. 45/2012-ST, dated 07.08.2012 clarified that in respect of services provided or agreed to provided by  a Director of a company to the said company the service tax liability on such services would be borne by the company under reverse charge mechanism.

                        This issue has hot discussion among the professionals.  Many are of the view that service tax is not liable to be levied in such cases.   One view is that the directors are not providing service but they are only discharging fiduciary responsibility and performing the management functions.   The functions of the directors are not under the terms of contract.   The term ‘consideration’ as found in the definition of ‘service’ is applicable if there is a contract arised between the company and the director.   The directors are not the agent of the company.   They are only discharging fiduciary responsibility.  As such no service tax liability is there. taxmanagementindia.com

                        The Notification No. 115/09/2009, dated 31.07.2009 is to be seen in this regard.  In some litigation the functions of the directors were brought in the ambit of ‘business auxiliary services’ and ‘management consultant services’ by the department but the cases were decided against the Department.   Hence the Department issued a Notification (supra) in which it considered the matters and issued the clarifications as under-

• Some companies made payments to Managing Directors/Directors (Whole time Director or Independent Director) terming the same as ‘commission’.   The said amount paid by a company to their Managing Directors (whole time or independent)  even if terms as commission is not the ‘commission’ that is within the scope of business auxiliary services and hence service tax would not be leviable on such amount;
• The Managing Director/Directors (whole time or independent) being part of board of directors perform management function and they do not form consultancy or advisory function.   The definition of management consultancy service makes it clear that what is envisaged from a consultant is advisory service and not the actual performance of the management function.   The payments made by companies to Directors cannot be termed as payments for providing management consultancy service.   Therefore, it is clarified that the amount paid to Directors (whole time or independent) is not chargeable to service tax under the category ‘Management Consultancy Service’.   However, in case such directors provide any advice or consultancy to the company, for which they are being compensated separately, such service would become charge to service tax.

The professionals claimed that this notification has not yet withdrawn by the Government till date.  The clarification issued by the Department holds good for the present scenario also and therefore no service tax liability arises in this case.

                        The relationship of the directors and their company is well explained by the decision of Commissioner of Central Excise (Appeals) in the case ‘Sunetra P. Sumnnawar’ – 2008 (12) STR 632 (Commr. Appeals).   In this five persons were non executive directors of the Company Hematic Motors (P) Limited.   The said directors were issued demand notices under Section 73 of the Finance Act, 1994 read with section 83 alleging –

• that they had provided services to Hematic Motors (P) Limited during the period from April 2004 to March 2005 and received commissions in addition to remuneration for the sales promotion activities such as procurement of orders/marketing of product of the said company;
• but they had neither obtained service tax registration nor paid the proper service tax on the said amounts received; and
• also they did not file ST 3 returns on half yearly basis.

The Adjudicating authority confirmed the demand with interest and also imposed penalties on the said directors.   On appeal, the Commissioner (Appeals) held that the appellants proved that they received commission as per Section 309(4)(b) of the Companies Act,1956 and the relationship of the appellants was not as that of a client and service provider.   The meaning of the term ‘client’ was analyzed as below:

• An individual, corporation, trust or estate that employs a professional to advise or to assist it in the professional’s line of work, professionals include but are not limited to attorneys, accountants, architects etc., (Black’s Law Dictionary)
• A person who engages the professional advice of services of another (Merriam Webster’s Collegiate Dictionary)
• A person using the services of a lawyer, architect, social worker or other professional person (Oxford English Reference Dictionary)

From the above meaning, it was held that HMPL could not become client for non executive directors.   The relationship of HMPL and the appellants was not that of a client and service provider, since they were part and parcel of the company.

                        The findings in the above said case is very apt and on this ground the service tax liability does not arise.   Views of the expert in this debate are welcomed.