Looking through the Lens Director's Remuneration

[BHAWNA SINGHAL]

Services provided by a Director have been brought under the Reverse Charge Mechanism (hereinafter referred to as RCM) by Virtue of Sl. No 6 of Notification No. 13/2017-CT( R) dated 28.06.2017 whereby every Company or a Body Corporate who is paying remuneration to the Directors for the services rendered by them to the said Company or Body Corporate  are required to pay tax on RCM. But the Management of the Companies or their tax consultants or advisors is of the view that the remuneration paid to the Directors is in the course of an employment of the Directors with the company, hence Reverse Charge on the remuneration paid to them is not applicable as Sl. No 1 of Schedule III to the CGST Act, 2017 considers Services by an employee to the employer in the course of or in relation to his employment neither as supply of goods nor as supply of services.

In this regard, there has been three back to back Advance Rulings passed by Advance Ruling Authorities of two different states. Before discussing the decisions of the various Advance Rulings it becomes very pertinent to understand what are the kind of services being provided by a director or what is the nature of business that a director is undertaking that his services are brought under the umbrella of taxable services of GST. This compelled me to study the definition of Business as defined u/s 2(17) of the CGST Act, 2017. Clause (g) of the said section states that any services supplied by a person as the holder of an office which has been accepted by him in the course or furtherance of his trade, profession or vocation is a business. So from this it can be deciphered that an Individual who has given his consent to accept the position of a Director in a company is undertaking the directorship due to his vocation and hence is rendering the directorial services under the HSN Service code 9983 or more precisely can be said 998311. (Please refer to the Explanatory Notes to the Scheme of Classification of Services as published on the GSTN portal for the detailed list of services falling under this category).

A Company is an artificial person who cannot interact directly with its stakeholders. The companies Act makes it mandatory for every company to have a Board of Directors consisting of individuals as directors. And hence the Directors are appointed to the board of the Company to provide the services to the Board in order to represent the company to various stakeholders, regulatory bodies, tax authorities etc. In return of his services the Director is entitled to the remuneration or let’s say consideration (be it in the form of salary, commission, percentage of profits, by whatever name called) for the services that he renders to the company. So the question comes, once a director is appointed to the Board of the Company, what is the nature of his appointment? Is he under a service agreement with the company to render his services in the capacity as a director or is he under an employment agreement with the company to render his services as an employee? What is the underlying difference between a service agreement and an employment agreement?

 To my understanding the employment agreement gives birth to the master servant relationship wherein the employee is subservient to the master’s instructions and is under an obligation to abide by the rules and regulations of the company like working hours, attendance, accountability, reporting, leave deductions, notice pay, Bonus etc. Once he becomes the employee of the company various other Acts such as Profession Tax Act, Provident Fund Act, ESI Act etc. also becomes applicable. His performance is monitored, appraisals are given, and promotions are granted and so on. Under employment agreement the consideration is paid to an employee in the form of remuneration which may be in the form of salary, perquisites, bonus, commission, incentives, % of profits by whatever name called, but all this consideration is given to him only because he is under the contract of employment and this varied nomenclature of remuneration is already mentioned in his employment letter/agreement.

 Whereas in a Service Contract the contractee is only under an obligation to provide the contracted service within the agreed time span for a pre decided price. He is not bound by the working hours, rules and regulations of the company. Once his task is completed the contract is said to be terminated or he enters into a new contract for any new work. There exists no appraisals, promotions, leave dedcutions etc.  The various other acts allied/applicable due to the employment is not applicable to him.

A director once appointed to the Board certainly does not become an employee of the company by default.  By giving his consent to act as the Director he only undertakes to be representative of the Company. He only contracts to become the Director of the Company and offers to provide his representative/managerial services by way of accepting his position as a Director for some remuneration. Further, only after being appointed to the Board as a director, there comes a question whether such a director is being appointed as an Executive Director or a Non-Executive Director.

Who is an Executive Director.  As per Rule 2(k) of the Companies (Specification of definition details) Rules, 2014 “Executive Director” means a whole time director as defined in clause (94) of section 2 of the Act. Since the definition starts with means so can it be said that the definition of Executive Director is an exhaustive definition which encompasses only a WTD director to be an executive director.

So who is a Whole Time Director.  Sec 2(94) of the Companies Act defines Whole Time Director as “whole-time director includes a director in the whole-time employment of the company”. This is an inclusive definition, a definition wide enough to cover any director who is in the whole time employment of the company as the Whole Time Director of the company. So can a Managing Director or Manager also fall into the definition of the whole time director and thereby making them the Executive Director of the Company?  Before answering this let us understand who is a managing Director or a Manager.

As per sec 2(53) of the Companies Act, 2013 Manager means an individual who, subject to the superintendence, control and direction of the Board of Directors, has the management of the whole, or substantially the whole, of the affairs of a company, and includes a director or any other person occupying the position of a manager, by whatever name called, whether under a contract of service or not;

And

Sec 2(54) of the Companies Act defines Managing Director as 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;

From the conjoint reading of the above two definition of Manager and Managing Director it can be said that the definition of the Whole Time Director is wide enough to encompass within it all the directors who are in the whole time employment of the company and the term Executive Director means a whole time director so it can be interpreted that the Managing Director, Manager and WTD would encapsulate under the definition of Executive Director.

Further, for every Director who is appointed to the Board of Directors,  a declaration in form  DIR 12 is required to be filed and such declaration specifically asks about the fact whether the appointed director is working in the capacity as an Executive  Director or Non-Executive Director. Further for every director (Executive Director) who is appointed as the managerial personnel of the company in the capacity of Manager, Managing Director or WTD, a separate form MR 1 is required to be filed with the ROC declaring the details of such director along with the break-up of Remuneration.

From the aforesaid paragraphs it can be concluded that it is only the Executive Directors who are into the whole time employment of the company and hence these are the directors who would render services on account of their employment agreement with the company. Any remuneration paid to be them under this employment agreement (by whatever name called ie, Salary, perquisites, commission, % of profits etc), provided they are fully declared in their employment agreement and also in the MR1 form filed with the Company, would not be leviable to GST by virtue of specific entry in Schedule III (as mentioned in the foregoing paragraph).  Any consideration paid to such executive directors beyond this declared remuneration would be subjected to RCM as that would be beyond the scope of the employment agreement. Remuneration paid to the Non-Executive Directors would be subjected to Reverse Charge Mechanism as that would not be due to employment agreement but director service agreement.

Now let us discuss the various decisions given by the Advance Ruling Authorities. In the case of   M/S. ALCON CONSULTING ENGINEERS (INDIA) PVT. LTD [2019 (10) TMI 793 - AUTHORITY FOR ADVANCE RULING, KARNATAKA], though the Advance Ruling Authority had held that the Directors’ remuneration is paid for the services supplied by the
Director to the applicant company and hence the same is liable to tax under reverse charge basis under section 9(3) of the Central Goods and Services Tax Act, 2017 but at the same time the Advance Ruling Authority in its judgement has also very explicitly stated that the question before the Authority was not whether the service was taxable or not but whether this supply of service was liable to tax under Reverse Charge mechanism. Also under the facts of the case the applicant has also very clearly sought a ruling as to whether tax under reverse charge mechanism is applicable on the remuneration paid to the Directors. Nowhere an Advance Ruling is sought as to whether the remuneration paid to the Executive Directors under the terms of employment would be liable to Reverse Charge Mechanism. And hence, in my humble understanding, considering the facts of the case the advance ruling has been decided accordingly. On the other hand the same authority for deciding the Advance Ruling in the matter of M/s Anil Kumar Agarwal  - 2020 (5) TMI 221 - AUTHORITY FOR ADVANCE RULING, KARNATAKA for the question stated in para 2(b) of the Advance Ruling as to whether Salary as director from Private Limited company will form part as Income for the purpose of considering his aggregate turnover for registration. And accordingly based on the specific question sought before  the Advance Ruling Authority, it has been held that the remuneration received by the applicant as Executive Director is not includable in the aggregate turnover, as it is the value of the services supplied by the applicant being an employee. Further if the applicant receives the remuneration as a Non-Executive Director, such remuneration is liable to tax under reverse charge mechanism under section 9 (3) of the CGST Act 2017, in the hands of the company, under entry no. 6 of Notification No. 13/2017-Central Tax (Rate) dated 28.06.2017. Thus the value of the said services of the applicant being a Non-Executive Director are includable in the aggregate turnover, as it is the value of the taxable services supplied by the applicant, though the tax is discharged by the private limited company, under reverse charge mechanism.

There had been views that how can the same Advance Ruling Authority give the contradictory rulings on the same matter. However, after making an in depth study of both the case law it can be inferred that both the cases cannot stand on the same footing with each other. In the first case the advance ruling was sought for a very general query whether tax under reverse charge mechanism is applicable on the remuneration paid to the Directors. There was no demarcation between remuneration paid to executive director or non-executive director. And hence the case was decided accordingly. Whereas in the second case there was a specific query as to whether salary received by the director of the Company would form part of his aggregate turnover and the case was decided accordingly.

When both these case laws are read together in tandem ruled by the same Authority, it can be very clearly understood that though the remuneration paid to the director for services rendered by him would be taxable under RCM but only the services of the non- executive director would fall under this category and not the Services of the Executive Director.

However, In the case of IN RE: M/S. CLAY CRAFT INDIA PVT. LTD. [2020 (4) TMI 228 - AUTHORITY FOR ADVANCE RULING RAJASTHAN] as decided by the Authority for Advance Ruling, Rajasthan, AR Authority failed to consider the fact of the employer employee relationship between the director and the company thereby giving an unfavourable decision by deciding that there exists no employer employee relationship between the director and the company. The Consideration paid to the director of the company is in relation to the services provided by the director to the company and such services would fall under the RCM category.

Conclusion: Though an advance ruling pronounced by AAR or AAAR shall be binding only on the applicant and on the concerned officer or the jurisdictional officer in respect of the applicant. It is only limited to the person who has applied for an advance ruling. But any Advance Ruling decided in favour of the revenue causes an undue harassment on the taxpayers whereby the departmental officers based on such advance rulings harasses the tax payers with the notices demanding the taxes and initiating proceedings accordingly. It is a serious concern for matters like these that suitable clarifications are issued in order to ensure uniformity and clear understanding of the applicable taxes PAN India basis. Such ambiguities are being carried forward from the erstwhile laws. It’s a humble appeal to the Government that a proper clarificatory circular may kindly be issued in this regard. An individual can be a director to various type of companies being, OPC, Private Ltd Company, Public Ltd Company. Such companies can also belong to MSME category. There can be two directors or more than two directors in a company. The directors can be both Executive and non-executive directors. An amendment can be done in the notification to include the services of non- executive directors under the RCM and the definition of Executive Director and Non-Executive Director can be stated accordingly or a clarificatory circular in this regard may be issued. Till the time such clarification is issued director’s remuneration will always be a disputed matter and for small companies it may result into a costly disputed matter.

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