A director in a company maintains a prolific role within an organization and usually has a higher role within an organization. He generally decides on how to control the business and also make the final and key decisions. A director can be an executive, non-executive or independent director. An executive director is responsible for the daily operations. An independent director is engaged by a company either to comply with the statutory requirement or to bring in the expertise in the policy-making. An independent director is not an employee of the company as his role does not include the day-to-day operations. His involvement is limited to providing the professional advisory to the company. The tax treatment of the emoluments paid to the directors will depend on his relationship with the company and the nature of services he renders.
At this juncture, it is important to first know about the provisions available for
taxability of director’s payments under the GST. In view of the notification
issued under the Reverse Charge Mechanism (hereinafter referred to as ‘RCM’), a company or a body corporate is liable to pay GST under the reverse charge in respect of the services received from the director.Further, Schedule-III of the Central Goods and Services Tax Act, 2017 (‘CGST Act’) provides that services by an employee to the employer in the course of or in relation to his employment shall not be treated as supply, and thus no GST would be applicable.
In a recent ruling,the Authority of Advance Ruling, Rajasthan (‘AAR’) in case of Clay Craft India Pvt. Ltd held that the GST shall be chargeable on the remuneration paid or payable to the directors. The Authority has only taken note of the RCM, and outrightly denied to treat directors as employees of the company. This ruling, thus, arises a moot question – Whether GST is chargeable on the consideration paid or payable for the services rendered by every director?
In this write-up, we have analysed various types of directors along with their nature of engagement under the Companies Act, treatment of consideration received by directors under Income-tax Act and the erstwhile Indirect-taxregime in respect of the services.
2. ADVANCE RULINGS ON THE IMPUGNED ISSUE
The applicant has raised the following questions before the Rajasthan AAR3:
a) Whether GST is payable on a reverse charge basis on the salary paid to the
director of the company as per the contract?
b) Whether GST applicability will differ if the said director is also a part-time
director in any other company?
The applicant submitted that GST will not apply on the remuneration paid to
directors as they are the employees and they are given salaries along with benefits as per the policy decided by the company for its employees, thus, covered under Schedule-III (supra). On the contrary, the department has simply provided that the director is not the employee of the company and therefore, the amount paid to them will not be covered under Schedule-III (supra).
The AAR held that directors are not the employees of the company, consequently, GST would be applicable. It emphasised that the director is a supplier of services and the applicant (company) is the recipient of such services. Services rendered by the director to the company for which the consideration is paid to them, under any head, is chargeable to GST on reverse charge basis. Therefore, in respect of both the questions raised above, the applicant will liable to pay GST.
A similar view was taken by the Karnataka AAR in the case of Alcon Consulting
Engineers (India) (P.) Ltd . The authority has observed that services provided by the Directors to the company are not covered under Schedule-III as the director is not the employee of the company.
3. OUR ANALYSIS
The taxability under GST legislation should be determined based on the principle of whether a director is an employee of a company. Notably, the GST legislation has not defined the terms ‘director’ and ‘employee’. Therefore, a reference to other laws including the erstwhile regime of service tax should be made.
3.1. Provisions of the Companies Act
As per Section 2(34) of the Companies Act, 2013 ‘director’ means a director
appointed to the Board of a company.Also, some directors are nominated by the
Financial Institutions/Foreign Collaborators/banks/investors to form part of the
board of directors. The Board has also powers to fill casual vacancies and appoint additional directors. All these directors collectively form a Board. The Board of Directors is the controlling authority of the company under the Companies Act 2013.
3.1-1. Executive and Non-Executive Directors
Directors who are in the whole-time employment or those who are entrusted with day-to-day operations of the company are termed as ‘Executive Directors’. Other directors are non-executive directors, who are from outside the company. Such non executive directors do not take part in the day-to-day activities of the company and do not have the knowledge about the routine operations of the company. They only attend the meetings of the board of directors or its committees and thus, work only at a periodic interval on a part-time basis. Thus, it can be inferred that non-executive directors, who are not entrusted with day-to-day operations, cannot be treated as an employee of the company.
3.1-2. Independent directors
As per Section 149(6) of the Companies Act, 2013, an ‘independent director’ has been defined as a director not being a managing director or a whole-time director or a nominee director. The selection of independent director shall be done by the board who is independent of the company management. Moreover, they have to pass/clear some examination as specified by the Ministry of Corporate Affairs. An independent director shall possess appropriate skills, experience and knowledge in one or more fields of finance, law, management, sales, marketing, administration, research, corporate governance, technical operations or other disciplines related to the company’s business.
The Independent directors do not work under the control and supervision of the
company and therefore it can be inferred that independent directors are not the
employees of the company.
3.1-3. Remuneration to directors
Directors who are in whole-time employment of the company are termed as ‘wholetime directors’. Some directors may be appointed as ‘Managing/Whole-time Director’ who will be entitled to monthly remuneration.It may be noted that a ‘Managing Director’ need not necessarily be a ‘Whole-time Director’. It is possible and permissible to appoint a director as ‘Managing Director’ though he may not be in full-time employment. As per Section 2(78) of the Companies Act, 2013, ‘remuneration’ means 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. Section 197 read with Schedule V of the Companies Act contains the provision for the computation and payment of director’s remuneration.
3.1-4. Payment of Sitting fees
Directors (other than whole-time directors and Managing Director) work only on a part-time basis. These directors are ‘Non Executive Directors’. Normally, they attend the meetings of Board or its committees. These directors get fees for attending the Board meetings or Committee meetings. But a managing director or a whole-time director, who is getting remuneration, is not entitled to sitting fee. Even if the sitting fee is paid, it will be treated as ‘other allowance’ and the overall salary will be subject to the limit of managerial remuneration specified in Schedule-V of the Companies
3.2. Provisions of the Income-tax Act
To tax any amount under the head ‘Salary’ there must be an existence of employee and employer relationship. Notably under the Income-tax Act, 1961 there are no predefined rules or principle to decide whether directors are treated as an employee of the company or not. It provides that if a person is treated as an employee, his remuneration will be taxable under the head salary and tax would be deducted under Section 192. Therefore, before a payment can be taxed as salary, the relationship of employer and employee or master and servant must be established.
3.2-1. Employer-Employee Relationship
Taxability of an income under the head ‘Salary’ pre-requisites existence of employee and employer relationship. Before a payment can be taxed as salary, the relationship of employer and employee or master and servant must be established. The judiciary has laid down various principles for determining the relationships of employer and employee. In the absence of the employer-employee relationship, the income shall be assessable either as business income or income from other sources. If a person has to work under the direct control and supervision of the principal and he has no discretion of his own in the performance of his duties, he is deemed to be an employee and the remuneration payable to him in such a case is chargeable to tax
under the head salaries. On the other hand, if principal exercises only a supervisory control in respect of work entrusted to the person and he has wide discretion of his own in the execution of the policies of the principal, the presumption is that such person is not an employee. The remuneration payable to such person in such a case is liable to be taxed under the head ‘Profits and gains of business or profession’. The nature of a director’s employment may be determined by the Articles of Association of a company and the service agreement, if any, under which a contractual relationship between the director and the company has been brought about.To decide the question of whether a director is an employee of the company or not, one has to find out as to whether the relationship of master and servant exists between the company and the director .
If Articles of the company confers a specific
right to the company to remove any director before the expiration of his period of office by an extraordinary resolution and if he were so removed he would
automatically be dismissed from the office of the managing director, the director could be considered as an employee of the company.
Example, if a company is carrying on business and an individual is employed to
manage its affairs in terms of its Articles and the service agreement, and his
employment can be terminated if his work is not satisfactory, he shall be treated as an employee of the company. If engagement for any work is incidental to the exercise of the profession, the gains arising from such engagement shall not be chargeable to tax under the head Salaries but under the head ‘Profits and gains from business or profession’. Thus, if he is not treated as an employee, any remuneration or fees or commission by whatever name called will be taxable under the head ‘Profit and gains from business or profession’ and tax would be deducted under Section 194J.
Based on the principles and jurisprudences cited above under Companies Act,
Income-tax Act and erstwhile Service tax regime, it can be concluded that the
consideration (except sitting fees) paid to the directors engaged in whole time
employment with the company will be treated as part of the salary, and will be excluded from the ambit of GST. The sitting fees paid or payable to the independent directors should be brought within the ambit of GST.
It appears that the AAR, Rajasthan had not evaluated the issue from the view-point of such principles. It just placed its reliance on the notification issued under the RCM. With due respect, this ruling requires re-consideration. Taxability of director’s remuneration under the GST should be determined on the basis of the fact whether the director is involved in routine work of management or not.