Controversy in relation to payment of GST on remuneration to a director of a company under reverse charge has erupted recently primarily because of two Advance Authority Rulings 1) In Clay Craft India Pvt. Ltd.1 and 2) In Alcon Consultancy Engineering Pvt. Ltd.2 Dust has also gathered on account of the decision of Hon’ble Kolkata Tribunal in case of Brahm Alloy Limited3 holding that GST is payable by company under reverse charge on remuneration paid to whole time / executive directors. In this article, an attempt is made to put the issue in right perspective and clarifying the doubts in the minds of the taxpayers.
The Charging section 9 of CGST Act4 (hereinafter referred to as ‘Act’) relating to levy and collections provides that barring certain item like supply of petroleum goods, crude, etc as mentioned in sub-section 2, tax shall be levied on supply of goods or services or both except the supply of alcoholic liquor for human consumption at the rate not exceeding 20%, as may be notified. The scope of supply of goods or services or both is provided in S.7, according to which all forms of supply of goods or services or both such as sale, transfer, barter, exchange, license, rental, lease or disposal made or agreed to be made for a consideration by a person in the course or furtherance of business.
Service provided by a director of a company to the said company is leviable to tax as a ‘supply’. However, Entry 1 of Sch. III attached to the Act which provides that service by an employee to the employer in the course of or in relation to his employment is neither a supply of goods nor a supply of service. Thus, provision of service by a director in the course of or in relation to his employment of a company is clearly out of the ambit of GST. However, a director can provide service to a company in different capacities. The issue of applicability of GST on various kinds of services by a director to a company for a remuneration (read consideration) revolves around these two provisions.
Notification No. 13/2017 – CT (R) issued in exercise of the powers granted u/s. 9(3) provides that in relation to certain type of supply of goods or services both, the tax shall be paid on reverse charge basis by the recipient as if he is the person liable for paying tax in relation to such supply. It is to be noted that payment under reverse charge by a company triggers only if a director provide a taxable service in the capacity of director. If the director provide a taxable service not in the capacity of director than he has to pay tax in forward charge.
Taxability of director’s remuneration in service tax regime:
Under the negative list based service tax regime from 01.07.2012, service rendered by a director of a company to the said company was taxable as an ‘activity’ as defined u/s.65B (44) of the Finance Act, 1994 and the company was liable to pay service tax under reverse charge vide Notification No. 45/2012 – ST dtd. 07.08.2012. At the same time, as per sub-clause (b) of the said section, the provision of service by an employee to the employer in the course of or in relation to his employment was excluded from the scope of definition of service. Thus, service provided by a director to the said company which is not in the course or in relation of employment, the reverse charge is not triggered. It can be said that the treatment of leviability and applicability of reverse charge is pari – materia same in both the laws and any clarification or judicial pronouncements under the erstwhile service tax law is equally applicable to GST.
Here it is relevant to refer to the Education Guide issued under service tax in relation to the term, “in the course or in relation to employment”:
“2.9.1 Are all services provided by an employer to the employee outside the ambit of services?
No. Only services that are provided by the employee to the employer in the course of employment are outside the ambit of services. Services provided outside the ambit of employment for a consideration would be a service. For example, if an employee provides his services on contract basis to an associate company of the employer, then this would be treated as provision of service”.
2.9.2 Would services provided on contract basis by a person to another be treated as services in the course of employment?
No. Services provided on contract basis i.e. principal-to-principal basis are not services provided in the course of employment.”
The CBIC had also issued a Circular No. 115/096/09 – ST on 31.07.2009 in relation to applicability of service tax under business auxiliary service on commission paid to the managing director, whole time or independent director by the company and also applicability of service tax on independent director under management consultant service. The board clarified that the remuneration paid to the managing director or whole time or independent director of the company are not liable to service tax within the scope of the business auxiliary or management consultant service, as the case may be. However, in case the director provide any advice or consultancy to the company, for which he is being compensated separately, such service is chargeable to service tax.
Though above clarifications pertains to pre-negative list period, they are relevant even today in the context of GST on director’s remuneration. They clarify the differentiation between service provided by a director in the course of employment and other services for which separate remuneration / consideration is charged.
The following table explains the liability of GST and the manner of payability in the context of service of a director to such company.
If a director is appointed to perform as an employee in the course of or in relation to his employment as per the terms of employment (contract of service) |
Not liable being employee – employer relationship (any payment such as sitting fees is also covered in this) |
Other services which are outside the scope of terms of employment for which separate remuneration is provided, for e.g. renting of his property to the company, sell or purchase of the goods, consultancy as a professional (contract for service) |
A director provide such service in his individual capacity for which separate remuneration is charged (payable by the director under forward charge) |
As a director who is not an employee, for e.g. a nominee director receiving sitting fees |
Payable by the company under RCM |
Guiding principles of the employee-employer relationship are found under the Indian Contract Act, the Companies Act, Income Tax Act and the Judicial pronouncements:
The definition of ‘director’ of the company under the Companies Act, 2013 is contained in S. 2(34) of the Companies Act, 2013. ‘Director’ means a director appointed to the Board of the Company. As per the Articles of Association directors are appointed by the shareholders in Annual General Meeting and power is given to the Board of Directors to appoint whole time director, managing director and executive director from the Board of directors. The Board of Directors may appoint any additional director or any person to fill a casual vacancy. Some directors are nominated by the banks or foreign collaborators to be a part of the Board of Directors (BOD) as nominee director. An ordinary director is not an employee of the company, however, an employee may be appointed as director. In such a case, he is acting in dual capacity as an employee and also as director as an agent of the company.
The terms of appointment of directors, their tenure and the remuneration is decided by the appointing authority which appointment determine the employee-employer relationship, e.g. If the director can be removed before expiry of his term, he is an employee of the company.
Under the Income Tax Act, a director’s remuneration as an employee of the company is taxable under the head, ‘salary’. The judiciary has laid down certain principles for establishing the employee – employer relationship and without such relationship the income is taxed as ‘income from other source’ or as ‘business income’ depending on the source of income. If the director is performing as a consultant or in exercise of his profession for a consideration or acting as agent of the company, it is treated as ‘income from business or profession’ and he may not be treated as an employee.
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 but an agent of the principle. 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’.
In Ram Prasad v. CIT AIR 1973 SC 637 = (1972) 42 Companies 544 = 86 ITR 122 (SC), the Hon’ble Supreme Court while holding that a managing director is an employee of the company, observed that, ‘A director of a company is not a servant but an agent inasmuch as the company cannot act in its own person but has only to act through directors who qua the company have the relationship of an agent to its principal. A Managing Director may have a dual capacity. He may both be a Director as well as employee, depending upon the nature of his work and the terms of his employment. Whether or not a Managing Director is a servant of the company apart from his being a Director can only be determined by the articles of association and the terms of his employment. Where the articles of association and terms and conditions of the agreement definitely indicate that the assessee was appointed to manage the business of the Company in terms of the articles of association and within the powers prescribed therein and under the terms of the agreement he can be removed for not discharging the work diligently or if he is found not to be acting in the interest of the Company as Managing Director, then it can hardly be said that he is an agent of the Company and not a ‘servant’.
In McDowell & Company v. CIT (2002) 123 Taxman 912 (Mad HC), the Hon’ble Madras High Court held that under S.197 of Companies Act, 2013 remuneration may be paid to any director by way of monthly payments or commission based on percentage of net profit.
In Rentworks India P. Ltd. v. CCE (2016) 43 STR 634 it was held that when salary paid to a foreign director was treated as income from salary by income tax department, service tax cannot be demanded.
In Allied Blenders and Distillers Pvt. Ltd v. CCE & ST (2019) 101 Taxmann.com 462 (Mum.) it is held that when remuneration to the whole time directors for managing day – to – day affairs of the company and deductions were made on account of provident fund, etc. and TDS as applicable to the salary in the course of employment and the company was not required to pay service tax under reverse charge.
In Brahm Alloy Limited Versus Commissioner Of CGST & C. Ex., Durgapur 2019 (24) G.S.T.L. 616 (Tri. – Kolkata) it is observed that the assessee has filed ledger copy of directors remuneration which showed that the remuneration payable to director has been accounted on quarterly basis and not on month on month basis as being done generally. On asking to establish employee – employer relationship between the company and the directors, a certificate from a chartered accountant was submitted. Apart from an Extract of the Minutes of Meeting of the Board of Directors regarding the appointment of the whole time director and also a copy of the appointment letter. The Ld. member held that, 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. The remuneration cheque has to be paid on a month to month basis along with the admissible perquisites. There is a deviation in the facts of the present case. I also observe that the directors have shown the remuneration under the head ‘Salary’ in the respective Income Tax Return and Tax was deducted at source by the appellant company on such payments”. (emphasis supplied).
In the view of the writer, respectfully the above decision of a Single Member Bench may not be regarded as correct decision as the reasoning is not appear to be convincing to hold that remuneration payable to whole time managing director is not covered the exclusion clause of S.65B(44) of the Finance Act, 1994.
AAR ruling in Alcon Consultancy Engineering Pvt. Ltd.
In the present case, the assessee wanted to know that whether payment under RCM is applicable or not. The Authority ruled that the company and is located in the taxable territory and 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.
This ruling does not lay down any principle of the law and therefore if any dust created on account of this ruling is wholly misplaced.
AAR ruling in Clay Craft India (P) Limited
In this case the ruling was sought by the assessee that,
“a) whether GST is payable under reverse charge mechanism (RCM) the salary paid to director of the company who is paid salary as per contract b) whether the situation would change from a) above if a director is also a part time director of a company?”.
The Authority considered the decision of Hon’ble Karnataka High Court in Regional Director, E.S.I. v. Sarathi Lines (P) Ltd. [1998] ILLJ 28 Kar. In this case, it is observed as follows:
“It is true in the case of a Director or Managing Director of a Company he is not an employee of the Company but an agent in as much as the Company cannot act in its own person but has only to act through their Directors. Still it is possible that such a Director or Managing Director can have a dual capacity of an agent as well as an employee. It will depend on his work and the terms of his employment as discernible from the articles of association or terms of agreement. This was the view taken by the Supreme Court in AIR 1973 SC 637 (supra), even though it was a case arising under the Income tax Act. One of the tests laid down to ascertain whether a person is a servant or an agent is to examine whether under the terms of his employment, the employer exercises a supervisory control in respect of the work entrusted to him. A servant acts under the direct control and supervision of his master, whereas the agent in exercise of his work is not subjected to the direct control or supervision of the principal, though he is bound to exercise his authority in accordance with all lawful orders and instructions which may be given to him from time to time by his principal. After examining the articles of association of the Company the Supreme Court came to the conclusion that powers of the Managing Director had to be exercised within the terms and limitations prescribed thereunder and subject to the control and supervision of the Directors, which, would indicate that he was employed as a servant of the Company.”
That the above view was also held by the Hon’ble Supreme Court in the case of Ram Pershad v. CIT AIR 1973 SC 637 with the concluding remarks:
“The powers of the assessee have to be exercised within the terms and limitations prescribed thereunder and subject to the control and supervision of the Directors which in our view is indicative of his being employed as a servant of the company. We would therefore hold that the remuneration payable to him is salary. In this view, the other questions need not be considered, and the appeal is dismissed with cost”.
Despite of reference made to the above decisions and being considered by the Hon’ble Tribunal, the Authority ignored them as being irrelevant to the issue and held as follows:
“5.7. We further observe that consideration paid to the Directors is against the supply of services provided by them to the applicant company and are not covered under clause (1) of the Schedule III to the CGST Act, 2017 as the Directors are not the employee of the Company. In the instant case Director is the supplier of services and the applicant company is the recipient of the services. So it is very clear that the services rendered by the Director to the company for which consideration is paid to them in any head is liable to pay GST under RCM.
5.8 We also observe that the applicant company is located in the taxable territory and the Director’s consideration is paid for the supply of services by the Directors to the applicant company and hence the same is liable to GST by way of reverse charge basis as provided under Notification No. 13 /2017- Central Tax (Rate) dated 28.06.2017 issued under Section 9(3) of the Central Goods and Services Tax Act, 2017.
5.9 Notification No. 13 /2017- Central Tax (Rate) dated 28.06.2017 has given the distinct identity to the services provided by the Director and specifically included in the category of service on which GST will be payable under RCM. The case laws citied by the applicant are not relevant in the present case in as much as that the liability to pay GST under RCM in this case is required to be decided on the basis of the existing provisions of CGST law as being discussed briefly in this order”.
Thus, the decision of AAR cannot be said to be a correct one.
On perusal of the above discussion, it can be said that if the director is appointed to perform his duties in the course of his employment, than the relationship of employee and employer exists between the company and the director and GST is not leviable. The following table explains the liability to pay GST and applicability of payment under reverse charge by the company on payment of remuneration to the director.
Directors’ designation |
Definitions |
Reasons |
Whether in the course of employment |
Whole time director / Executive director |
Section 2(94) of the Companies Act, 2013 defines the term ‘whole-time director’ as a director, who is in the whole-time employment of the company |
Clearly the director is in whole time employment. |
YES |
Managing director |
Section 2(54) of the Companies Act, 2013 defines ‘managing director’ as 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 |
They may be involved in day-to-day operations. They may also not whole time director. It is possible to appoint a director as managing director though may not be under full time employment. Terms of the employment are the deciding factor that whether a managing director is an employee. |
In majority cases, YES. However, depends on the terms of the employment. |
Non executive Director |
Other than an executive director |
They do not take part in the day-to-day activities of the company. They only take part in the meetings of the BOD. |
NO |
Independent Director |
Independent Director means an independent director referred to in Section 149(6) of Companies Act 2013. |
They are not under the control and supervision of the company. |
NO |
Nominee Director |
Nominee director means a director nominated by any financial institution in pursuance of the provisions of any law for the time being in force, or of any agreement, or appointed by any Government, or any other person to represent its interests [Explanation to Section 149] |
They are under the employment of the company to which they represent. They are entitled to Sitting fees for attending the BOD meetings. Even the Sitting fees is paid to the organization that they represent. |
NO |
Conclusion:
Based on the principles set out in the Indian Contract Act, service tax, companies law and Income Tax Act, it appears that the AAR has failed to apply the provisions of the Act to the facts of the case. Further, the ruling in Clay Craft India (P) Limited, the decisions of the Hon’ble High Court and Supreme Court have been brushed aside. The decision of Hon’ble Mumbai Tribunal in Allied Blenders (supra) has correctly examined the same. It is increasingly proven that the remedy of advance ruling illusionary are sometimes like ‘aa bail mujhe maar’ and therefore should be used vary sparingly and after exercising proper discretion. Though AAR rulings are not binding on taxpayer other than the Applicant, it has created nuisance value. Therefore, the AAR rulings that have created controversy and confusion is not a cause of concern.
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(2020) 116 Taxmann.com 114 (AAR Rajasthan)
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(2019) 110 Taxmann.com 357 (AAR Karnataka)
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2019 (24) G.S.T.L. 616 (Tri. – Kolkata)
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Same as otherwise provided reference to any section under this article relates to the Central Goods and Service Tax Act, 2017 also various State Goods and Service Tax Acts and Union Territories Goods and Service Tax Act. Identical provisions are also made in the Integrated Goods and Service Tax Act, 2017.
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Rajkamal Shah, CA. Ritu Swali