India: GST on Directors’ remuneration – An unresolved mystery

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published on 5 May 2020 | reading time approx. 6 minutes

 

The Goods and Services Tax (GST) law was supposed to be a ‘Good and Simple Tax’ (at least as quoted by the Government), however, it’s almost been three years after the implementation of the new tax regime and certain issues are still unsettled.

 


In this article we intent to discuss one of such issues i.e. of applicability of GST on Director’s remuneration. This issue has always been a disputed area be it erstwhile Service Tax regime or the current GST regime and the same has resurfaced recently after the recent Advance Ruling passed by Rajasthan Authority of Advance Ruling (“AAR”) in the case of M/s Clay Craft India Private Limited (‘the Applicant’) which is reported at 2020-TIOL-64-AAR-GST.

 
The Hon’ble AAR in the present case has held that the salary paid by the Applicant to its Directors is liable to GST under reverse charge mechanism (RCM) as per Section 9(3) of the CGST Act read with Sr. No. 6 of the Notification 13/2017-Central Tax (Rate) dated 28 June 2017.

 
In the present ruling, the Applicant has clearly mentioned in his application that they are paying GST on RCM basis on the commission paid to the directors for providing services in the capacity of Director. However, GST has not been discharged under RCM on the salary paid to the Directors for working in the capacity of full time employees of the company wherein the Applicant is deducting withholding taxes and Provident Fund under the relevant Indian statutes.

 
Given this background, the Authority had held that the services provided by the Directors as explained above, cannot be considered as services provided by an employee to an employer even though the directors are working in two separate capacities for the Applicant. Hence, the services provided by the Directors of the company cannot be considered as ‘services provided by an employee to an employer’ which are covered under the ambit Clause 1 of Schedule III (which consists of supplies which are neither considered as supply of goods nor services) to the CGST Act. Therefore, the authority held that the said services would be covered within the definition of the term “Supply” as defined under Section 7 of the CGST Act and consequently, liable to GST in India.

 
Given the analysis provided by the Advance Ruling Authorities in the State of Rajasthan, the Pandora’s Box of litigation faced under the erstwhile service tax regime may get opened again.  Therefore, it would be important to understand the outcome of the litigation under the erstwhile service tax regime.

 

Jinxed issue under Service Tax Regime

It is pertinent to note that the definition of the term “service” under the erstwhile service tax regime was very wide in nature.  Having said above, the definition of the term service excluded the ‘a provision of service by an employee to the employer in the course of or in relation to his employment’.

 
It is also pertinent to note that the services provided by a Director to Company for a consideration was liable for service tax under RCM after introduction of the negative list regime under the erstwhile service tax regulations.

 
However, in case of M/s. Allied Blenders and Distillers (P.) Ltd. [2019 (24) GSTL 207 (Tri. – Mum.)], the revenue authorities had issued notice to demand service tax under reverse charge mechanism on the amount of remuneration paid the to the directors who were working on full time basis and not merely acting in Board of Directors meeting  / Independent Directors.  Further, the demand proposed in the show cause notice was confirmed against assessee and the case travelled before the Hon’ble CESTAT.  In the said case, the Hon’ble CESTAT had held that the Directors, who are concerned with the management of the company, were declared to all statutory authorities as employees of the company. The company has complied with the provisions of the respective Regulations indicating the Director is an employee of the company. Further, the revenue could not establish that the Directors, who were employees of the assessee, 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. Thus, the Hon’ble CESTAT held that the Service Tax is not payable on salary paid to the Directors.

 
Attention is also invited to Circular no. 115/09/2009-ST dated 31 July 2009 issued by CBEC in positive list tax regime (under the erstwhile service tax regime) clarifying that remunerations paid to Managing Director / Directors of companies whether whole-time or independent when being compensated for their performance as Managing Director/Directors would not be liable to service tax. This indicates that amounts paid in relation to employment is not leviable to service tax.

 
However, the aforesaid settled position of law under the erstwhile service tax regime is again unsettled under the present GST regime by way of AAR issued by Rajasthan Authorities.
 

Other regulatory provisions for consideration of relationship between Director and the Company

A. Interpretation of the term ‘employer/employee’

The terms ‘employee’ or the ‘employer’ are not defined anywhere in the GST regulation nor they were defined under the erstwhile Service Tax regulation. As per Black’s Law Dictionary, the term ‘employee’ is defined as:

 
 “An employee is a person who works in the service of another under express or implied contract for hire, under which the employer has the right to control details of work performance.”

 

We can also draw the meaning of the term employee from various judicial precedents where the courts have made distinction between ‘Contract of Service’ (i.e. employment contract) and ‘Contract for Service’ (i.e. Service Contract). In certain cases it has been laid down that the indicia of a contract of service are:

  • The master's power of selection of the servant;
  • The payment of wages or other remunerations;
  • The master's right to control the method of doing the work; and
  • The master's right to suspension or dismissal."

 

Thus, a clear distinction can be made in a relationship between an employee-employer and service provider- service recipient.

 

B. The Companies Act, 2013

Further, a reference can also be drawn from the provisions of the Companies Act, 2013 in order to decide whether a Director can also work in a capacity of employee of the company.

 

There is no restriction under Companies Act, 2013 to appoint the employees of the company as Directors. In fact, as per Section 2(94) of the Companies Act, 2013 “whole-time director” includes a director in the whole-time employment of the company’. Basis the same it appears that, a person can work in both the capacities in any company.

 

Further, the Ministry of Corporate Affairs (“MCA”)issued a General Circular No 24/2012 dated 9 August 2012 whereby the MCA had confirmed that Service Tax is payable on the sitting fees/ commission paid to the Directors and the same will not be considered as a remuneration for the purpose of Section 309(4) of the Companies Act, 1956. This indicates that even the MCA, which is a part of government, believes that service tax is payable only on the sitting fees/commission payable to the directors and not on the salary paid to them during the course of employment.

 

C. Income Tax Act, 1961

In case of Ram Pershad v. CIT - (1972) 2 SCC 696, the Hon’ble Supreme Court laid down a principle as to which payment should be considered as a salary payment to the Managing Director (‘MD’) of the company. In this case, the apex court has held that the Board of Directors manage the business of the Company and they have every right to control and supervise the MD’s work whenever they deem it necessary. Every power which is given to the MD therefore emanates from the articles of association which prescribes the limits of the exercise of that power. The powers of the MD 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. Thus, it was held that the remuneration payable to the MD was salary.

 

Therefore, it can be said that where the Director is working in a capacity where they are answerable to the Board of Directors and the company is deducting withholding tax u/s 192 of the Income Tax Act, 1961 for making salary payments to the Directors, issuing Form -16 to the Directors, and where the Directors are declaring this income under the Head ‘Income from Salaries’ in their Income Tax returns, it is pretty much clear that they are not acting as a Service Provider to the company but in fact are the employees of the company.

 

D. Other Regulations

In case where the company is deducting Employees’ Provident Fund amount, Professional Tax amount from the salary of the Directors, it can also be considered as one of the factors to prove that Directors are receiving the remuneration in the capacity of employees.

 

Conclusion

In the recent past, several judgments passed by the Authority of Advance Rulings across India have been questionable thereby raising doubts on the efficacy of this model. In the present case, the decision of a higher authority (CESTAT under erstwhile service tax regime) which had analysed the tax liability by analysing the pari-materia provisions of law has also been completely overlooked.

 
With the above, there is a possibility that the revenue authorities in other states may start issuing notices to companies raising demand of GST under reverse charge mechanism on the amount of salaries paid to the Directors by applying the ratio laid down in the above referred Advance Ruling. 

 
It is also pertinent to note that that the applicability of Advance Ruling is limited to the Applicant who sought the ruling and not to other companies. However, it does have a persuasive value and may be used to set a precedence.  It does not mean that all companies should start discharging GST on Director’s remuneration on a conservative basis, but this should be seen as an opportunity to evaluate the applicability of the GST depending upon the facts in each case. 

 
Further, creation of suitable documents such as drafting of suitable board resolution for appointment of director, executing appropriate contracts with the Directors appointed, etc. should be seen with utmost priority and existing positions may be revisited to understand the implications.

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