The recent decision of Authority for Advance Ruling (AAR), Rajasthan in Re: M/s. Clay Craft India Pvt. Ltd. (RAJ/ AAR/ 2019-20/33) that the Directors’ remuneration is paid for the services supplied by the Director to the applicant company shall be liable to tax under reverse charge basis under section 9(3) of the CGST Act, 2017 has left companies perplexed. On the onset, it maybe relevant to note that section 103(1) of CGST Act states that the advance ruling pronounced by the Authority or the Appellate Authority shall be binding only on the applicant who had sought it in respect of any matter referred to in the said ruling and on the concerned officer or the jurisdictional officer in respect of the applicant. The applicant may even go on appeal against the pronouncement. Nonetheless, it reflects the views of the department in respect of the particular issue for which ruling was sought and for that reason it cannot simply be ignored.
It all started with the article in the Economic Times dated 14th November, 2019 reporting Tax department wants to impose 18% GST on CXO salaries and that some of the top companies headquartered in Pune, Mumbai and New Delhi have
started receiving queries from the tax department on cross-charging of CEO and CFO salaries. Consequently, the CBIC come out with a clarification on 15th November, 2019 that salaries are not subject to GST and no GST has been demanded on salaries paid to CEOs or employees. CBIC said that the media report in this regard alleging that tax authorities want to impose GST on salaries paid to employees is factually incorrect and misrepresents tax authorities.
In this issue, ruling of the AAR has come out contrary to the popular understanding and hence, requires some consideration. Since litigation in GST is still in the beginning stage, the Department may issue notices demanding tax on director’s remuneration in the days to come. This article is an attempt to analyse the issue in light of various judicial precedents under various statutes such as Companies Act, Income Tax Act, Service Tax law; and to give a very practical solution to the problem.
LEGAL PROVISIONS UNDER GST
Supply is the keystone on which entire edifice of GST is built. Taxability is attracted when a transaction or activity comes within the scope of supply as set out in section 7 of the CGST Act, 2017 read with Schedule I, II and III. Section 7 sets out as under:
(1) For the purposes of this Act, the expression “supply” includes–
(a) all forms of supply of goods or services or both such as sale, transfer, barter, exchange, licence, rental, lease or disposal made or agreed to be made for a consideration by a person in the course or furtherance of business;
(b) import of services for a consideration whether or not in the course or furtherance of business and;
(c) the activities specified in Schedule I, made or agreed to be made without a consideration ;
(1A) where certain activities or transactions constitute a supply in accordance with the provisions of sub-section (1), they shall be treated either as supply of goods or supply of services as referred to in Schedule II.
(2) Notwithstanding anything contained in sub-section (1)–
(a) activities or transactions specified in Schedule III; or
(b) such activities or transactions undertaken by the Central Government, a State Government or any local authority in which they are engaged as public authorities, as may be notified by the Government on the recommendations of the Council, Shall be treated neither as a supply of goods nor a supply of services.
(3) Subject to the provisions of sub-sections (1), (1A) and (2), the Government may, on the recommendations of the Council, specify, by notification, the transactions that are to be treated as-
(a) a supply of goods and not as a supply of services; or
(b) a supply of services and not as a supply of goods.
Section 7(2) read with Clause (1) of the Schedule III to the CGST Act, 2017 provides that services by an employee to the employer in the course of or in relation to his employment shall be treated neither as a supply of goods nor a supply of services.
Further, Section 9(3) of the CGST Act extends the levy on the recipient of the goods or service for specific category of goods and service as notified. According to Serial no. 6 of Notification No. 13/2017 – Central Tax (Rate) dated 28.06.2017, services supplied by a Director of a company or a body corporate to the said company or the body corporate is liable to tax under reverse charge. Thus, the company or a body corporate located in the taxable territory, being recipient of service is liable to pay tax under reverse charge.
According to section 2(31), “consideration” in relation to the supply of goods or services or both includes –
(a) any payment made or to be made, whether in money or otherwise, in respect of, in response to, or for the inducement of, the supply of goods or services or both, whether by the recipient or by any other person but shall not include any subsidy given by the Central Government or a State Government;
(b) the monetary value of any act or forbearance, in respect of, in response to, or for the inducement of, the supply of goods or services or both, whether by the recipient or by any other person but shall not include any subsidy given by the Central Government or a State Government:
Provided that a deposit given in respect of the supply of goods or services or both shall not be considered as payment made for such supply unless the supplier applies such deposit as consideration for the said supply;
In light of the aforesaid legal provisions, the moot question that arises here is whether the remuneration paid to the directors is a consideration for supply of service and hence liable to GST on RCM basis or is it covered under Clause(1) of the Schedule III ibid.
In Re: M/s. Alcon Consulting Engineers (India) Pvt. Ltd KAR ADRG 83/2019, the Authority for Advance Ruling, Karnataka observed and held that the remuneration to the Directors paid by the applicant are not covered under clause (1) of the Schedule III to the CGST Act, 2017, as the Director is not the employee of the Company. The consideration paid to the Director is in relation to the services provided by the Director to the Company and the recipient of such service is the Company as per clause (93) of section 2 of the CGST Act and the supplier of such service is the Director. However, the AAR, Karnataka has not ventured into the possibility of a person being director of the company and simultaneously working as an employee also.
In Re: M/s. Clay Craft India Pvt. Ltd. (supra), the applicant has raised the following questions before the Rajasthan AAR:
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. In support of their contention, the applicant submitted excerpt of memorandum and article of association which mentioned that appointment of directors and so on.
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. The AAR held that directors are not the employees of the company and hence, liable to GST. It emphasised that the director is a supplier of services and the applicant (company) is the recipient of such services. The 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. The AAR in the above case, further noted that since the applicant is 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 Notification No. 13 /2017- Central Tax (Rate) dated 28.06.2017 issued under Section 9(3) of the CGST Act, 2017. Therefore, in respect of both the questions raised above, the applicant will liable to pay GST.
The Advance Rulings neither provide for a detailed reasoning nor considered the situations in which a director maybe also be an employee of the company. For these reasons, the said rulings are against the letter and spirit of Departmental Clarification dated 15th November, 2019 (supra) and hence bad in law.
WHO IS A DIRECTOR? – COMPANIES ACT PERSPECTIVE
The term “director” is defined in Companies Act, 2013 which is the principal statute governing the affairs of companies in India. According to Section 2(34) of the Companies Act, “director” means a director appointed to the Board of a company. According to Section 2(10) of Companies Act, “Board of Directors” or “Board”, in relation to a company, means the collective body of the directors of the company. The Companies Act recognizes various types of directors such as whole-time director, managing director, independent director, additional director, nominee director, women director, director for small shareholders, etc. The said selection needs to be done at the time of filing DIN-12, which is a return containing the particulars of appointment of director. Broadly speaking, these directors are classified into two categories – executive directors and non-
executive directors. Further, section 197 read with Schedule V of the Companies Act contains the provision for the computation and payment of director’s remuneration.
According to Rule 2(1)(k) of the Companies (Specification of definitions details) Rules, 2014 “Executive Director” means a Whole-Time Director as defined in clause (94) of section 2 of the Act. As per section 2(94) of the Companies Act, “whole-time director” includes a director in the whole-time employment of the company. Thus, a director who is in whole time employment of a company is an executive director. In other words, a whole-time director or an executive director means a director who is entrusted with the routine day-to-day operations of the company. They are generally entitled to a monthly remuneration as they are in full time employment of the company. As per Section 2(78) of the Companies Act, “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.
A “managing director”, according to Section (54) of the Companies Act, 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. Before concluding the position of “managing director” as to an executive director or not, it would be relevant to see the definition of “manager” and related provisions in Companies Act.
According to section 2(53) “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. Section 196(1) of the companies Act, further states that no company shall appoint or employ at the same time a managing director and a manager.
From the above reading, one can opine that a managing director or manager (only if he is a director), being entrusted with substantial powers of management would be a whole time employee of the company and hence an executive director. This
position is further strengthened by the decision of Hon’ble Supreme Court in Employees State Insurance Corpn. v. Appex Engineering P. Ltd., (1998) 1 Comp LJ 10 wherein the Court held that managing director occupies dual capacity – one as a “principle employer” and another as an “employee”, in the context of Employee State Insurance Act, 1946.
The “non-executive director”, on the other hand, does not take part in the daily activities of the company and attend only meetings of board or committee thereof held at periodical intervals. They assist the executive directors in making strategic decisions. According to section 197(5) of Companies Act, these directors may receive remuneration by way fee for attending the Board or Committee meetings. A managing director or a whole time director, who is getting remuneration, is generally 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 Act, 2013.
An “independent director” in relation to a company, means a director other than a managing director or a whole-time director or a nominee director. The selection of independent director shall be done by the board, independent of the company management. Moreover, they have to satisfy some eligibility criteria 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. Such directors are non-executive directors of the company. Similarly, Nominee directors are those directors, who are nominated by a bank or financial institutions or foreign collaborators/investors to form part of the board of directors. Such directors are also non-executive directors of the company.
TEST OF EMPLOYER-EMPLOYEE RELATIONSHIP
The term “employee” is not defined under the GST law. In such circumstances, the ordinary and natural meaning of the term “employee” has to be examined. It is trite law that if a word is not defined in a statute itself, it is permissible to refer to the dictionary meaning. Cambridge Dictionary defines “employee” as a person who is paid to work for someone else. In other words, there has to be master and servant relationship subsiding between the employer and the employee. Under the Income Tax law also, master-servant relationship is a sine qua non for the purpose of – a) treating an income under the head “salary”; and b) deducting tax at source (TDS) under section 192 of the Income tax Act, 1961. The issue as to whether a director is an employee or not has been considered by the courts in many occasions.
In Ram Pershad v. Commissioner of Income Tax 1973 AIR 637, the Hon’ble Supreme Court held that the assesse, a managing director of a company, had to exercise his powers under the agreement within the terms and limitations prescribed under the articles of association and subject to the control and supervision of the directors, This is indicative of his being employed as a servant of the company, and therefore, the remuneration payable to him was salary within the meaning of section 7 of the Income Tax Act. The Court following test for determining whether a director is employee or not-
1. The nature of the particular business and the nature of the duties of the employee should be considered in each case in order to arrive at a conclusion as to whether the person employed is a servant or an agent, and, it is not possible to lay down any precise rule of law to distinguish one kind of employment from the other.
2. A managing director has the dual capacity of a director as well as an employee, and whether he is the one or the other depends upon the articles of association and the terms of his employment. (See: Anderson v. James Sutherland (Peterhead) Limited,  SC 203, para 218 where Lord Normand at para 218 said “the managing director has two functions and two capacities. Qua Managing Director, he is a party to a contract with the company and this contract is a contract of employment; more specifically I am of the opinion that it is a contract of service and not a contract for service”.)
3. Whether a person employed by a company is a servant or an agent is not solely dependent on tile extent of supervision and control exercised on him. The control which the company exercises over the assessee need not necessarily be one which tells him what to do from day to day. Nor does supervision imply that it should be a continuous exercise of the power to oversee or superintend the work to be done.
4. A perusal of the articles and terms and conditions of the agreement which would indicate whether the director was appointed to manage the business of the company in terms of the articles of association and within the powers prescribed therein. The control and supervision exercised by the company is exercisable in terms of the articles of association by the Board of Directors and the company in its general meeting.
5. Under s. 17(2) of the Indian Companies Act, 1913, regulation no. 71 of table A, which enjoins that the business of the company shall be managed by the Directors is deemed to be contained in the articles of association of the company in identical terms or to the same effect. Since the Board of Directors are to manage the business of the company they have every right to control and supervise the managing director’s work whenever they deem it necessary. A managing director also function as a member of the Board of Directors whose collective decision he has to carry out in terms of the articles of association and he can do nothing which he is not permitted to do.
6. The very fact that apart from his being a managing director, he is given the liberty to work for the company as an agent is indicative of his employment as a managing director not being that of an agent.
7. If the company is itself carrying on the business and the managing director is employed to manage its affairs in terms of its articles and the agreement and if he could be dismissed or his employment can be terminated by the company if his work is not satisfactory, it could not be said that he is not a servant of the company.
In CIT v. L. Armstrong Smith, 1946 14 ITR 606 Bom, it was held that remuneration of the assessee, as a chairman and managing director, is to be taxed under the head ‘income from salary’ and not under ‘business income’.
In CIT v. M.S.P. Rajes, (1993) 77 Com Cases 402, the hon’ble Karnataka high Court also, relying on decision in Dharangadhara Chemical Works Ltd v. State of Saurashtra 1957 AIR 264 wherein test of master-servant relationship was used by the Apex Court, held that remuneration received by managing director is taxable under the head income from salary.
In this context, it is relevant to examine clause (ba) inserted into Section 194J(1) by the Finance Act, 2012 which reads as under:
“any remuneration or fees or commission by whatever name called, other than those on which tax is deductible under section 192, to a director of a company, or”
The memorandum explaining the amendment brought in by the finance bill 2012 is as under:
“TDS on remuneration to a director:
Under the existing provisions of the Income Tax Act, a company, being an employer, is required to deduct tax at the time of payment to its employees including Managing Director/whole time director. However, there is no specific provision for deduction of tax on the remuneration paid to a director which is not in the nature of salary. It is proposed to amend section 194J to provide that tax is required to be deducted on the remuneration paid to a director, which is not in the nature of salary, at the rate of 10% of such remuneration. This amendment will take effect from Ist July, 2012.”
In the light of the above judgements and the above provisions, it is safe to conclude that even under Income Tax Act, the remuneration paid to whole time director/Managing Director, being an employee of the company, is in the nature
of “salary” and TDS is to be deduced under section 192 of the IT Act. The Mumbai bench of Tribunal in the case of Rent Works India Pvt Ltd vs. CCE, Mumbai 2016 (43) STR 634 (Tri-Mum), held that there is a difference between salary and consultancy fee inasmuch as when the Income Tax Department considers payment in the nomenclature ‘consultancy fee’ as salaries, on which TDS is also made, the said payments cannot be said towards rendition of taxable service for levy of service tax. In the opinion of the author, the analogy can be applied in GST regime also.
POSITION UNDER ERSTWHILE SERVICE TAX REGIME
A similar entry was also covered under reverse charge in the erstwhile Service Tax regime. The CBEC vide Letter No. F. No 354/127/2012-TRU dated 27-07- 2012 in para 7 clarified as follows in this regard:
“Services of a director on the board of a company have now become taxable. A director may be appointed either in an individual capacity or to represent an entity (including government) who has either invested in the company or is otherwise authorized to
nominate a director. When a director receives payment in his personal capacity, the same is liable to be taxed in the hands of the director. However, where the fee is charged by the entity appointing the director and is paid to such entity, the services shall be deemed to be supplied by such an entity and not by the individual director. Thus, in the case of Govt. nominees, the services shall be deemed to be provided by the Govt. and liable to be taxed under the exclusion sub- (iv) of clause (a) of section 66D of the Finance Act, 1994 i.e. support services by Government to business. Such services are liable to be taxed on reverse charge basis.”
Even then, services rendered by an employee to an employer in the course of or in relation to his employment were leviable to service tax. Thus, service tax was not leviable on remuneration paid to director-employee. The CBIC in Circular No. 115/09/2009 – ST, Dated 31-07-2009 clarified that the amount paid by the companies to managing director/directors (whole-time or independent) even if termed as commission, is not ‘commission’ within the scope of business auxiliary service and, hence, service tax would not be leviable on such amount. It was further clarified that managing director/directors (whole-time or independent) being part of the board of directors, performed management function and not a consultancy or advisory function. Thus, the payments made by companies to directors could not be termed as payments made for providing the management consultancy service.
The Ministry of Corporate Affairs also issued a General Circular No. 24/2012, Dated 9-8-2012 regarding the applicability of service tax on commission payable to non-whole time directors of a company under Section 309(4) of The Companies Act, 1956. The circular clarified that non-whole time directors of the company are not covered under the exempted list and, thereby, the sitting fee/commission payable to them by the company is liable to Service Tax. It is evident from the above circular issued by MCA that service tax was payable only on any commission or sitting fees paid to Non-Whole Time Directors. The exclusion of Whole-time Directors and Managing Directors in the above circular clarifies the intention of legislature to tax only those services rendered by Non- Whole Time Directors which are not in the course of their employment. This preposition holds good even in the GST regime also.
Even during Service Tax regime, there was hue and cry regarding the taxability of director’s remuneration due to the decision of a single member bench of Calcutta CESTAT in Brahm Alloy Limited v. Commissioner of CGST & C. Ex., Durgapur 2019 (024) GSTL 0616 Tri.-Cal. The department started issuing notices to companies relying on the aforementioned decision. The Calcutta CESTAT, while examining the applicability of service tax under reverse charge liability on director’s remuneration, held the director remuneration was taxable considering the facts of the case. The Tribunal further observed as to when the
same would not subjected service tax: “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.”
In the above case, 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. The Tribunal failed to consider the ratio laid out in Rent Works India Pvt Ltd vs. CCE, Mumbai (supra). However, in Maithan Alloys Ltd v. CCE & ST, 2019-VIL-250-CESTAT-
KOL-ST, the appellant had duly deducted tax under section 192 of the Income Tax which is the applicable provision for TDS on payments to employees. The Division bench of the Calcutta CESTAT noted that the whole time directors who are entitled to variable pay in the form of commission are ‘employees’ and payments actually made to them are in the nature of salaries. In the absence of any evidence to the contrary, the tribunal held that demand of service tax on remuneration paid to whole time directors cannot be sustained and hence liable to be set aside.
In Allied Blenders and Distillers (P.) Ltd. v. CCE & ST  101 taxmann.com 462 (Mumbai – CESTAT), it was held that where a company paid remuneration to its the whole-time directors for managing day-to-day affairs of the company and made necessary deductions on account of Provident fund, Professional Tax and TDS as applicable and declared these directors to all
statutory authorities as employees of the company, remuneration paid to them was nothing but salary and company was not liable to pay service tax on remuneration paid to the directors.
In NRB Industrial Bearings (P) Ltd v. CCE & ST 2019-TIOL-2594- CESTAT-MUM, it was held that where a person was appointed as a Managing Director and salary was paid to him as per MOA and AOA and Forms filed before ROC has mentioned salary and perquisites payable/paid to the managing director, then no service tax was liable to be paid on such salary paid to managing director as the department failed to produce evidence which provides that remuneration was not for routine work but for the consultation provided.
As much as hyped by the media in this regard, the department may start issuing notices to company directing them to pay GST on director remuneration on reverse charge basis. Practically, there can be various payments made to the directors by the company, which can be classifiable under the following heads:
1. Remuneration for services as a director-employee
2. Rent, commission, brokerage, etc.
3. Sitting fee
4. Independent Professional/advisory fee
Firstly, the type of director and nature of payment made has to be determined. Remuneration paid for the services rendered by whole-time directors/managing directors, (in the form of monthly salary or a percentage of turnover or in any other form), which is in the course of employment would not attract GST in the opinion of the author, as it is in the course of employment and covered under Schedule III. Necessary documentation in this regard must be maintained by the company such as board resolution, letter of appointment, and so on. Further, it must be ensured that TDS is deducted under section 192 on such remuneration and the concerned director offers his income under the head ‘income from salary’ in his income tax returns.
In case of ‘sitting fee’ paid to non-executive directors including independent directors or nominee directors, GST at 18% must be paid by the company on reverse charge basis under section 9(3) read with serial no. 6 of Notification No. 13/2017 (supra). Even in case of those services provided by directors (whether whole-time directors or not), which are in their independent professional capacity or not in the course of their employment such as rent, commission, brokerage, etc., the company will have to pay GST on RCM basis. Those companies which are liable to pay GST on RCM basis, would have to take registration regardless of their turnover. The company will have to raise an invoice in terms of section 31(3)(f) of CGST Act on the date of receipt of such service and a payment voucher in terms of section 31(3)(g) of CGST Act on the date of payment. Moreover, the company shall be eligible to avail the input tax credit of such tax paid on reverse charge.
The Advance ruling pronounced in M/s. Alcon Consulting Engineers (India) Pvt. Ltd. (supra) and Re: M/s Clay Craft India Private Limited (supra) seems have missed a key point, that is, a director can also work in the capacity of the employee in the company and the remuneration in respect of such services is to be governed by clause 1 of Schedule III to Section 7 of CGST Act. That being said, the above interpretation of the AAR may have serious ramification especially for those small companies which are not registered under GST as they are below the threshold turnover. It is recommended that the suitable clarification shall be issued by the CBIC in this aspect into resolve the issue urgently and avoid the unnecessary litigation.