MAY 16, 2016

By Suhrid Bhatnagar

THE NEED FOR EXAMINATION

THE companies and body corporate are not paying service tax on director's remuneration because they are treating the director's remuneration as income from salary and deducting TDS under relevant provisions of Income Tax laws and issuing Form 16 to the Directors.They contend that this ‘establishes' that the directors are their employees and, therefore, the services provided by the directors are in the exclusion clause of the definition of service.

Conversely, in terms of Section 198 and 309 of the Companies Act, 1956 (now clause 78 of Section 2 of the Companies Act, 2013) directors remuneration includes payments made to Directors for services rendered in any other capacity and, therefore, the salary paid to Managing director/whole time director, Commission, sitting fees paid to directors and any other fees paid for professional services shall be treated as remuneration under the Companies Act, 1956 and 2013, as well. Therefore, there is nothing as director's salary - it is all director's remuneration.

From the above, a dire need arises to look into the taxability of director's remuneration. Since payments to the directors were made under the salary head, the companies took this as an ample proof of the relation between the company and the director as that of employer and employee, and accordingly service tax is not being paid on director's remuneration by the companies under reverse charge mechanism.

The only issue that needs examination for taxability of director's remuneration under service tax is whether a director of a company is an employee or not.

HISTORY AND PROVISIONS OF LAW

The taxability of the services provided by a director of a company to the company has always been under dispute. The reason first stemmed from the meaning of service given in section 65B(44) of the Finance Act, 1994 which read as follows:

(a) …. ;

(b) a provision of service by an employee to the employer in the course of or in relation to his employment;

(c) …..

It was the above meaning of service which excluded provision of service by an employee to the employer in the course of or in relation to his employment that gave rise to the issue as to whether a director of a company is an employee of the company or not.

Perhaps, to clarify the issue, the Government notified the Service Tax (Third Amendment) Rules, 2012 dated 07.08.2012 which inserted an item (EE) in Rule 2(1)(d)(i) of the Service Tax Rules, 1994. After the insertion, the relevant entry read as under:

Rule 2(1) In these rules, unless the context otherwise required,-

(d) "person liable to pay service tax',-

(i) in respect of the taxable services notified under sub-section (2) of section 68 of the Act, means,-

(EE) in relation to service provided or agreed to be provided by a director of a company to the said company, the recipient of such service;

Simultaneously an entry 5A was inserted vide Notification No. 45/2012-ST dated 07.08.2012 in the Notification No. 30/2012-ST dated 20.06.2012,which provided the percentage of service tax payable by the service provider and service receiver, to the following effect:

(II)  The extent of service tax payable thereon by the person who provides the service and the person who receives the service for the taxable services specified in (I) shall be as specified in the following Table, namely:-

With effect from 11.07.2014, the Service Tax (Amendment) Rules, 2014 further amended the meaning of the person liable to pay service tax in this regard in the following manner:

(EE) in relation to service provided or agreed to be provided by a director of a company or a body corporate to the said company or the body corporate, the recipient of such service;

Accordingly, the Notification No. 30/2012-ST dated 20.06.2012 was also amended vide Notification No. 10/2014-ST dated 11.07.2014 with effect from 11.07.2014 in the following manner:

The above provisions amply provided that the services provided by a director to a company or a body corporate are not in the course of employment since even when the services provided by an employee to the employer in the course of employment were out of purview of meaning of service, the services provided by a director to the company or the body corporate were made explicitly taxable with effect from 07.08.2012 / 11.07.2014.

DISTINCTION BETWEEN DIRECTORS AND EMPLOYEES FOR A LAYMAN:

++  Directors are elected / appointed, employees are recruited.

++  Directors are removed, employees are ‘fired' / retrenched.

++  Directors get remuneration, employees get salary.

++  Directors decide their remuneration; employees do not decide their salary.

++  Directors represent the company, employees work for the company.

++  Directors hold an office, employees have workplace.

++  Directors serve the interests of the shareholders of the company; employees serve the company and are not concerned about t.he shareholders.

++  Director's remuneration is separately shown in balance sheets, whereas what an employee gets is shown under Salaries and Wages in the balance sheets.

IS DIRECTOR AN EMPLOYEE- LEGAL PERSPECTIVE

There has not been a clear consensus on the issue as to whether a director is an employee or not. However, most of the judicial decisionsfavour the thought that the director is not an employee but an agent who acts between the company and all the stakeholders including government. In this regard, the following judgementsbeing of utmost importance are referred.

++  The earliest reference of the status of a director can be found in the case of Ferguson v. Wilson [(1866) LR 2 Ch App 77] wherein it was held that ‘The company has no person; it can act only through directors and the case is, as regards those directors, merely the ordinary case of principal and agent'.

++  In the case of Ram Chand & Sons sugar Mills (P) Ltd. Vs. KanhayalalBhargava [AIR 1966 SC 1899] it was held that the position that the directors occupy in a corporate enterprise is not easy to explain.

++  In the case of Ram Prashad v. CIT [(1972) 86 ITR 122] the Supreme Court observed that a company director 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 with the company. In

++  In the case of Moriarty Vs. Regent's Garage Co. [(1921) 1 KB 423, it has been held that ‘A director is not a servant of any master. He cannot be described as a servant of the company or of anyone'. It was also held that ‘A director is in fact a director or controller of the company's affairs. He is not a servant.'

++  In the case of RKDalmia vs. Delhi Administration [1963 SCR (1) 253], quoting the authoritative book Palmer's Company Law, it was found that Directors are, in the eye of the law, agents of the company for which they act, and the general principles of the law of principal and agent regulate in most respects the relationship of the company and its directors.

++  In the case of CIT v. Smt. Shanti Devi [1993] 199 ITR 800/[1992] 64 Taxman 251 the Orissa High Court has held that where a person holds the office of a director of a company, the remuneration by virtue of that officedoes not bring about the relationship of a master and servant.  

++  In the famous case of Lee v. Lee's Air Farming Ltd. [1961 AC 12], the principal controller and a director of the company was also working as its pilot and when he died while acting as a pilot, his widow recovered compensation from the company under the Workmen's Compensation Act. Therefore, this implied that a director may also work as an employee in a different capacity.

++  In the case of Bachan v. Secretary of State for Employment [(1997) BCC 145] it was held that ‘A director is neither an employee nor a servant, unless he is working, as such, in a different capacity'.

To conclude, it may be said that the directors are not employees of the company. Rather, they are professionals hired by the company to run its affairs smoothly. They are, therefore, also highly paid. Generally the directors, while working as an agent of the company, act on behalf of the company. They enter into contracts on behalf of the company for which, in case of disputes, only company is liable. A small part of their work may be to look into mundane affairs of the company which an employee may also have looked into which implies that sometimes they may alsowork in the capacity of an employee.

In parting:

The payment of service tax by the company on director's remuneration under reverse charge may be a ‘revenue neutral' exercise since many of the companies are service providers or manufacturers and are eligible to take CENVAT credit of the service tax paid on director's remuneration under reverse charge.

While a director can have dual capacity, as a director and an employee, only facts and circumstances can decide that the director has also served as an employee and that the dual capacity may not be a farce.However, the line between a person being a director and an employee is also not so thin. Also, merely a Form-16 or deduction of TDS under a particular provision under Income Tax lawis not a conclusive proof to substantiate that director was working only as an employee.

If it is a uniform assumption that a director works as such and as an employee also, the Government can think of exempting part of the value of service by providing an entry in Notification No. 26/2012-ST dated 20.06.2012.However, it is felt that the taxability of the services provided by the directors is in no way disputed.

(The author is Superintendent, Central Excise Audit Commissionerate, Jaipur and the views expressed are strictly personal.)