APRIL 14, 2020

By Kevin N Shah

1. Introduction:

REMUNERATION/dividend paid to directors/shareholders has always been a subject of ambiguity under any taxation law. Deemed dividend is a topic of ambiguity under the Income Tax Act, 1961 and applicability of GST as per reverse charge on remuneration paid to directors have been a topic of ambiguity under the erstwhile Service Tax Law and now under the GST as well. The Service Tax on remuneration paid to directors was first introduced under the service tax law under Negative List based Taxation in 2012.

2. Relevant provisions under GST:

a. Services supplied by a director of a company or a body corporate to the company or a body corporate located in a taxable territory shall be subject to be taxed ¹ under GST by applying principles of reverse charge mechanism.

b. Services provided by the employees to the employer in the course of or in relation to his employment shall not ² be treated as a supply of services.

3. Advance Rulings under GST

a. Alcon Consulting Engineers Private Limited - 2019-TIOL-378-AAR-GST

The Karnataka Advance Ruling Authorities have said that services provided by directors of the company are not covered under Schedule III of the CGST Act, 2017. Thus, the services provided by the directors are subject to reverse charge mechanism under Notification 13/2017 - Central Rate dated 28.06.2017.

b. Clay Crafts India Pvt. Ltd. - 2020-TIOL-64-AAR-GST

In the recent Advance Ruling issued by the Rajasthan AAR authorities, the Authorities have said that the Directors of the company are not employees of the company. Hence, the benefit of Schedule III given in Point 2(b) shall not be available to the Directors. The services provided by the directors shall be considered as being covered under Notification 13/2017 - Central Rate dated 28.06.2017.

4. Rulings under Service Tax

A similar issue was also examined under service tax as RCM on fees paid to directors was also prevalent under the service tax regime. The Hon'ble Kolkata Tribunal ³ held that RCM is payable on any amount paid to both executive as well as non-executive directors whereas Hon'ble Mumbai Tribunal ⁴ held that RCM is not payable on any amount paid to executive directors. Thus, there were divergent views by the Hon'ble Tribunals itself on such issues.

5. Relevant provisions under the Companies Act, 2013 & other allied acts:

a. The term "Director" ⁵ includes a director in the nature of the employment of the company. Thus, it can be said that the Companies Act, 2013 recognizes directors of the company as an employee also.

b. For the purpose of keeping a check on issue of share capital the term "employee" has been defined ⁶ which reiterated hereinunder:

"employee" means, -

(i) a permanent employee of the company who has been working in India or outside India; or

(ii) a director of the company, whether a whole-time director or not but excluding an independent director; or

(iii) an employee as defined in clause (i) or (ii) of a subsidiary, in India or outside India, or of a holding company of the company

but does not include-

(a) an employee who is a promoter or a person belonging to the promoter group; or

(b) a director who either himself or through his relative or through any body corporate, directly or indirectly, holds more than ten per cent of the outstanding equity shares of the company;

c. Based on the reading of provisions given above, it can be said that the directors are employees of the company except if they are independent directors or directors acting as a promoter or belonging to the promoter group. Accordingly, all the private limited companies including start-up companies or promoter-driven companies would have wide ramifications.

d. In our opinion, drawing an inference of the term "employee" from the above-mentioned definition would be like walking on a narrow path because primarily the instant definition of "employee" is crafted to keep a check on further issue of equity shares to promoter who can be a managing director or any such director who is from the promoter group or such person who holds more than 10% of the outstanding equity shares. Further, it is for this purpose the term "employee" restricts its applicability limited to certain provisions of the Companies Act, 2013 and accordingly it should act as a base for exploitation in other areas.

6. Our Analysis

a. On analysis of both the advance rulings, it can be substantiated that the Hon'ble Members have presumed that directors are not the employees of the company without providing any opinion or analysis on the same. Considering the facts of the case, it may be applicable but the same cannot be made applicable universally for the reasons mentioned explained below. Further, the instant advance ruling may not be applicable universally as Hon'ble Delhi Tribunal ⁷ has held that any Advance Ruling issued by the Advance Ruling Authorities shall only be binding on the company who has applied for advance ruling since the advance Rulings do not constitute any binding precedent.

b. In our opinion, the term "employee" means any such person who is a servant to the company. In terms of establishing whether a particular person is a servant to the company or not, one has to understand his/her locus standi in the company.

c. Under the Companies Act, a Managing Director means, a director who, by virtue of an agreement with the company or of a resolution passed by the company in general meeting or by its board of directors or by virtue of its memorandum or articles of association, is entrusted with substantial powers of management which would not otherwise be exercisable by him, and includes a director occupying the position of a Managing Director, by whatever name called. Thus, a director who has also taken employment in the company would be functioning in dual capacities, namely, one as a director of the company and the other on the basis of the contractual relationship of master and servant with the company, i.e., under a contract of service entered into with the company.

d. Merely from the fact that a Managing Director gets a remuneration as envisaged under the  Co mpanies Act, 2013 it cannot be inferred that he is a servant of the company. The test to determine ⁸ whether a managing or an ordinary director is also an employee, is whether he/she is under a contract of service. Where there is contract of service and the relationship of employer-employee between the company and the director is established, there would be control over his work as an employee of the company and that capacity would be different from his other role as a director of the company. Therefore, a director including a managing director who is not an employee under any contract of service with the company, would not be an employee of the company merely by virtue of his having been paid remuneration or benefits or amenities in his capacity as such director of the company.

e. Further, it is a settled ⁹ position in the Income Tax Act, 1961 that a managing director/whole-time director may have a dual capacity. He may be both, a director as well as an employee and accordingly TDS under the head "Income from Salaries" is being deducted for any amounts paid/payable to them. Accordingly, it is for this reason we are of the opinion that all executive directors are employees of the company.

f. The above-mentioned aspects were not discussed in the recently pronounced judgments and accordingly the water needs to be tested again. There is, therefore, a need for clarification in this space from CBIC.

g. We would suggest that the companies shall review the terms of appointment of the directors and ensure that it passes the test of employment. Without prejudice to anything mentioned above, in case where the companies are getting complete credit and do not desire to have any litigation in the future, they may pay GST under RCM and avail Input Tax Credit for the same.

(The author is Practicing Chartered Accountant, Kevin N Shah & Associates, Mumbai and the views expressed are strictly personal.)

¹Section 9 (3) of the CGST Act, 2017 read with notification 13/2017 - Central Rate dated 28.06.2017

² Entry 1 of Schedule III of the CGST Act, 2017

³Brahm Alloy Limited vs CCE 2019 (24) GSTL 616 [Tri - Kol.]

⁴Allied Blenders and Distillers Pvt. Ltd. vs. CCE - 2019-TIOL-25-CESTAT-MUM

⁵Section 2(94) of the Companies Act, 2013

⁶ Explanation to Rule 12(1) of Companies (Share Capital & Debenture) Rules, 2014 which also justifies employees as referred under Section 62(1)(b) of the Companies Act, 2013

⁷Laxmi Electricals & Decorators vs Commissioner of C. Ex., Jaipur-I 2016 (041) STR 0132 Tri.-Del

⁸Ambica Mills Ltd. vs Commissioner of Income-Tax 1999 235 ITR 264 Guj

⁹ Ram Pershad v. Commissioner of Income Tax, New Delhi  (1972) 2 SCC 696