APRIL 16, 2020

By Gopal Mundhra, Partner &  Kumar Harshvardhan, Associate Manager , Economic Laws Practice

BACKGROUND

OVER the past few days, much has been said about the liability of a company to pay Goods and Services Tax ('GST') on Directors' remuneration. The dispute resurfaced after the recent ruling by Rajasthan Authority for Advance Rulings ('AAR') in Clay Craft India ¹ wherein it was held that Directors, including Whole-time Directors, can never be treated as employees of the company in respect of the salary paid to them and such salary is liable to GST under reverse-charge mechanism in the hands of the Company.

One might recall that a similar issue took centerpiece in November 2019 as regards collection of GST on salaries received by Chief Executive Officers ('CEOs') and other employees. In an effort to end the unrest, the Central Board of Indirect Taxes and Customs ('CBIC') vide a statement dated 15.11.2019 clarified that "…media report in this regard alleging that tax authorities want to impose GST on salaries paid to employees is factually incorrect and misrepresents the tax authorities." ²

Given the above background, coupled with the fact that remuneration paid to Directors was punctuated with considerable dispute in the erstwhile Service tax regime too, it is pertinent to revisit the present legal position under the GST law and the impact of the referred AAR ruling.

Relevant provisions under GST

As per Section 7 of the CGST Act, 2017 ('CGST Act'), supply of goods or services made or agreed to be made for a consideration by a person in the course or furtherance of business shall constitute 'supply' and be liable to GST at the applicable rate in terms of Section 9.

However, in terms of Section 7(2) of the CGST Act, activities or transactions specified in Schedule III are to be treated neither as a supply of goods nor as a supply of services and shall therefore be outside the GST net. It is pertinent to note that Sl. No. 1 to the said Schedule III includes 'services by an employee to the employer in the course of or in relation to his employment' .

Further, in terms of Section 9(3) of the CGST Act read with Sl. No. 6 of Notification No. 13/2017-Central Tax (Rate) dated 28.06.2017, GST on 'services supplied by a director of a company or a body corporate to the said company or the body corporate' shall be paid on reverse charge basis by the recipient of the services, i.e., by the company or body corporate.

From a conjoint reading of the aforesaid provisions, the following propositions are emerging:

- If services provided by the Directors to the company are in the course of or in relation to their employment with the Company and are provided in the capacity of an employee, no GST shall be leviable on the remuneration paid to the Directors insofar as its relates to such employment.

- If services provided by the Directors are not in the course or in relation to their employment, GST shall be payable by the company under reverse charge mechanism.

Generally, the Executive Directors, which include Managing Directors and Whole-time Directors, are the directors who manage the day-to-day affairs of a company and are engaged as "C-Suite" individuals with roles, both as board members and employees of the company. However, the Non-executive Directors are conventionally characterized by their relative separation from the company and are not involved in the day-to-day running of the company. Typically, such directors are involved in policymaking and developing long-term strategies and are paid sitting fees.

In order to ascertain the liability of a company to pay GST on a remuneration paid to its Directors, it is pivotal to identify the relationship of the Directors with the company qua payment of such remuneration.

The test for employment

The term 'employee' has nowhere been defined in the CGST Act or the rules made thereunder. Therefore, the meaning of the said term along with the presence of the employer-employee relationship is to be inter alia derived from the following tests laid down by the Hon'ble Supreme Court ³:

a. Whether there exists complete control and supervision on the employee by the employer;

b. Whether the salary or remuneration is paid directly by the employer;

c. Whether the employer has the right to dismiss the employee;

d. Whether the employer has the right to take disciplinary action; and

e. Whether there is continuity of service;

f. Whether the employee has been directly appointed by the employer; and

g. Whether the other provisions of the contract or agreement are consistent with its being a contract of service.

In addition, it must also be borne in mind that in cases where a Managing Director or an Executive Director is treated as a principal employer, she or he may carry a dual capacity of being the principal employer as well as the employee. Such a view has recently been upheld by the Hon'ble Supreme Court in Venus Alloy ⁴ after taking note of the definition of employee under the Employees' State Insurance Act, 1948 ('ESI Act').

It is also pertinent to note that the salaries paid to Directors is subject to Tax Deducted at Source ('TDS') under Section 192 of the Income Tax Act, 1961 ('IT Act'). However, in cases where the remuneration is in the nature of professional fees and not salary, the same is liable for deduction under Section 194J ⁵. Thus, one may place reliance on the decision of Mumbai CESTAT in Rentworks India ⁶ to argue that where a remuneration paid to Directors is treated as a salary liable to TDS under said Section 192 by the Income Tax Department (a division of Ministry of Finance), the same amount cannot be treated as professional fees by GST Department (another division of Ministry of Finance). Having said that, the Courts may still require the companies to prove the presence of an employer-employee relationship in respect of any payment made to the Directors as the treatment of Directors' remuneration under the IT Act may not be considered as conclusive evidence.

Treatment of Director's remuneration under GST

From a perusal of the above, it is evident that the relationship of the Directors with the company shall be in the nature of an employer and employee if the afore-mentioned tests laid down by the Hon'ble Supreme Court is satisfied. A company may, therefore, examine the following documents / information to determine the same:

a. Employment contract or terms of agreement setting out the responsibilities and remuneration payable;

b. Manner in which control and supervision is exercised on the Directors;

c. Resolution passed by company to employ the Directors; and

d. Article of Association of the company.

After examination of the aforesaid documents, if it is found that the Directors (including Managing Directors, Whole-time Directors and Executive Directors) satisfy the tests laid down by the Hon'ble Supreme Court, the relationship shall be that of an employer and employee. Accordingly, remuneration which is paid to the Directors in the course of or in relation to their employment shall be outside the GST net and the company shall not be liable to pay GST under reverse charge mechanism on such remuneration. Reliance in this regard may also be placed on the decisions of the Mumbai Tribunal in Allied Blenders and NRB Industrial Bearings ⁷ as well as the Circulars issued by the Ministry of Corporate Affairs ⁸ and Central Board of Indirect Taxes and Customs ⁹ ('CBIC').

However, in all other cases where the relationship of the company with the Director is not that of an employer and employee, the company shall be liable to pay GST under reverse charge mechanism. It is pertinent to note that each payment made to directors would have to pass through such test.

In any event, taxpayers effecting taxable supplies shall be eligible to avail the input tax credit of the GST paid by it on Director's renumeration subject to the conditions stipulated under Section 16 and 17 of the CGST Act. With a view to avoid frivolous litigation, after the said advance ruling, a few taxpayers might take a conservative decision to pay GST under reverse charge mechanism in all cases and avail input tax credit of the same unless it gives rise to a situation of accumulation of credit.

Concluding remarks

The AAR, in the said ruling, has flagrantly disregarded the various tests laid down by the Hon'ble Supreme Court and has failed to note that Executive Directors generally hold dual roles in a company, viz., as board members as well as employees of the company.

Further, even though the AAR ruling is binding only on the applicant, i.e., Clay Craft India Pvt. Ltd. in the present case, the ruling has created a state of uncertainty and deep concern in the industry. Given the same, it is recommended that the Board issues a detailed clarification explaining the GST implications on the remuneration paid to the Directors.

[The views expressed are strictly personal.]

¹Clay Craft India Pvt. Ltd. - 2020-TIOL-64-AAR-GST

² No GST on salary, says CBIC, The Hindu Business Line available at https://www.thehindubusinessline.com/economy/no-gst-on-salary-says-cbic/article29983587.ece

³Balwant Rai Saluja vs. Air India Ltd. [(2014) 9 SCC 407]; Ram Singh vs. Union Territory, Chandigarh, [(2004) 1 SCC 126]; Workmen of Nilgiri Coop. Mkt. Society Ltd. vs. State of T.N. [(2004) 3 SCC 514], Bengal Nagpur Cotton Mills vs. Bharat Lal, [(2011) 1 SCC 635]; and National Aluminium Co. Ltd. v. Ananta Kishore Rout & Ors., [(2014) 6 SCC 756]

⁴ESIC vs. Venus Alloy Pvt. Ltd. [Civil Appeal No. 1464 of 2019, decided on 05.02.2019]

⁵ Clause 71 of the Memorandum to the Finance Bill, 2012

⁶ Rentworks India Pvt Ltd vs. CCE - 2016-TIOL-1199-CESTAT-MUM

⁷Allied Blenders - 2019-TIOL-25-CESTAT-MUM and NRB Industrial Bearings - 2019-TIOL-2594-CESTAT-MUM

⁸ General Circular No. 24/2012 dated 09.08.2012

⁹Circular No. 115/09/2009-ST dated 31.07.2009