MAY 18, 2020

By K V Srinivasamurthy

I. RCM on consideration paid to both Executive and Non-Executive Directors in GST :

- Notification 13/2017-Central Tax (Rate) dated 28.06.2017 issued under Section 9(3) of the Central Goods and Services Act, 2017 reads as below:

 

- Insofar as it relates to the consideration inclusive of remuneration, commission etc., paid to the executive/whole time directors, there exists a confusion as to whether these considerations should be subject to GST under RCM basis or not.

Is Director Employee of the Company?

1. Neither the word Director nor distinction between Independent and Non-independent directors have been defined under the GST laws.

2. Directors are de-facto employees of the company and thus payment made to them as salary + benefits are not liable to GST and consequently the company is not liable to pay any GST on such payments by way of reverse charge mechanism.

3. Further the activities or transactions specified in Schedule III shall be treated neither as a supply of goods nor a supply of services".

4. As per Section 2(94) of the Companies Act "director" includes a director in the employment of the company.

5. In case of Regional Director, E.S.I. vs Sarathi Lines (P) Ltd., on 29th January 1997, the Hon'ble High Court of Karnataka held as below:

a. The powers of the Managing director had to be exercised within the terms and limitations prescribed thereunder and subject to the control and supervision of the Directors, which would indicate that he was employed as a servant of the company.

6. In the case of Ram Pershad vs Commissioner of Income Tax, 1973 SCR (3) 1985, it was held as below:

a. The Managing director is subject to control and supervision of the directors which in our view is indicative of his being employed as a servant of the company. We would therefore hold that the remuneration payable to him is salary.

7. Generally speaking, there are usually two sources of a director's remuneration: the one source flows from the fees that he receives for his services as director (example, fees for attending board meetings) and the other source flows from such director's employment contract (if any) which would provide for the payment of a salary

8. In Anderson vs James Sutherland (Peterhead) Ltd., (1941) SC 203 - Scottish Case - A central question that the court had to determine was whether Mr. Anderson was employed in his capacity as managing director. The Court held that while director is ordinarily not an employee of the company, a managing director holds two separate and distinct offices - manager and director - and that management role is one of servitude. Because of this fiduciary relationship, a managing director may be considered as an employee of the company.

9. A managing director occupies the dual capacity of being a director as well as an employee of the company. In Employees State Insurance Corpn. v. Apex Engineering P. Ltd. [87 1998 (I) LLJ 274] , the apex Court upon taking into consideration various decisions, inter alia, held that a managing director of a company having limited liability would be employee within the meaning of the said Act. In that case, the apex Court clearly held in the facts and circumstances thereof, that all the requisite conditions for applicability of the term 'employee' as defined by the Act stood satisfied in the case of the Managing Director, holding that a Managing Director of a company could not be treated at part with partner of a partnership firm who has been given some remuneration for his extra work.

10. Hon'ble Karnataka High Court in the case of  Regional Director, ESI Corpn. V. Margarine & Refined Oils Co. (P) Ltd. 6  where it was held that a Company is a legal person and can employ one of its Directors as Managing Director, thus, the Managing Director of a Company shall fall under the definition of "employee" under Section 2(9) of the ESI Act, 1948 and the remuneration paid to the Director shall amount to wages under Section 2(22) of the ESI Act, 1948.    Merely because it is legally possible for a Director or Managing Director to function in the capacity of an employee also it does not mean that in all cases a Director or Managing Director who receives remuneration has necessarily to be treated as an employee. It has to be further established that either under the provisions of Articles of association or of separate agreement there was a contract of employment between the Company and the Managing Director or the Director.

11. In re Anil Kumar Agrawal (GST AAR Karnataka) - Date of Order: 4th May, 2020 - 2020-TIOL-95-AAR-GST- It was that held Executive director's salary being employee of the company is neither supply of goods nor supply of services under Schedule III and is not includable in the aggregate turnover. Hence, not subject to GST on Reverse charge basis.

12. Many companies have taken a stand that the consideration in the form of salary, commission paid to the whole time/managing directors shall form part of the payments made in the course of employer employee relationship and thus shall attract the provisions of Schedule III of the CGST Act, 2017 and shall be treated neither as a supply of goods nor a supply of services".

13. Further certain companies are including the commission paid to the whole time/managing directors in the salary income of them.

14. Thus, it could be noticed that many companies are taking a stand not to remit GST on reverse charge method as provided in Notification No.13/2017 Dt.28.06.2017.

II. Contrary Findings to the above Views:

- Notification No.13/2017 Dated 28.06.2017 merely reads as below:

- It does not make a distinction between Executive directors and independent directors.

- It merely goes on to state that the services provided by the directors shall be subject to GST under RCM.

- This being the statutory position, the scope and ambit of the service is to be examined. What is taxable under this category of service is the 'Service by a DIRECTOR of a Company or body corporate provided to the said Company

- Sec. 2 (34) of Companies Act, 2013 defines a DIRECTOR as a Director appointed to the Board of a Company. Again, as per Sec. 2 (10) of Companies Act, 2013, 'Board of Directors or a Board' in relation to a Company, means the collective body of the Directors of the Company. Thus, it may be seen that 'All those who are part of the Director Board' is/are a DIRECTOR(s).

- In these circumstances, the definition of 'Managing Director' and 'Whole time Director" (Executive Director) also may be noted. Sec. 2 (54) ibid reads "Managing Director means a Director who by virtue of the article of a 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. Similarly, Sec. 2 (94) ibid reads 'a whole time Director includes, a Director in the whole-time employment of the Company'. It, therefore, appears that every person occupying a position in the Director Board, including the Managing Director and whole time Director is essentially a DIRECTOR, and the service provided by them to the Company or body corporate is exigible to Goods and Service tax.

- The legislature delegate a part of their legislation to the Executive. Now, the Executive can make ground rules for proper implementation of the law. Notifications are executive orders and confirm to the broader requirement of law though it is not approved by the legislature.

- The executive should be definitely aware of the concept of Independent and Non-independent directors at the time of issuing the notification. Similarly, they should be well aware of the concept of employer employee relationship which is neither treated as supply of goods or services under Schedule III of the CGST.

- Going by the wordings in the notification supra, either the executives are ignorant of the concept of employer employee relations under Schedule III or they have deliberately avoided the distinction between executive and non-executive directors while framing the notification.

- However, it appears that the executives appear to have not made any distinction between executive and independent directors while issuing the notification and have generally stated that the "Consideration paid to Directors" shall be subject to RCM in GST. In other words they have gone to frame the notification in such a way that the RCM shall be applicable as a whole for those services rendered by persons who fall within the definition of the word "Director" and avoided to make a distinction between the Independent and Non-Independent directors.

- Going by the above the word "Directors" should include both Executive and Independent directors.

- Hence, the possibility of the Revenue by relying upon the said notification 13/2017 make a demand that GST shall be paid by the company under RCM on all the consideration paid to the directors irrespective of the fact whether they are Executive or Independent directors by going about the phrase contained in the notification that the "Services supplied by a Director of company or a body corporate to the said company or the body corporate" shall be subject to RCM payment by the company.

- Further it is also interesting to note the contradictory view taken by the Advance Ruling authorities in the following cases wherein it was held that remuneration payable to the Directors shall be subject to RCM payment by the company. The authorities have not made any distinction between Executive and Independent directors and merely clarified that GST shall be paid on the services rendered by the Directors. The stand adopted by the Authorities are as below:

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

a. We observe that the consideration paid to the Directors for the supply of services to the company is specifically covered under Notification No.13/2017 - Central Tax (Rate) Dt.28.06.2017 which states that the service rendered by directors shall be subject to RCM payment by the company.

b. Further it observed that the consideration is paid to Directors is against the supply of services provided by them to the company and are not covered under clause

(1) of Schedule III to the CGST Act, 2017 as the Directors are not employees of the company. Here the director is the supplier of service and the company is the recipient of the service. So, it is very clear that the services rendered by directors to the company for which consideration is paid to them in any head is liable to pay GST under RCM.

c. It also observed that the said notification 13/2017 has given distinct identity to the services provided by the director and specifically included in the category of service on which GST will be payable under RCM.

b. M/s ALCON CONSULTING ENGINEERS INDIA PVT LTD - 2019-TIOL-378-AAR-GST - Held - The services provided by the Directors to the Company are not covered under clause (1) of the Schedule III to the Central Goods and Services Tax 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.

- The Supreme Court in Ram Prasad (Supra) has held that whether a Managing Director is an employee or not, can be determined only from the Articles of Association of the company and the terms of employment and there is no hard and fast Rule.

III. Contract of Service Test:

Directors are often seen as individuals looming over employees on top of the company pyramid. Generally, a directorship is an office and is a separate persona altogether from an employee but in the modern company sphere, it is not uncommon to have directors wearing "two hats" at the same time; an employee and a director.

It would be pertinent to note the "Contract of Service Test" as laid down by the Federal Court case of  Hoh Kiang Ngan v Mahkamah Perusahaan Malaysia & Anor [1995] 1 MELR 1 , wherein it clarified the confusion by reaffirming a contract test set forth in  Dr. A. Dutt v Assunta Hospital [1981] 1 MLJ 304   to distinguish directors from employees. If an individual is engaged under a contract of service, they are deemed as an employee.

These are some of the other key factors which are typically considered by the courts in assessing the employment status of an individual.

- The degree of control exercised by the employer;

- Whether the worker's interest in the relationship involved any prospect of profit or risk of loss;

- Whether the worker was properly regarded as part of the employer's organization;

- Whether the worker was carrying on business of his own account or carrying on the business of the employer;

- The provision of equipment;

- Tax and insurance;

- The parties' own view of their relationship; and

- The structure of the trade and profession concerned and the arrangements within it.

If one's work is dictated by a superior, then it is quite possible that he fits the role of an employee as he has limited control over his work.  However, the exact determination of one's degree of control is a question of fact that can only be established on a case by case basis.

The Court in  Phua Cheng Wai v Katecs Asian Sdn Bhd [2013] 2 MELR 146, held that although EPF, SOCSO and tax deductions are not conclusive evidence, it is among the factors to be taken together with the contract test to determine the issue of whether one is an employee. That being said, although it is an inconclusive factor, the courts will likely see it as a positive indication that the individual retains the character of an employee if payment of wages and EPF contributions are made.

Similarly, employees who are subsequently "promoted" to directorship may also still be classified as an employee so long as the contract of service remains intact and they continue to receive wages or salary.

As such, the key points to look out for in determining whether a director could also be an employee (and therefore be granted the corresponding legal rights of an employee) are:

- Whether there is a contract of service or contract of employment;

- Whether the contract of service was terminated when the employee was made a director;

- Whether the individual receives wages or other benefits typically reserved only for employees, or whether the individual was otherwise treated as an employee;

- The nature of the individual's role in the company and the degree of control possessed;

- Whether the company makes statutory contributions or deductions for the individual as if they were an employee (eg: EPF, and income tax).

In Lincoln Mills (Aust) Ltd Vs Gough [1964] VR 193, 198 - it was held, that A necessary requirement to a finding of the existence of an employment relationship, including one between company and director, is that the relationship is governed by a contract of service and not a contract for services.

IV. Conclusion

- There are three advance rulings on the said subject, out which two are adverse and one is favorable to the taxpayer.

- It is important to note here that as per Section 103 of the GST Act, the advance ruling is binding only on the applicant who has sought the same.

- Needless to say, though these rulings are not binding on third party, GST authority may, guided by the aforesaid adverse ruling, start issuing notices against the companies for not paying GST amount against the payment made to the Executive director. 

- Contrary rulings by AARs will lead to increased confusion for taxpayers.

- It is important to understand the  relationship that director has with the  company and identify whether the executive director is both a director and employee or not.

- At present the Advance Ruling authorities are in the cadre of Joint Commissioners, who appear to be mostly revenue biased.

- It is high time that the authorities shall consist of Judicial and Technical members as it existed during the erstwhile regime who would be independent and neutral, and this will be better for the taxpayers as well as the tax administration.

- Necessary clarification on the part of the Government will go long way to ease the burden of litigation on taxpayers and will lead to ease of compliance.

[The author is Senior Consultant - Indirect Taxes, PKF Sridhar & Santhanam LLP, Chartered Accountants, Chennai and the views expressed are strictly personal.]