RCM ON SALARY TO DIRECTORS

Dear Readers,

Recently Rajasthan AAR in the case of M/s Clay Craft India Pvt. Ltd. has promulgated that the salary drawn by directors from the company is liable to GST under reverse charge mechanism and this AAR has created panic as law clearly stated that the services provided by an employee to the employer in the course of or in relation to his employment will not be taxable. Therefore it's the need of an hour to write this article and share my opinion on the taxability of salary of directors drawn from company as an employee of such company. 

1.    Entry No. 1 of Schedule III of CGST Act, 2017 clearly states that the “services by an employee to the employer in the course of or in relation to his employment” is neither treated as supply of goods nor as supply of services. Further entry no. 6 of Notification 13/2017 dated 28.06.2017 provides for RCM implications on the services rendered by the director of a company to the said company or body corporate thereby creating an onus on the company to pay taxes under RCM on the said services supplied by directors.

1.1However recently Rajasthan AAR has passed an advance ruling in the case of M/s Clay Craft India Pvt. Ltd. 2020(4) TMI 228 where authority has promulgated that the salary drawn by directors from the company is liable to GST under reverse charge mechanism even though TDS on such amount has been deducted by company u/s 192 as per TDS provisions and thus leaving question again open for a debate on GST applicability on the employment contracts of the directors.

1.2 Brief Facts of the case are as below:

1. The applicant is a private limited company registered under Companies Act, 1956 where Board of Directors comprises of 6 whole time directors of the company and have been assigned different business functions under the company.

2. The directors are being compensated by the company by way of salary and other allowances as per the company policy and as per their employment contract.

3. Company is deducting TDS on their salary and PF laws are also applicable to their services.

4. Salary paid to directors is being booked under Income from Salary by the directors in their income tax return.

5. Applicant sought for advance ruling due to the doubt created by another advance ruling of Karnataka AAR on similar lines in the case of M/s Alcon Consulting Engineers (India) Pvt. Ltd. 2019(10) TMI 793.

1.3 In this case no attempt was made to evaluate the existence of the employer-employee relationship which was a critical aspect to determine the correct taxability on the director’s remuneration. Further AAR opines that distinct identity has been created for directors services by way of notification 13/2017 dated 28.06.2017. However the Hon’ble AAR failed to appreciate that the RCM provisions applies in respect of those categories of transactions that are supply in the first place and transaction has to first pass the test of supply before applying RCM provisions.

1.4 The issue of taxability of the directors remuneration is not taxable and has its roots falling in the erstwhile service tax regime as well wherein department had considered that the directors are not employees of the company and to understand the scope of director and remuneration we should resort to relevant provisions of Companies Act, 2013.

1.5 The term “employee” has not been defined under either C.G.S.T. Act, 2017 or SGST Act, 2017. Therefore, to understand as to who is an employee we would have seek understanding from other sources;

     As per Cambridge Dictionary an employee is: “someone who is paid to work for someone else”

1.6 Section 2(94):”director” includes a director in the employment of the company. A director refers to a director who has been in employment of the company on a fulltime basis and is also entitled to receive remuneration.

1.7Section 2(24) (copy enclosed) of the Companies Act, 1956 makes it clear and reads as under:

     Section 2(24) “manager” means an individual (not being the managing agent) 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 manger, by whatever name called, and whether under a contract of service or not;

           Also, section 2(26) of the Companies Act, 1956 (copy enclosed) states as under;

     Section 2(26) “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 any powers of management which would not otherwise be exercisable by him, and includes a director occupying the position of managing director, by whatever name called;

1.9The definition of an employee under Employee’s Provident Fund and Miscellaneous Provisions Act, 1952 reads as under

     2F Any person who is employed for wages in any kind of work, manual or otherwise, in or in connection with the work of an establishment, and who gets his wages directly or indirectly from the employer, and includes any person- (i) employed by or through a contractor in or in connection with the work of the establishment; (ii) engaged as an apprentice, not being an apprentice engaged under the Apprentices Act, 1961, or under the standing orders of the establishment.

     1.10Employees Provident Fund Scheme, 1952 also defines the employee as the one:

     Clause 2(e) “Employee” means a person appointed to or borne on the cadre of the staff of the Corporation, other than persons on deputation;

1.11Rule 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.

1.12As per Section 2(78), ‘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.

1.13Under the Companies Act, a General Circular No. 24/2012 dated 09.08.2012 issued by Ministry of Corporate Affairs (MCA) clarifies that “The Non-Whole Time Directors of the company are presently not covered under the exempted list and as such, the sitting fees/commission payable to them is liable to Service Tax. Service tax is payable on the commission/sitting fees payable to Non-Whole Time Directors of the company.”

     A perusal of the above provisions reveals that the director whether the whole-time director or managing director can also be an employee of the company. Further, the remuneration is wide enough to cover any monetary, non-monetary, fixed or variable component. The directors are appointed to the Board of Directors of the Company and are also accountable for their actions and performance to the Board. That is, the Board has supervisory control over the functions being performed by the Directors.

1.14Settled Position:

1. In the case of Ram Prashad vs Commissioner of Income-Tax, 1972 (8) TMI 61 - SUPREME COURT, the Hon’ble SC has observed that there is no doubt that for ascertaining whether a person is a servant or an agent, a rough and ready test is, whether, under the terms of his employment, the employer exercises a supervisory control in respect of the work entrusted to him. Further, the nature of employment of managing director may be determined by the articles of association of a company and/or the agreement, if any, under which a contractual relationship between the director and the company has been brought about, where under the director is constituted an employee of the company, if such be the case, his remuneration will be assessable as salary under section 7. The similar view was taken in Regional Director, E.S.I. .. vs Sarathi Lines (P) Ltd. on 29 January 1997 [1997 (1) TMI 559 - KERALA HIGH COURT]

2.  The issue also came up in the service tax regime before Tribunals and in the case of M/s Allied Blenders And Distillers Pvt. Ltd. V/s Commissioner of CST, Aurangabad, 2019 (1) TMI 433 - CESTAT Mumbai it was held that it is the agreement between the employer i.e. company and the Director would reveal the exact relationship between them.

3.  In the case of M/s Rent Works India Pvt. Ltd. V/s CCE, Mumbai-V 2016 (5) TMI 786 – CESTAT Mumbai, the Hon’ble Tribunal opined that the same department of Government of India cannot take a different stand on the amount paid to the very same person and treat it differently.

     Given the above legal and judicial position, the presence of following factors would entail the existence of employer and employee relationship.

      ·   There is an employment contract entered into between Director and the company clearly defining roles and responsibilities, terms of the appointment, terms of the remuneration, terms of the termination, the person to whom director would report.

      ·   The Director is paid a salary on a monthly basis. The component of salary can be in monetary as well in non-monetary, can be fixed as well variable pay

   ·    Supervisory aspect is important i.e. MD/WTD is accountable for his performance and will be under the supervisory control of another person i.e. Board of Directors of the Company.

      ·  Treatment under Income-tax Act- if treated as Salary, TDS deduction u/s 92 and Form 16 issued and in ITR of Directors, disclosed as Salary Income.

      ·  Treatment under other laws like Provident fund, Professional Tax, ESIC etc.- whether declared as an employee or not.

   Hence, keeping in view the above provisions and judgments, it can be concluded that GST is not applicable on the salary paid to directors by invoking applicability of entry no. 1 of Schedule III.