Overview

In a recent advance ruling in the matter of M/s Craft India Private Limited, the Authority of Advance Ruling, Rajasthan (“Authority or AAR”) [Advance Ruling No. RAJ/ AAR/ 2019-20/ 33] held that the Good and Service Tax [“GST”] shall be chargeable under the reverse charge mechanism, on the consideration paid or payable to the directors. This ruling of the AAR has created much ambiguity within the corporates and the directors of the companies, as to whether the consideration paid or payable to the directors would attract GST or not.

This write-up will provide an understanding of the legal provisions of the GST law relating to levy of GST on the consideration paid or payable to the directors for their services.

BACKGROUND

M/s Craft India Private Limited has raised the following questions before the Rajasthan Authority:

1. Whether GST is payable under Reverse Charge Mechanism [“RCM”] on the salary paid to the director of the company as per the contract?
2. Whether GST applicability would change if the said director is also a part-time director in other company?

The company submitted that directors are being paid compensation regularly by way of salary and other allowances as per the terms of the policy of the company and their employment contracts. Further, the company is also deducting Tax Deducted at Source [“TDS”] and Employees’ Provident Fund etc., and also providing benefits to the directors as per the policy decided by the company for its employees. Accordingly, GST is not leviable on the remuneration paid to its directors as they are the employees of the company as per the Entry Number 1 to the Schedule III of the Central Goods and Services Tax Act, 2017 [“CGST Act”].

On the contrary, the Authority has simply relied on the Notification No. 13/ 2017- Central Tax (Rate) dated 28.06.2017 and held that the director is not an employee of the company. Therefore, the amount paid to the directors will not be covered under the said Entry Number 1 to the Schedule-III of the CGST Act. Thus, the AAR held that, the consideration paid or payable to the directors, will attract GST, under the RCM, as the same is covered under the Notification No. 13/ 2017. The relevant Para 6 of the ruling is extracted below for ease of reference:

“The consideration paid to the Directors by the applicant company will attract GST under reverse charge mechanism as it is covered under entry No. 6 of Notification No. 13/2107 Central Tax (Rate) dated 28.06.2017 issued under Section 9(3) of the CGST Act, 2017”

It is also pertinent to note that a similar view was also taken by the Karnataka (Bengaluru) AAR in the case of M/s Alcon Consulting Engineers (India) Private Ltd [Advance Ruling No. KAR ADRG 83/ 2019].

ANALYSIS

In both the rulings as mentioned Supra, the AARs have only considered the Notification No. 13/ 2017- Central Tax (Rate) dated 28.06.2017, for confirming the levy of GST on the consideration paid to the directors.

Further, the AARs have failed to determine the moot question, whether a director is an employee of a company, in view of the fact that, they also draw salary as per the employment contracts, like any other regular employees of the company.

Before discussing the tax treatment on the emoluments of the directors, it is pertinent to discuss the provisions related to RCM and exemptions [i.e., Schedule III] provided under the CGST Act.

PROVISIONS OF THE CGST ACT

Normally, the supplier of goods or services pays the GST on supply. In the case of Reverse Charge Mechanism, the receiver of such goods or services becomes liable to pay the tax. Section 9(3) and 9(4) of the CGST Act, which deal with RCM, are extracted below, for ease of reference:

“(3) The Government may, on the recommendations of the Council, by notification, specify categories of supply of goods or services or both, the tax on which shall be paid on reverse charge basis by the recipient of such goods or services or both and all the provisions of this Act shall apply to such recipient as if he is the person liable for paying the tax in relation to the supply of such goods or services or both.

(4) The central tax in respect of the supply of taxable goods or services or both by a supplier, who is not registered, to a registered person shall be paid by such person on reverse charge basis as the recipient and all the provisions of this Act shall apply to such recipient as if he is the person liable for paying the tax in relation to the supply of such goods or services or both.”

In the above context, it is relevant to note that vide Entry No. 6 to the Notification No. 13/2017 – Central Tax (Rate) dated 28.06.2017, the Central Government has notified that the services provided by a director of a company or a body corporate to such company or a body corporate, are liable to be taxed under reverse charge mechanism. Entry No. 6 of the Notification No. 13/2017 – Central Tax (Rate) dated 28.06.2017 is extracted below:

S.No.	Category of Supply of Services	Supplier of service	Recipient of Service
6	Services supplied by a director of a company or a body corporate to the said company or the body corporate.	A director of a company or a body corporate	The company or a body corporate located in the taxable territory.

From the above, it can be construed that, the services provided by a director, to the company or a body corporate (recipient of service), located in the taxable territory, will attract GST under the reverse charge mechanism.

However, before drawing any conclusion on the basis of the said notification, it is also relevant to go through Section 7(2) read with Entry No. 1 to the Schedule III of the CGST Act. The relevant text of Section 7(2) and Entry No. 1 of the Schedule III are extracted below:

“Section 7: Scope of Supply

(1)        ……..

(2)        Notwithstanding anything contained in sub-section (1),–

(a) activities or transactions specified in Schedule III; or

(b) such activities or transactions undertaken by the Central Government, a State Government or any local authority in which they are engaged as public authorities, as may be notified by the Government on the recommendations of the Council,

shall be treated neither as a supply of goods nor a supply of services.

SCHEDULE III

Activities or transactions which shall be treated neither as a supply of goods nor a supply of services

1. Services by an employee to the employer in the course of or in relation to his employment.
2. …….”

From the above, it is pertinent to note that, Section 7(2) contains a non-obstante clause, starting with the word “Notwithstanding”, which overrides Section 7(1). Thus, if any activity or transaction falls under Schedule III [even it is covered under Section 7(1) (i.e., scope of supply)], it would not be considered as supply of goods or services.

In simple terms, the activities or transactions specified in Schedule- III would be treated neither as a supply of goods nor a supply of services. Therefore, the services by an employee to the employer in the course of or in relation to his employment are neither supply of goods nor supply of services.

In the above context, now it would be important to analyse, whether the services provided by a director to the company, come within the preview of Entry No. 1 to the Schedule III of the CGST Act.

It is important to note that, under the GST legislation, the terms ‘director’ and ‘employee’, are not defined. Therefore, a reference to other laws, such as Companies Act, 2013 and Income Tax Act, 1961, including the erstwhile Service Tax law can be made.

PROVISIONS OF THE COMPANIES ACT, 2013

Section 2(34) of the Companies Act, 2013, defines the term “director”, which means a director appointed to the Board of a company. Further, the directors can be broadly divided into two categories: (a) Executive Directors and (b) Non- Executive Directors.

As per Rule 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 Companies Act, 2013. As per Section 2(94) of the Companies Act, 2013, “whole-time director” includes a Director in the whole-time employment of the company.

Thus, in simple terms directors who are in the whole-time employment or those who are entrusted with day-to-day executive operations of the company, are called Executive Directors. Further, those directors, who do not participate in the day-to-day activities of the company and only attend the board meetings or its committees on a part-time basis, are called non-executive directors. Thus, it can be inferred that non-executive directors (who are not in the whole time employment with the company) cannot be treated as employees of the company.

Remuneration paid to directors

As per Section 2(78) of the Companies Act, 2013, “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. Thus, money or its equivalent paid to the directors for their services shall qualify as remuneration.

The company may appoint directors such as “Managing or Whole-time Director”’ who will be entitled to a monthly remuneration. It is pertinent to note that a managing director may not be a whole time director of the company. In simple terms, a managing director will be considered as an executive director, as and when he/ she is involved in the day-to-day operations of the company.

Payment of sitting fees to directors

The sitting fee is generally paid to non-executive directors for attending the board meeting or its committee meeting. The sitting fee paid the non-executive directors are not considered as salary because such non-executive directors are not in whole time employment with the company.

Further, in case the sitting fee is paid to a whole-time director or a managing director (if employed for overseeing day to day business) then such fee will be treated as ‘other allowances’ and will became an overall part of salary, for the purposes of computation of managerial remuneration limits as specified in Schedule-V of the Companies Act, 2013.

PROVISIONS OF THE INCOME TAX ACT, 1961

In the Income-tax Act, 1961, there are no pre-defined criteria, which prescribe whether a director is treated as an employee of the company or not. As per Section 192 of the Income Tax Act, 1961, if TDS of an employee is deducted on remuneration (i.e., salary), based on it, it is assessed under the head “Income from Salary”. In simple terms, a relationship of employer and employee or master and servant must be established before a payment can be taxed as salary. Further, in the absence of the employer and employee relationship, the remuneration (i.e., sitting fee) paid to non-executive directors shall be assessable under the head “Income from Other Sources or Profits and Gains of Business or Profession”.

PROVISIONS OF THE ERSTWHILE SERVICE-TAX LAW

As per the erstwhile Finance Act, 1994 (i.e., Service Tax) the services rendered by an employee to the employer in the course of or in relation to his employment were kept outside the scope of service tax. Further, as per the following judicial pronouncements of the Customs, Excise and Service Tax Appellate Tribunal [“CESTAT”] and Departmental clarifications, no service tax was applicable on the remuneration paid to directors who are engaged in day-to-day operations of the organization:

Judicial Pronouncements

In the case of M/s Allied Blenders and Distillers Private Limited. Vs. CCE & S.T, Aurangabad [MANU/CM/0499/2018], the Hon’ble CESTAT Mumbai held that where assessee company has paid remuneration to its four whole time Directors for managing day-to-day affairs of company and made necessary deductions on account of Provident fund, Professional Tax and TDS as applicable and declared these Directors to all statutory authorities as employees of company, remuneration paid to Directors was nothing but salary and assessee was not required to discharge service tax on remuneration paid to Directors. The relevant paras of the judgement are extracted below for ease of reference:

“15. We do not find merit in the argument of the Revenue inasmuch as during the course of investigation, the statement of Shri Atit Dalai, Vice President (Finance & Accounts) of the appellant company was recorded by the investigating officers on 4-6-2015. Answering the question No. 3. Mr. Dalai informed that there were four directors in the company and they were appointed in accordance with the provisions of Companies Act and Regulation of Article of Association of Company for managing day-to-day affairs of the company. Further answering to question No. 4, he has stated that the company are paying them remuneration which is nothing but salary. All the necessary deductions on account of Provident Fund, Professional Tax and TDS under Section 192 of the Income Tax Act are made as applicable; also they were issuing Form-16 like it is issued to all other employees. Even in the salary return filed by the appellant company before the Income Tax authorities, the director’s names have been included. The company does not pay the director’s sitting fee to any of the directors. To discredit the said statement, no contrary evidence was produced by the Revenue to establish that the directors are not involved in the day-to-day function of the Company, but participate only in Board Meetings and consequently paid remuneration.

16. Also, from the documents produced by the appellant it is crystal clear that the Directors who are concerned with the management of the company, were declared to all statutory authorities as employees of the company and complied with the provisions of the respective Acts, Rules and Regulations indicating the Director as an employee of the company. No contrary evidence has been brought on record by the Revenue to show that the Directors, who were employee of the appellant received amount which cannot be said as ‘ salary’ but fees paid for being Director of the company. The Income Tax authorities also assessed the remuneration paid to the said directors as salary, a fact cannot be ignored. The judgments cited by the revenue cannot be applied to the present case as the facts are different and the finding of Income tax authorities accordingly also different in the said case.

17. In these circumstances, we do not find merit in the impugned order. Consequently, the impugned order is set aside and the appeal is allowed.”

Further, a similar view was also taken in the matter of M/s NRB Industrial Bearings Pvt. Ltd. Vs. CCE and ST, Aurangabad [MANU/CM/0267/2019] wherein the Hon’ble CESTAT, Mumbai held that the service tax is not leviable on salary paid to the managing director. As per the findings of Hon’ble CESTAT, the person was appointed as a Managing Director and salary was paid to him as per Memorandum of Association and Article of Association. Further, the requisite Form 32 and Form 25C were filed before Registrar of Companies, which shows that salary and perquisites are payable/ paid to the managing director. Furthermore, no evidence was produced by the department which provides that remuneration was not for routine work but for the consultation provided. The relevant text of the judgement is extracted below for ease of reference:

“4.1. I find that as per the Memorandum of Articles of Association, Shri D.S. Sahney is appointed as Managing Director and salary is being paid to him as per the Memorandum and Articles of Association. The board resolution dated 04.10.2012 clearly indicates the appointment of Shri D.S. Sahney and the amount payable to him as salary and perquisites like house allowance, electricity and furnishings for the accommodation, leave travel concession, reimbursement of medical expenses for self and family, medial/accident insurance, club fees, car with driver, telephone at residence etc. I also find that in the Form 31 and Form 25C, which is required to be filed under company’s act before the Registrar of Companies, the name of Shri D.S. Sahney is shown as Managing Director and salary and perquisites payable or paid to him are also mentioned. I find force in that Appellants claim that only due to the fact that taxable income is shown in Form 16, it cannot be said that other perquisites are not part of remuneration to the employee and are paid for consultation etc. rendered by him. No case is made out by the department that such remuneration, other than salary paid to him, was not for the routine work he performs as Managing Director, but was for the consultation he provides. Therefore, the instant case is squarely covered by the exclusion contained under Section 65(44)(b) of Finance Act, 1994. I also find strength from the case law cited by the Appellant and also the case of Allied Blenders and Distilleries Pvt. Ltd. Vs. CCE ST Aurangabad MANU/CM/0499/2018 : 2019 (24) GSTL 207 (Tri. Mumbai). In view of the above, I find that the Impugned Order is not maintainable.”

Department Clarification

Vide Circular No. 115/09/2009-ST dated 31.07.2009, the Central Board of Excise and Customs [“CBIC”] has clarified that remunerations paid to Managing Director/ Directors of companies whether whole-time or independent when being compensated for their performance as Managing Director/ Directors would not be liable to service tax.

OUR COMMENTS  

The AAR, Rajasthan while passing the advance ruling has completely failed to understand that the services by an employee to the employer in the course of or in relation to his employment shall be treated neither as a supply of goods nor a supply of services as per the Schedule III appended to the CGST Act.

Further, as per the above legal provisions of Companies Act, Income-tax Act and judgements under the erstwhile Service tax regime and also the departmental Circular, it can be construed that the directors who are drawing remuneration (i.e., salary) in whole time employment with the company, will be out from the preview of GST net, as per Entry No. 1 to Schedule III appended to the CGST Act. Further, at best only non-executive / independent directors, who are receiving remuneration (i.e., sitting fee) from the company, will be covered within the ambit of GST as there is no employer employee relationship between them and the Company.

It is also pertinent to note that, as per Section 103 of the CGST Act, the advance ruling is only binding on the applicant who had sought it and it is not binding on the other taxpayers. In simple words the AAR rulings do not have precedentiary value. Therefore, the Advance Rulings sought by the Clay Crafts India Private Limited and Alcon Consulting Engineers (India) Private Limited are not binding on the other taxpayers/ assesses.