Services by Directors

‘Service’ means any activity carried out by a person for another for consideration, and includes a declared service, but shall not include –

(b) A provision of service by an employee to the employer in the course of or in relation to his employment;

Explanation 1 – for the removal of doubts, it is hereby declared that nothing contained in this clause shall apply to, –

• Vide Notification No.45/2012–ST dated 07-08- 2012, an amendment is made in the notification No.30/2012–ST dated 20-06-2012 by including the services provided or agreed to be provided by a director of a company to the said company, as a service taxable under reverse charge mechanism. Further, the extent of service tax payable on the same by the service provider and the service recipient is also stipulated as under:-

Payments to Directors – Service tax implications
i) Remuneration to Executive Directors

Sections 198 and 309 of the Companies Act, 1956 (“CA 56”) supplemented by Schedule XII, deal with remuneration of directors (including managing director and whole-time director) of a public company or a private company which is a subsidiary of a public company.

Section 309 of CA 56 lays down the ceilings on the remuneration payable to managing and whole-time employment of the company or a managing director may be paid remuneration either by way of a monthly payment or at a specified percentage of the net profits of the company or partly by one way and partly by the other.

The term ‘remuneration” is inclusively defined in the Explanation appended to section 198 of CA 56. This definition is relevant for the purposes of all the provisions of CA 56 which deals with director’s remuneration. The definition of ‘remuneration’, indicates that any payment by whatever name called and whether in cash, kind or money’s worth, or by way of perquisite, amenity or benefit, or by discharging an obligation amounts to ‘remuneration’, and such payment would attract the provisions of CA 56 regarding remuneration to directors

Section 309(2) of CA 56 contemplates payment to a director of remuneration by way of a fee for attending meetings of the board of directors or committees constituted by the board.

In case of managing director and whole time director, the payment of sitting fees forms part of managerial remuneration and if amounts are payable in accordance with Schedule XIII, no such sitting fees is payable to them; Department letter No. 3/1/90 CL – V, dated 18/07/1990, makes it very clear that, sitting fee may be paid only to a director who is not a whole time director or a managing director.

(ii) Remuneration to Non-Executive Directors

According to section 309 of CA 56, a public company can pay its non-executive director (meaning a director who is not a managing or a whole time director) remuneration in the form of fees for attending board meetings at the rate prescribed under CA 56, which are to be excluded for the purpose of the percentage limits on directors’ remuneration as specified in section 198 and 309 of CA 56.

In addition to sitting fees, a company’s nonexecutive director can be paid commission on net profits for a financial year. The total remuneration to all directors (executive and non–executive) excluding the fees for attending meetings, should not exceed the percentage limits laid down in section 198.

Section 309(4) permits payment of remuneration to the non–executive directors in two alternative ways:
• by way of monthly, quarterly or annual payment; or
• by way of commission.

(iii) Whether all Directors are employees of a Company

In terms of the provisions of CA 56 Act managing and whole time directors are executive directors and those who are not managing and whole time directors are non – executive directors. They are called “managerial personnel” and their appointment and remuneration are governed by the provisions of CA 56. Even when an executive director is designated as “executive chairman” or “executive vice chairman” or any other designation, such executive director is either a managing director or a whole–time director under CA 56 depending upon the nature and extent of powers of management because CA 56 does not recognise any other designation although it does not prohibit it. Therefore, a company has to treat its executive director either as managing director or whole–time director but both are equal so far as the provisions of the CA 56 regarding appointment and remuneration are concerned, all the provisions equally apply to both.

An important issue for consideration is, whether employer–employee relationship exists between the company and the executive directors.

It is a well–settled principle in company law that a director of a company as such is not a servant of the company and that the fees he receives are in recognition of services, but the same does not prevent a director or a managing director from, entering into a contractual relationship with the company, so that, quite apart from his office of director he becomes entitled to remuneration as an employee of the company. Further that relationship may be created either by a service agreement or by the articles themselves. [Refer CIT vs. Armstrong Smith (1946) 14 ITR 606 (Bom); (1946) 16 Comp as 172 (Bom)]

However, a managing director has a dual capacity. He may both be a director as well as an employee. It is, therefore, evident that, in his capacity as a managing director, he may be regarded as having not only the capacity as persona of a director but also the persona of an employee, or an agent depending upon the nature of his work and the terms of his employment. Where he is so employed, the relationship between him as the managing director and the company may be similar to a person who is employed as a servant or as an agent, for the term ‘employee’ can cover any of these relationships. The nature of his employment may be determined by the Articles of Association of the company and/or the agreement, if any, under which a contractual relationship between the director and the company has been brought about, under which the director is constituted as an employee of the company. The control which the company exercises over the managing director need not necessarily be one which tells him what to do from day-to-day. That would be too narrow a view of the test to determine the character of the employment. Nor does supervision imply that it should be a continuous exercise of the power to oversee or supervise the work to be done. The control and supervision is exercised and is exercisable in terms of the Articles of Association by the board of directors and the company in its general meeting.

It has been held in an English case that as directors they are not employees, but it cannot be doubted that a managing director may for many purposes properly be regarded as an employee. [Refer Boulting vs. Association of Cinematograph, Television and Allied Technicians (1963) 33 Comp. Cases 475 (CA)]

In one case, the question was whether the managing director was ‘employed’ by the company in any capacity. The managing director had claimed that he was not employed by the company, but that his position was an office or function of a director, i.e. he was an ordinary director entrusted with some special powers. However, this argument was rejected, and it was held that the proposition that a director can be regarded as having not only the persona of director but also the persona of employee was plain from the case of Beeton and Co. In re [1913] 2 Ch 279. Lord Normand summarised the position as follows :

“In my opinion, therefore, the managing direc-tor has two functions and two capacities. Qua managing director he is a party to a contract with the company, and this contract is a contract of employment; more specifically I am of opinion that it is a contract of service and not a contract for services. There is nothing anomalous in this; indeed it is a common place of law that the same individual may have two or more capacities, each including special rights and duties in relation to the same thing or matter or in relation to the same persons.”

Useful reference can also be made to Fowler vs. Commercial Timber Co. Ltd. [1930] 2 KBI (CA)

There are several cases under the Income Tax Act which dealt with this issue and the consensus appears to be that regardless of whether there is an agreement of service between the assessee company and the managing director the relationship between the company and the managing director is that of employer and employee. In some cases a provision or a term as to the removal or termination of the managing director has been considered to be one of the factors determining the relationship of employer and employee. [Refer Travancore Chemical Manufacturing Co (1982) 133 ITR 818 (KER) affirmed by SC – (1982) 137 ITR (St) 13]

The various provisions of CA 56 Act relating to managing director also indicate that a managing director has a role of an employee. For instance, the use of the term ‘agreement’ (section 2(26); use of the term “appoint or employ” (sections 316, 317); the expression “occupying the position of a managing director by whatever name called” (section 2(26); use of the expressions “appointment or employment” (section 267), the various kinds of remuneration enumerated in Schedule XIII, etc., go to indicate that a managing director is a director in the garb of an employee. Moreover, the Schedule also allows certain perquisites to the managing director and some of them (e.g. LTC) are to be given “in accordance with the rules of the company”. Section 17(2) of the Income Tax Act defines the term ‘perquisite’ the purport of which is that it is an amenity or a benefit granted by an employer to an employee. In fact, clause (iii)(a) of the said section specifically covers as perquisite the value of any benefit or amenity granted or provided free of cost or at concessional rate by a company to an employee who is a director thereof.

The nature of extent of control which is requisite to establish the relationship of employer and employee must necessarily vary from business to business and is by its very nature incapable for precise definition. It is not neces-sary for holding that a person is an employee, that the employer should be proved to have exercised control over his work. The test of control is not one of universal application and that there are many contracts in which the master could not control the manner in which the work was done.

There may be a formal contract between a managing director and the company evidencing the contractual relationship between the two. However, in the absence of a formal agreement the relationship may be established by an implied contract. Where a managing director is appointed, and acts as such, in accordance with the company’s articles, and no separate formal contract is entered into, the existence of an implied contract may be inferred, although the articles do not constitute a contract between the company and the managing director qua managing director.

Summation

In light of discussion above, it would reasonably appear that, a managing director is an employee of the company. This principle equally applies to any whole–time director or any other director (by whatever name called) who has executive powers relating to the management of the affairs of a company and responsibility to look after the day-to-day affairs of the company (fully or partly) under a service contract which is either express or implied and evidenced by the board/shareholders resolution appointing him and additionally, a formal agreement between him and the company.

Taxability of Services provided by Directors

According to one school of thinking, since a company is a legal entity, it has no option but to operate through the medium of directors. Therefore, services provided by directors to a company (excepting those on a contractual or professional basis), are essentially in a fiduciary capacity. Hence, such services would not fall within the ambit of ‘service’ as defined u/s. 65B(44) of the Act so as to be liable to service tax. However, this is a very extreme view, which is likely to be disputed by the service tax authorities.

Subject to such extreme view, it would reasonably appear that, with effect from 01-07-2012 services provided by directors to companies would be taxable except in the following cases:

•    Services provided by a director to a company in the course of or in relation to his employment as discussed in detail above.

•    Services provided by a director in a non– taxable territory to a company located in a non–taxable territory.

•    Services provided by a director to a company without consideration (for example in case of nominee directors where no sitting fee is paid).

•    According to Point of Taxation Rules, 2011, the point of taxation of services provided by a director to a company, would be either the time when invoice is issued for service provided or to be provided. If invoice is not issued within 30 days, point of taxation will be the date of completion of service. For sitting fees, date of completion of services, would generally be the date of meeting or the time when the payment/advance is received to the extent of such payment.

•    In case of reverse charge payments, point of taxation is reckoned from the date of payment by the company to the director.

Subject to the above discussion, the taxability for the period 01-07-2012 to 06 -08 -2012 (the period till amendment was brought in vide Notifications 45/2012 and 46/2012 provided above) and 07-08-2012 onwards and taxability of reimbursements is discussed hereafter.

Taxability of services provided by directors during the period 01-07-2012 to 06-08-2012.

Liability at the end of Directors

•    During this period, the director’s services were not covered under reverse charge, the directors would be liable to pay service tax and also comply with the requirements under the service tax law. The said position is confirmed by draft CBEC Circular F.No.354/127/2012–TRU dated 27-07-2012, which states that when a director receives payment in his personal ca-pacity, the same is liable to be taxed in the hands of the director. However, the concerned director would be entitled to the threshold exemption of Rs. 10 lakh, subject to compliance of stipulated conditions.

•    However, in the following cases, service tax would not be payable by the directors:

As per draft CBEC circular dated 27-07-2012, a director may also be appointed to represent an entity including Government who has either invested in the company or is otherwise authorized to nominate a director. Where the fee is charged by the entity appointing the director and is paid to such entity, the services shall be deemed to be provided by such entity and not by the individual director. Accordingly, in such cases, the service tax would be payable not by the director but by such entity appoint-ing the director. Nevertheless, in the case of Government nominee directors where the fee is charged by the Government appointing the director and is paid to the Government, the services may be deemed to be provided by the Government and may be liable to be taxed under the exclusion sub-(iv) of clause (a) of section 66D of the Act viz. support services by Government to a business entity. Such services are liable to be taxed on reverse charge basis from 01-07-2012 and therefore, tax is to be paid by the service recipient i.e. the company. Secondly, if the director is located in a non-taxable territory i.e. the State of Jammu & Kashmir or outside India, then service tax is not payable by such director. In this case, if the company is located in a taxable territory, the transaction would be covered under reverse charge from 01-07-2012 and tax is payable by the company.

Implications at the end of Company receiving the service

•    No service tax would be payable in respect of fees paid to directors located in taxable territory. However, in case of any payment towards taxable service to a director, located outside India or in the State of Jammu and Kashmir or in case of payment to Government against consideration of Government nominee director as discussed above, the company receiving the service is required to pay service tax under reverse charge as per Rule 2(1)(d) of ST Rules read with Notification No. 30/2012–ST dated 20-06-2012. Further, in case of reverse charge the threshold exemption of Rs. 10 lakh is not applicable.

•    Vide Circular No.24/2012, dated 09-08-2012 of Ministry of Corporate Affairs, Government of India, it is clarified that any increase in remuneration of non–whole time director(s) of a company solely on account of payment of service tax on commission payable to them by the company shall not require approval of Central Government u/s. 309 and 310 of the CA 56 even if it exceeds the limit of 1% or 3% of the profit [u/s. 309(4)] of the company, as the case may be in the financial year 2012-13.

Taxability of services provided by directors from 07-08-2012 onwards

Implications at the end of directors

For the period 07-08-2012 onwards, since the services by directors are covered under reverse charge, the directors are not liable to pay service tax. Even the entities receiving fee in respect of directors nominated by them are not required to pay service tax on the same.

Implications at the end of the Company receiving the service

The companies other than those located in a non taxable territory, would be required to pay service tax under reverse charge basis in respect of taxable services received from the directors for a consideration, irrespective of fact whether they are located within or outside the taxable territory or are nominee directors of Government/ other entitles. Further, as discussed earlier, the threshold exemption of Rs. 10 lakh is not applicable when the liability is fastened under reverse charge mechanism.

Further as stated above, the Circular No.24/2012-ST of the Ministry of Corporate Affairs is equally relevant here as well.

Taxability of reimbursements/out of pocket expenses

From 19- 04-2006, stringent provisions were introduced under the service tax law in regard to taxability of reimbursements. The Constitutional Validity of Rule 5 of the said Valuation Rules has been challenged before the Delhi High Court in International Consult & Tech (P) Ltd vs. UOI (2009) 19 STT 320 (DELHI), in particular on the ground being ultra vires the provisions of section 66 and 67 of the Act. The Delhi High Court has recently ruled in 2012 TIOL 66 DEL HC that Rule 5(1) of Valuation Rules is ultra vires of sections 66 & 67 of the Act. Implications of the said ruling in particular the continued relevance of principles laid down in Larger Bench ruling in Shri Bhagawathy Traders vs. CCE, Cochin 2011 (24) STR 290 (Tri.-LB) is discussed in detail in the January, 2013 issue of BCAJ. Hence the same are not repeated here.

Subject to the above, the following needs to be noted in particular, while determining taxability of expenses reimbursed to directors since the liability vests in the company under reverse charge:

•    According to Rule 5(1) of Valuation Rules, where any expenditure or costs are incurred by the service provider in the course of providing any taxable services, all such expenditure or costs shall be treated as consideration for the taxable services provided or to be provided and shall be included in the ‘value’ for purpose of charging of service tax on the said services. Expenditure or costs incurred by a service provider as “pure agent” of the recipient of service shall be excluded from the value of taxable service if all the conditions specified in Rule 5(2) of valuation Rules are satisfied.

•    For the purpose of Rule 5(2) of Valuation Rules, a pure agent is defined to mean a person who receives only the actual amount incurred to procure such goods or services.

•    According to the department clarification dated 19-04-2006, “value for the purpose of charging service tax is the gross amount received as consideration for provision of service. All expenditure or costs incurred by the service provider in the course of providing a taxable service forms integral part of the taxable value and are includible in the value. It is not relevant that various expenditure or costs are separately indicated in the invoice or bill issued by the service provider to his client”.