[Ashutosh Choudhary (BA.LLB) and Anuj Jain (BBA.LLB) are 3rd year students at National Law University Odisha]
The issue of applicability of Goods and Services Tax (“GST”) on the remuneration of directors has prevailed since the very inception of the legislation. The bone of contention that needs to be settled is whether the remuneration paid to directors by companies falls within the ambit of Schedule III of the Central Goods and Services Tax Act, 2017 (“CGST Act”) under the heading “services by an employee to the employer in the course of or in relation to his employment”. Schedule III of the CGST Act, deals with activities or transactions that shall not be treated as supply of goods or services and, hence, have been kept out of the ambit of GST. If directors are to be treated as employees of the company, then the work carried out by directors in their course of employment is neither supply of services nor goods and, thus, GST cannot be levied. However, if directors are not employees of the company, then services provided by them would be treated as “supply of services” under section 7 of the CGST Act and, thus, GST will be levied on companies on services provided by directors through reverse charge mechanism. Reverse charge, as defined under section 2(98) of CGST Act, means the liability to pay tax is on the recipient of supply of goods or services instead of the supplier of such goods or services.
The answer to the issue at hand lies in the examination of the classifications of directors. The Companies Act, 2013 broadly classifies directors as executive or whole time directors on the one hand and non-executive or independent directors on the other. The definition of a ‘whole time director’ under section 2(94) of the Companies Act, 2013 read with rule 12 of the Companies (Share Capital and Debentures) Rules, 2014 states that “a whole time director may or may not be an employee of the company” [emphasis added]. However, section 149(6) of the Companies Act read with rule 12 of the Companies (Share Capital and Debentures) Rules, 2014 makes it clear that independent directors are not employees of the company.
In this backdrop, this post examines the contradictory decisions of the Authority for Advance Ruling (“AAR”) on the imposition of GST on directors’ remuneration. The authors further discuss the much-needed clarification issued by the Central Board of Indirect Taxes and Customs (“CBIC”) by way of Circular No. 140/10/2020- GST dated 10th June 2020.
This question arose and was first answered in 2019 in In Re: Alcon Consulting Engineers (India) Pvt. Ltd, wherein the Karnataka-AAR ruled that the remuneration paid to the directors of a company is liable to be taxed under section 9(3) of the CGST Act according to the reverse charge mechanism, as the services provided by directors are covered under entry No. 6 of Notification No. 13/2017-Central Tax (Rate), dated 28 June 2017. Similarly, in 2020, in Clay Crafts India Pvt Ltd, the Rajasthan-AAR also ruled that GST will be levied on remuneration paid to directors by the company under the reverse charge mechanism.
However, in year 2020, a contrasting view was taken by the Karnataka-AAR in the case of In Re: M/s Anil Kumar Agrawal, wherein it was held that there are two possible scenarios pertaining to the issue of levy of GST on remuneration paid to directors by the company. In the first scenario, where directors are executive or whole-time directors, they will be treated as employees of the company under schedule III of the CGST Act, and services provided by them would be in the course of employment. Thus, income received by them will be treated as “salary”, which is outside the purview of CGST Act. In the second scenario, where the directors are non-executive or independent directors, the remuneration paid to such directors by the company would be taxable under section 9 of the CGST Act in the hands of the company under the reverse charge mechanism.
Consequently, the unsettled issue on account of divergent views of AARs of different states was later clarified by the CBIC through Circular No. 140/10/2020-GST dated 10 June 2020. The ruling of Karnataka-AAR in M/s Anil Kumar Agrawal, which is based on classification of directors, has acted as a guiding standard for the CBIC.
The June 2020 CBIC Circular sought to clarify the implication of GST on the remuneration paid to ‘whole time directors’ as well as ‘independent directors’. For this purpose, the reference was drawn to the Income Tax Act 1961 (“IT Act”) and the Companies Act, 2013 in the Circular.
The Circular clarifies that, for the levy of GST on independent directors, such directors should not be treated as employees or proprietors or partners of the said company in terms of section 149(6) of the Companies Act, 2013 read with rule 12 of the Companies (Share Capital and Debentures) Rules, 2014. Therefore, independent directorsare ousted from the definition of an ‘employee’, and thus the services provided by such directors would not fall within Schedule III of the CGST Act and instead qualify as “supply of service” taxable under GST as reverse charge in the hands of the company.
Moreover, for the levy of GST on whole time directors, such directors may or may not be employees of the company in terms of section 2(94) of the Companies Actread with rule 12 of Companies (Share Capital and Debentures) Rules, 2014. Therefore, in such cases, it is apposite to look into the activities provided by such directors to the company.
For whole time directors, the remuneration received by such directors can be either be treated as ‘salaries’ in the company’s account and be subjected to tax deduction at source (“TDS”) under section 192 of the IT Act or as ‘fees for professional or technical services’ in the company’s account and subject to TDS under Section 194J of the IT Act.
As a consequence of such treatment and deduction of TDS, the CBIC Circular clarifies that the former income, i.e., salary subjected to TDS under section 192 of the IT Act shall be considered as consideration received towards ‘services by an employee to the employer in the course of or in relation to his employment’ in terms of schedule III of the CGST Act and thereby shall not be taxable under the CGST Act. However, income subjected to TDS under section 194J shall be treated as ‘consideration for providing services’, which are outside the scope of schedule III of the CGST Act and is therefore taxable under the CGST Act. Further, according to notification No. 13/2017 –Central Tax (Rate) dated 28 June 2017, the said income would be taxable under reverse charge in the hands of the company.
Analysis and Concluding Remarks
Both the advance rulings in Alcon Consulting and Clay Craft have erred and missed the basic essence with respect to implication of GST on different classes of directors under the Companies Act, 2013, which was clarified later by the CBIC Circular and the Karnataka-AAR in M/s Anil Kumar Agrawal. While, in the Circular, there was clarity pertaining to the taxability of services rendered by independent directors, the issue regarding taxability of services rendered by a whole time director still remains problematic. The Circular has failed to bring clarity on the significant aspect as to whether whole time director would be considered as an employee of the company.
The Circular streamlined the prevalent issue on the basis of the tax treatment of such remuneration under the IT Act on scaling the classifications of directors under the Companies Act, 2013. However, the Circular fails to independently analyze the role of a whole time director as an employee. Given that section 190 of the Companies Act 2013 mandates the maintenance of a written memorandum of contract of service setting out terms of employment of a whole time director, perhaps the CBIC should have relied on such a contract of service instead of relying on the applicability of TDS provisions under the IT Act to determine the nature of relationship between the company and the whole time director.
As of now, the position on levy of GST on remuneration paid to Independent directors is settled. However, for the purpose of whole time directors, companies must look at the terms of employment of such directors. If the terms are same in all respects with that of any other employee of the company, then TDS would be deducted under section 192 of IT Act and there shall be no GST liability on remuneration paid to ‘whole time directors’.
– Ashutosh Choudhary & Anuj Jain