ST on Director's remuneration - Instigating litigation!

Introduction: - The issue regarding livability of service tax on remuneration paid to the directors has been matter of concern since 07.08.2012 when reverse charge mechanism was introduced vide notification no. 45/2012-ST dated 07.08.2012 for the service tax liability as regards services provided by a director to a company. The question as regards what kind of amount paid to the directors is leviable to service tax has haunted the minds of various company assesses because since then, a number of companies have been slapped service tax demands with interest and equivalent penalties for non-payment of service tax under reverse charge mechanism for amounts paid to the directors. The amendment made in the Budget 2014 vide Notification no. 10/2014-ST dated 11.07.2014 has further added fuel to the fire of litigation by extending reverse charge mechanism for services provided by directors to company or a body corporate and the definition of body corporate under section 2(11) of the Companies Act, 2013 has a very wide scope. In this article, an attempt is made to untangle the conceptions taken as regards service tax liability with respect to services provided by directors.

Quick look at relevant statutory provisions: - Entry no. 5A of the Notification no. 30/2012-ST dated 20.06.2012 reads as follows: -

The definition of service as given under section 65B (44) of the Finance Act, 1994 is produced as follows: -

“Service” means any activity carried out by a person for another for consideration, and includes a declared service, but shall not include-

a. An activity which constitutes merely, -

i. A transfer of title in goods or immovable property, by way of sale, gift or in any other manner; or

ii. Such transfer, delivery or supply of any goods which is deemed to be a sale within the meaning of clause 29(A) of article 366 of the Constitution; or

iii. A transaction in money or actionable claim;

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

c. Fees taken in any court or tribunal established under any law for the time being in force.”

Analysis of the statutory provisions: - It is pertinent to note that the whole time directors, managing directors and executive directors are engaged in managing day to day functioning of the company or the body corporate and so can be considered as employees of the company. Furthermore, the fact that the TDS is deducted under section 192 Income Tax Act, 1961 on the salary/remuneration paid to the whole time directors/managing directors/executive directors is conclusive evidence that the amount paid as remuneration is nothing but consideration paid for services rendered by such directors in the capacity of employee of the company. Furthermore, the fact that remuneration received by the whole time directors, managing directors etc. is shown in their Income Tax Returns under the head ‘Income from Salary’ also fortifies the fact that the amount received is in lieu of their employment with the company. As such, when CBDT, being one of the wing of the government department is accepting the amount paid to the managing directors, whole time directors etc. as salary in lieu of employment, the other wing of the government department, i.e., CBEC cannot take a contrary stand to levy service tax on the same. Therefore, the consideration received by the directors in lieu of managing day-to-day affairs of the company is in fact in the capacity of employee and cannot be considered as ‘service’ as per the definition of service given under section 65B(44) of the Finance Act. When the activity of managing day-to-day affairs of the company by a director is treated as in relation to employment, the said activity is outside the purview of the definition of service and consequently no service tax is leviable on the same. Furthermore, when an activity is not within the ambit of ‘service’, the question of reverse charge mechanism does not arise. However, following points are also worth observing in this context: -

a. The serial no. 5A of the notification no. 30/2012-ST does not make distinction between different types of directors. Therefore, service tax demands are being raised on payments made to all directors by the company. However, service tax should be demanded on the amount paid to non-executive directors only and other amounts paid to executive directors such as sitting fees, commission etc.

b. The exclusion clause in the definition of service does not specify whether directors are to be treated as employees of the company. It only mentions that the service provided by an employee to employer during the course of employment to be excluded from the definition of service. Now, who all are treated as employees remains debatable.

c. General Circular No. 24/2012 dated 09.08.2012 issued by Ministry of Corporate Affairs confirms the fact that service tax is payable on the commission/sitting fees payable to the Non-Whole Time Directors of the company and the increase in the quantum of remuneration paid to them on account of service tax will not be considered for the purpose of approval of Central Government under section 309 and 310 of the Companies Act even if it exceeds the limit of 1% or 3% of the profit. This indicates that even the MCA, which is a part of government, believes that service tax is payable only on the sitting fees/commission payable to the directors and not on the salary paid to them during the course of employment.

d. Circular no. 115/09/2009-ST dated 31.07.2009 issued by CBEC in positive list tax regime 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. This indicates that amounts paid in relation to employment is not leviable to service tax.

Before Parting: - It can be concluded that service tax is payable only on the amounts paid to the directors other than in lieu of their capacity as employee of the company. Furthermore, the non-executive directors of the company are not paid salary, as they are not involved in executing/managing day-to-day affairs of the company. Therefore, the sitting fees/commission etc. payable to non-executive directors and the executive/whole time directors/managing directors is leviable to service tax. However, amount paid as salary for which TDS is deducted under section 192 of the Income Tax Act, 1961 is not leviable to service tax as the said amount is received by the directors in lieu of their employment with the company. It is practically observed that various companies are being raised demand for service tax on the total amount paid to the directors but one is required to examine the amounts for which service tax is leviable. Furthermore, the companies should pay service tax on the sitting fees/commission and other amounts paid to the directors which do not form part of salary because the company is entitled to take cenvat credit of the amount paid as service tax under reverse charge mechanism on the strength of challan. As such, there is no loss to the company in paying service tax and instead, non-payment of service tax may attract interest and penal consequences.  

By:CA Neetu Sukhwani & CA Pradeep Jain