Saturday, May 26, 2012

Payment of Sitting Fees to Directors – Whether tax is deductible at source?



INTRODUCTION

One is often confronted with the question whether there should be deduction of tax at source against payment made by way of sitting fees to directors for attending meetings of the board and the committees constituted by it. The day before the Finance Bill, 2012 was presented in the parliament of India by Hon’ble Finance Minister Pranab Mukharji there was an ambiguity  regarding the applicability of TDS provisions on the payment of sitting fees to the directors, that whether TDS is required to be deducted under section 192 or under section 194J of the Income Tax Act, 1961 or no TDS itself. But it seems that the above ambiguity has been resolved by the Finance Bill, 2012 with an introduction of clause (ba ) to sub section (1) of the Section 194J effective from 1st July, 2012.  

SIGNIFICANCE OF THE ISSUE

The above issue is gaining significance in the current scenario when large corporations in india are paying substantial sum of money to their directors for attending meetings of their board and also those of the committees constituted in lines with the twin requirement of the Companies Act, 1956 and clause 49 of the Listing Agreement with stock exchanges relating to corporate governance.

Today , as per rule 10B in the Companies ( Central Government’s ) General Rules and Forms, 1956 corresponding  to section 310 of the Companies Act, 1956 made effective by notification dated 24-07-2003, sitting fee payable by a company having an aggregate net worth at least Rs. 10 Crores or turnover at least Rs.50 Crores can be as high as Rs. 20,000 per meeting for a director.  Central  Government permission has to be obtained , in case more amount is paid by way of sitting fees.

It is customary, for a listed company, to have 6 to 7 meetings of board and committees constituted by it in each financial year. If there are, on an average 4 or 5 directors in the company to whom sitting fees is payable, assuming that all of them regularly attend the meetings, we would realize  that it is not a small amount that a company would be charging to statement of profit and loss for a financial year. 


WHO ARE ELIGIBLE FOR SITTING FEES ? 


It is pertinent to note that section 309(2) of the Companies Act, 1956 contemplates payment to a ‘Director’ of remuneration  by way of a fee for attending meetings of the board or committees constituted by the board. The term director is inclusively defined by section 2(13) of the Companies Act, 1956 to include any person occupying the position of director by whatever name called.   The definition of the term ‘Managing Director’ is provided by section 2(26) of the companies Act, 1956. What distinguish managing director from a director in terms of the definition is that managing director is entrusted with  substantial powers of the management. 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 whole time director or a managing director. i.e. sitting fees may be paid to a non-executive director only.




SITTING FEE IS REMUNERATION ?

Section198(2) of the Companies Act, 1956 clarifies that for the purpose of determining the overall  maximum managerial remuneration, sitting fees payable to directors shall not be considered.  However, section 309(2) of the Companies Act, 1956  expressly provides that a director may receive remuneration by way of a fees for attending meetings of the board and committees constituted by the board. Apart from these both sections of the Companies Act 1956 , Department Letter No. 3/1/90 CL-V, dated 18-07-1990 clearly says sitting fee may be paid only to a director  who is not whole time director or a managing director.

Above makes it very clear that if sitting fees is paid to managing director or whole time director then it will be considered only as payment of remuneration to the directors.  


IS TDS DEDUCTIBLE AGAINST PAYMENT OF SITTING FEE ?

Position Under section 192 of the Income Tax Act, 1961

Section 192 deals with deduction to be made by an employer against salary  paid to employees. Now, first question comes to mind is whether sitting fee paid to director does constitute part of salary income. Assuming but not admitting sitting fee paid to director constitute part of salary income, then second question comes to mind is whether non-executive director is an employee of the company ?

It is very clear provision of the law for taxing any income under the head "Salaries"  there must be existance of the relationship of  an employer-employee as ruled in CIT v. Lakshmipati Singhania [1973] 92 ITR 598 (All). The Supreme Court in Ram Prashad v. CIT1972] 86 ITR 122 laid down a number of tests for determination of the employer-employee  relationship. Moreover,  company's  directors are not servant of the company, but  agents asmuch as the company cannot act in its own person, but has only to act through directors. it makes the directors to have the relationship of  agents with the company.The Orissa HC in CIT v. Smt. Shanti Devi has held that where a person holds the office of a director of a company, the remuneration by virtue of that office does not bring about the relationship of a master and servant.

From the above case laws, it becomes clear that a non-executive director cannot be considered as an employee or servant of the company. The sitting fees paid to him cannot, therefore, form a part of salary income warranting deduction of tax at source under section 192 of the Income Tax Act, 1961.  

Position under section 194J of the Income Tax Act, 1961- 

Next question that have to be considered is whether sitting fees paid to director can be considered as a fee for discharging professional services.
Since the services rendered by non-executive directors to the company may be considered as managerial services and, hence, covered by the provisions of  sec. 194J, read with the Explanation to sec. 9(1)(vii) of the Income Tax Act, 1961. It is said that the person holding the position of a company director must possess intellectual or professional skills.  Clause 49 of the Listing Agreement calls for all the members of the Audit Committee to be financially literate in the sense of having the ability to read, to understand and to analyze the basic financial statements of the company. Thus, the sitting fees paid to the Directors is covered by sec. 194J of the I.T. Act, 1961.

CONCLUSION

From the above what conclusion is drawn ,sitting fee paid to the Non-Executive Directors  is  not the part of the salary income for the purpose of deducting TDS under section 192 of the Income Tax Act, 1961 but it is the payment for rendering managerial services. So companies are required to deduct TDS from the payment of sittting fee to directors under section 194J otherwise companies would be exposed to disallowance u/s. 40(a)(i)  of the Income Tax Act, 1961.

Moreover, In finance bill 2012, section 194J  of the Income Tax Act, 1961 has been amended, wherein it has been proposed that tax is required to be deducted on the remuneration paid to director, which is not in nature of salary , at the rate of 10% of such remuneration. Therefore, now TDS is required to be deducted on the payment of sitting fee to directors.







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