1980 (12) TMI 30 - HC - Income Tax

Court rules managing directors are employees per company's articles, impacting tax deduction.

The court determined that the managing directors were considered employees of the company under the company's articles of association, despite the absence ... Company, Employee, Limits, Remuneration Issues Involved:1. Whether the managing directors of the company are employees of the company.2. Applicability of Section 40A(5) of the Income-tax Act, 1961 to the remuneration paid to the managing directors.Issue-wise Detailed Analysis:1. Whether the Managing Directors are Employees of the Company:The main question addressed by the court was whether the managing directors of the assessee-company, receiving remuneration in excess of Rs. 60,000, were considered employees of the company, thereby attracting the provisions of Section 40A(5) of the Income-tax Act, 1961.The Tribunal had previously held that the managing directors were not employees, based on the absence of a service agreement, disciplinary provisions, and typical employee benefits like provident fund, bonus, or leave privileges. However, the court disagreed with this view, emphasizing that the relationship between the company and the managing directors is governed by the company's articles of association.The court referred to the articles of association, particularly Article 65, which outlines the powers and appointment conditions of managing directors, and Article 66, which specifies that managing directors operate under the supervision, control, and direction of the board of directors. The court also noted that the managing directors could be removed by an extraordinary resolution, indicating a clear employer-employee relationship.The court cited precedents, including the Supreme Court's ruling in Ram Prashad v. CIT, which clarified that the nature of employment should be determined by the articles of association and the terms of employment. The court concluded that the managing directors, despite not having a formal service agreement, were indeed employees of the company as their roles and remuneration were subject to the company's control and supervision as outlined in the articles of association.2. Applicability of Section 40A(5) of the Income-tax Act, 1961:Section 40A(5) of the Income-tax Act, 1961, imposes a ceiling on the deductible amount of salary paid to an employee. The court examined whether this section applied to the remuneration paid to the managing directors.The Tribunal had allowed the full deduction claimed by the assessee for the remuneration paid to the managing directors, arguing that they were not employees. However, the court found that since the managing directors were employees, the provisions of Section 40A(5) were applicable.The court noted that under Section 40A(5)(a), expenditure resulting in the payment of salary to an employee is subject to a ceiling limit. Given that the managing directors were employees, the remuneration paid to them was subject to this limit. The court emphasized that the use of the term 'salary' in the articles of association to describe the managing directors' remuneration further supported this conclusion.In light of these findings, the court held that the company could only claim a deduction for the remuneration paid to the managing directors subject to the ceiling limit specified in Section 40A(5). Consequently, the court answered the referred question in the negative, ruling against the assessee and in favor of the department.Conclusion:The court concluded that the managing directors were indeed employees of the company, and therefore, the provisions of Section 40A(5) of the Income-tax Act, 1961, applied to their remuneration. The assessee-company's claim for full deduction of the remuneration paid to the managing directors was thus subject to the ceiling limit specified in the said section.