Director remuneration treated as salary with TDS establishes employer-employee relationship, excluding service tax under Section 65B(44)

CESTAT Chennai set aside service tax demand on remuneration paid to whole-time directors. The tribunal held that where director remuneration is treated as salary subject to TDS under Income Tax Act, an employer-employee relationship is established, excluding such payments from service tax purview under Section 65B(44) of Finance Act 1994. The department's contention that director services constitute taxable services under negative list regime was rejected. Following precedent in Dixcy Textiles case, both service tax demand and penalties were set aside, allowing the appeal with consequential relief.

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The primary legal issue considered in this appeal is whether the remuneration paid by the appellant company to its whole-time directors attracts service tax under the reverse charge mechanism.

In addressing this issue, the relevant legal framework includes Section 65B(44) of the Finance Act, 1994, which defines "service" and specifically excludes "a provision of service by an employee to the employer in the course of or in relation to his employment" from the definition of service. The appellant contends that the directors in question are whole-time directors who are in an employer-employee relationship with the company and receive remuneration akin to salary, which is subject to TDS under Section 192 of the Income Tax Act, 1961. Therefore, the appellant argues that the remuneration paid does not constitute a taxable service.

The Department, on the other hand, contends that services rendered by directors are taxable under the reverse charge mechanism effective from 07.08.2012, and that the remuneration paid to the directors should be treated as consideration for taxable services rendered.

The Court examined the factual matrix, including the nature of the directors' roles, the manner of their appointment, and the evidence of employer-employee relationship such as Board Resolutions and Form 16 certificates evidencing TDS on salary. It was noted that the directors were appointed as executive directors through an Extra Ordinary General Meeting and were engaged in managing day-to-day affairs of the company, receiving remuneration comparable to other employees.

In interpreting the law, the Court relied heavily on the exclusion clause in Section 65B(44)(b) of the Finance Act, which excludes services provided by an employee to the employer from the ambit of taxable services. The Court also referred to binding Board Circulars No. 115/09/2009-ST dated 31.07.2009 and earlier Circular No. 324/Comm.(ST)/2008 dated 01.12.2008, which clarify that remuneration paid to managing directors or whole-time directors, when they are employees, is not liable to service tax.

Precedents were pivotal in the Court's reasoning. The Tribunal's decision in a prior case involving remuneration paid to whole-time directors was cited, wherein it was held that such directors are employees under the Companies Act and that remuneration paid to them is akin to salary, not a taxable service. The Tribunal emphasized that the employer-employee relationship is determinative, and the mode of payment, whether salary, commission, or performance bonus, does not alter this relationship or attract service tax. The Tribunal further noted that the Income Tax Act's treatment of such remuneration as salary subject to TDS under Section 192 corroborates the existence of an employer-employee relationship.

In applying these principles to the facts, the Court found that the appellant had established the employer-employee relationship with the directors. There was no evidence that the directors were providing services outside the scope of their employment or acting as independent service providers. The remuneration paid was consistent with salary and other perquisites paid to employees. Therefore, the services rendered by the directors fell within the exclusion under Section 65B(44)(b).

The Court also addressed and rejected the Department's argument that the negative list regime introduced from 07.08.2012 made services by directors taxable. The Court clarified that the negative list regime does not override the exclusion of employer-employee services from the definition of service. The Court pointed out that the Department's reliance on the absence of appointment orders was misplaced, as the Board Resolutions and Form 16 certificates sufficiently established the employment relationship.

Regarding competing arguments, the Court acknowledged the Department's position but found it legally unsustainable in light of the statutory exclusions, binding circulars, and judicial precedents. The Court emphasized that the burden was on the Department to prove that the directors were not employees, which was not discharged.

Consequently, the Court concluded that the demand for service tax on remuneration paid to the whole-time directors was not tenable. The impugned order confirming the demand, interest, and penalty was set aside.

Significant holdings from the judgment include the following verbatim excerpt from the Tribunal's earlier decision cited by the Court:

"The whole-time director is essentially an employee of the Company and accordingly, whatever remuneration is being paid in conformity with the provisions of the Companies Act, is pursuant to employer-employee relationship and the mere fact that the whole-time director is compensated by way of variable pay will not in any manner alter or dilute the position of employer-employee status between the company assessee and the whole-time director."

Further, the Court affirmed that remuneration paid to whole-time directors, subject to TDS under the Income Tax Act, constitutes salary and is excluded from service tax liability under Section 65B(44)(b) of the Finance Act, 1994.

The final determination was that the appellant was not liable to pay service tax on the remuneration paid to the whole-time directors, and the demand, interest, and penalty imposed by the lower authorities were quashed. The appeal was allowed with consequential relief as per law.

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