Regulation on payment of directors' remuneration becomes necessary for several reasons, prominent among them being, prevention of diversion of corporate funds for personal use and unduly high executive rewards.
For Public Limited Companies the provisions under Companies Act, 1956 and the Corporate Governance requirements as per the Listing Agreement, would regulate the remuneration paid to the Directors. But, for Private Limited Companies, are there any provisions which regulate the payment of Directors' Remuneration? Many of us are under the impression that there are no provisions restricting the amount of remuneration payable to a Director in a Private Limited Company and hence we conclude that any amount can be paid as remuneration. It may also be argued that in a closely held companies where promoters and the Directors are same, there will not arise the diversion of corporate funds for personal use and hence no restrictions are posed.
But, a director is neither an employee nor an agent of the Company. He is holding fiduciary relation with the Company.
In general, remuneration of whatever nomenclature can be paid to any person for his services as mentioned below:
a) rendering services as an employee
b) supply of services as an consultant or agent
Even a Director is paid in a similar manner. It is here, the regulation of remuneration to be paid to the Director comes in force. Let us look at how the provisions of Companies Act, 1956, indirectly regulate the remuneration paid to the Directors in a Private Limited Company.
The following regulate the payment of remuneration to Directors in a Private Limited Company:
Companies Act, 1956
Contract of Employment
Companies Act, 1956
Though there are no direct provisions controlling on payment of remuneration to Directors in a Private Limited Company, there are certain provisions which regulate the payment made to Directors. They are:
Articles of Association:
If a Company has an Article on Appointment and mechanism to make the payment of remuneration to a Director, the Company has to abide by such regulation. But this should be in addition to the conditions under the provisions of Companies Act, 1956 and other laws.
As per Schedule VI – Part II (4), the Profit & Loss Account shall contain by way of note, the detailed information with respect to remuneration, commissions payable, other allowances and commission, perquisites or benefits in cash or in kind, pension, etc.
Irrespective of the nature of remuneration paid to the Directors, the same needs to be disclosed under the Notes to Accounts of the Final Accounts.
Subject to the provisions of Section 297 of Companies Act, 1956, inter alia, a Director cannot enter into contract with the Company for supply of services without the Board's consent. Such consent may be obtained either before the contract is entered or within three months of the date on which the contract was entered into. Further, if the paid-up capital of the Company is Rs.1 Crore or more then the prior approval of Central Government is a must. Such approval of Central Government is a prior approval and no remuneration can be paid when the application is pending for approval.
However, the following payments do not fall under the purview of Section 297:
If the Director is being paid as an employee of the Company
If the Director is being paid for professional services, other than the Director, in his professional capacity.
If payment is being made to a Director, who is not an employee of the Company, then it can be made only for rendering of services under the professional capacity such as advocate, CA, CS, etc. If not, Board's consent is a must and if required, prior approval of Central Government is also required.
If consent is not obtained, the Contract is voidable at the option of the Board.
If the Director obtains from the Company anything by way of remuneration over and above the remuneration to which he is entitled as a Director, then Members' consent by way of special resolution is required. However, this is not required in case of remuneration to Managing Directors or Managers.
Though, Whole Time Director is not explicitly exempted from Section 314, the remuneration paid to him does not fall under the purview of Section 314, as he is paid for his whole time employment.
Another, exception even here is - payment to Directors for the services rendered in their professional capacity.
The non-compliance of Section 314 leads to the vacation of such office for which he is being paid in excess to his entitlement as a Director and he has to return to the Company all the remuneration which he has already received.
The remuneration payable would also be subject to the terms and conditions for remuneration under the Employment Contract, if any.
TAXABILITY OF REMUNERATION
Remuneration, Salary, Commission, Perquisites, Sitting Fees, etc., whatever the form of payment, it is taxable under the Income Tax Act, 1961 either under the head “Income from Salary” (if Director is an employee) or under the head “Profits from Business or Profession” (if Director is an agent – supplier of services) in the receiver's hand. Tax is deductable at source.
Even a Private Limited Company must have a credible and transparent policy in determining and accounting for the remuneration of the directors. Directors or Promoters of a Private Companies cannot simply divert the funds from corporate accounts to their personal accounts in the name of remuneration, to reduce the tax burdens or for any other reason.
If it has to pay the remuneration, it has to disclose the details of payment and comply with the provisions of Section 297 and 314, wherever applicable, to obtain the necessary approvals.
Crux is, to consider the following while determining the payment of remuneration to a Director of Private Limited Company:
(1) Director should be an employee or Managing Director or Manager of the Company
(2) If Director is an employee, he would be eligible for all the benefits such as gratuity, insurance, provident fund, etc. Hence the compliance of such Acts should be verified.
(3) If Director is neither an employee nor a Managing Director / Manager, he can be paid for only the services under professional capacity.
(4) If (1) or (3) are not applicable, the provisions of Section 297 and 314 are to be complied to the required extent:-
Under Section 297 – Board's Consent and/or prior approval of Central Government has to be obtained, else the contract is voidable at the option of Board of Directors (Central Government approval is required in case the paid up capital is Rs.1 Crore or more)
Under Section 314 – Members' approval as special resolution is required, else the Director has to vacate the office for which he is receiving excess remuneration and has to refund the company the remuneration received so far.