Service Tax on Director Fees & Impact under Section 309/310 of Companies Act

Section 65B(44) of Finance Act, 1994 as Amended by Finance Act 2012 defines Service as follows :

"service" means any activity carried out by a person for another for consideration, and includes a declared service.

This definition further goes on to exclude in clause (b)

(b)  a provision of service by an employee to the employer in the course of or in relation to his employment

 This definition under 65B(44) and above exclusion makes it amply clear that :

Services of a Director who is not an Employee of the Company (ie) Non Executive Directors are covered under the scope of Service tax.  Accordingly any  remuneration to Non Executive Directors both monetary and non monetary are subject to Service Tax from 1.7.2012.

Valuation of Service

All monetary benefits like Fees, Commission, bonus etc to be taken at the monetary value.  Non monetary benefits like Car, Phone, accommodation etc to be valued as per valuation Rules and subject to Service Tax

Foreign Directors (Only Non Executive)

Irrespective of Directors are within India or abroad Service tax is applicable on their monetary and non-monetary considerations for services rendered as Director

Who Pays Service Tax

From 1.7.2012 to 6.8.2012 for Non Executive Directors within India, liability is on the Directors to pay Service tax.  Hence they need to have registration under Service Tax and discharge their liability.  On their option they can choose to take the Rs.10 lakh exemption limit for discharge of their liability

From 1.7.2012 for Directors outside India (Foreign Directors), the company has to pay Service tax on Reverse Charge Mechanism as a Representative Assessee.  Here there is no provision for Rs.10 lakh exemption.  For the full amount (irrespective of the quantum) service tax needs to be paid.

On 7.8 2012 Notification No.45/2012 was introduced under which even for local Non Executive Directors service tax liability has to be discharged by the Company.  In this situation, the company has to get itself registered under Service Tax and discharge the Service tax liability.

In short, the situation as on today is that for all Non Executive Directors the company has to discharge service tax liability under Reverse Charge Mechanism as per Notification No.45/2012.

Implications under Company Law

Due to the above changes in Service Tax and the Service Tax amount being 12.36% of the monetary and non monetary benefit of the Non Executive Directors the expenses on Directors to the company has increased to that extent, this in turn affects section 198, 309 & 310 of the Companies Act, 1956.  This would mean that some companies have to approch Central Government again if they breach the threshold limits specified in these sections.  To avoid this complication for the financial year 2012-13 the Ministry of Corporate Affairs have issued a Notification No.24/2012 dated 9.8.2012 wherein it exempts companies from applying to Central Government for approval for increase in remuneration of Directors only on account of Service Tax.  Note, this provision is only for the year 2012-13 and from next year onwards the companies have to apply for approval inclusive of service tax.

Can a director remain outside state forever - Indian Companies Act, 1956

Question : Can a director remain outside state forever

Yes there is no restriction in the location of a Director.  Section 252 to Section 284 of the Companies Act, 1956 deals with appointment, qualification, disqualification, restriction etc of Directors, which does not specify any conditionality on location of directors

As the director is overseas care should be taken under section 283(1)(g) which states that a director shall vacate office if

"he absents himself from three consecutive meetings of the Board of directors, or from all meetings of the Board for a continuous period of three months, whichever is longer, without obtaining leave of absence from the board"

So it should be ensured that this directors attends the board meetings or takes a proper leave of absence.

Share Buyback of Less than 10% of a Private Limited Company or Unlisted Public Company & if the shareholder is a Foreign Entity

Buyback of Shares is an elaborate process. The purpose of this article is to provide the steps required for buy back of shares in case of (all conditions cumulative): 

1. The company is a Private Limited or Unlisted Public Company
2. Buyback is of less than 10% of Equity shares
3. The Shareholder is of a foreign national or a foreign company and
4. The shares are not de-materialized

Relevant Legislations :   

1. Private Limited Company and Unlisted Public Limited Company (Buy-Back of Securities) Rules, 1999
2. Companies Act, 1956 – Specifically Section 77A, 77AA & 77B
3. Income tax Act, 1961
4. Foreign Exchange Management Act, 1999 (FEMA), rules and regulations thereunder

Company Law Implications

All provisions listed under Section 77A, 77AA & 77B of Companies Act, 1956 should be followed. Also provisions contained in Private Limited Company and Unlisted Public Limited Company (Buy-Back of Securities) Rules, 1999 should be adhered to.

To list major implications: 

1. Buyback should be authorised by Articles
2. Buyback should be less than 25% of total paidup capital and free reserves of the company
3. Buyback should not exceed 25% of share capital in a year
4. Debt Equity ratio should not be more than 2:1 after buyback

Income Tax Implications

Buy back whether Dividend? - Provisions of Section 2(22) of Income tax Act, 1961 is relevant

“Dividend does not include………any payment made by a company on purchase of its own shares from a shareholder in accordance with the provisions of section 77A of the Companies Act, 1956”

Transfer Pricing – The buy back transaction would be considered as International Transactions and it would attract Transfer Pricing regulations if the company buys back the shares and its non resident shareholders are part of the same group.

Capital Gains Tax - For the non-resident shareholders, If the shares are held for less than one year provisions of “Short Term Capital Gains” apply, incase shares are held for more than one year then provisions of “Long Term Capital Gains” apply

Applicability of Tax Treaty – To explore the taxable impact of Capital Gains tax a close reading of relevant Tax Treaties between the countries should be made (county in which the company is incorporated & the county in which the shareholder is incorporated), and if an exemption is available from payment of tax in India, then it is prudent to make an application under section 195(2) of the income tax Act for full clarity.

Filing of income tax return – the non resident shareholder should file an income tax return (see CBDT circular 91 of 2008 dated 28th August, 2008) to give an opportunity to the Revenue authority to examine the payment of Capital Gains Tax or the claim for exemption under Double Taxation Avoidance Agreement.

FEMA Implications

Transfer of Shares under Buy back from non residents is covered under Automatic route (No.A.P (Dir Series) Circular No.10 dated 30th August 2005). Hence prior approval of RBI is not required.

Share Valuation

If shares are not listed then valuation should be done using “Discounted Cash flow” method by either a SEBI registered Category I Merchant Banker or a Chartered Accountant

Secretarial Matters

1. Hold Board Meeting (as buyback is less than 10%), and approve the proposal for buyback in the meeting
2. The approval in the board should include the following
1. Full & complete disclosure of all material facts
2. The necessity of buyback
3. Method of buyback
4. Amount to be paid for this buyback along with valuation certificate
3. Prepare and File “Offer Letter” with the Registrar of Companies in eform 62. The disclosures to be included in Offer Letter are clearly illustrated in Schedule II to “Private Limited Company and Unlisted Public Companies (Buyback of Securities), Rules 1999”
4. The offer letter should contain “Declaration of Directors” as contained in clause xii of Schedule 1 of the “Private Limited Company and Unlisted Public Companies (Buyback of Securities), Rules 1999”
5. The offer letter should contain “Report by Company’s Auditors” as contained in clause xiii of Schedule 1 of the “Private Limited Company and Unlisted Public Companies (Buyback of Securities), Rules 1999”
6. Prepare “Declaration of Solvency” in Form 4A and file the same with Registrar of Companies in eform 62 along with letter of offer
7. Despatch the Letter of Offer to Shareholders within 21 days of filing with the ROC (this preferably should be done through registered post or Speed Post or Certificate of Posting)
8. The offer shall be kept open for 15 days and not more than 30 days from the date of despatch of offer letter
9. In case the number of shares offered by shareholders exceed the total number of shares proposed to be bought back then the acceptance per shareholder will be on proportionate basis
10. Within 15 days of closure of offer the offers received should be verified. The shares offered will be deemed to be accepted unless a communication of rejection is made within 21 days from the date of closure of offer
11. The company should open a “Special Bank Account” and deposit therein all the monies payable on this buyback
12. Payment to shareholders should be made within 7 days from the date of 15 days of closure of offer (or 21 days from the date of communication of rejection)
13. File eForm 4c (return in respect of buy back of securities) with ROC within 30 days after completion of buyback

RBI & Remittance Formalities

The following should be submitted to authorised dealers (banks) to remit out the proceeds of share buyback

1. A2 Form in duplicate
2. Board Resolution authorising the buyback
3. Form 15CA & 15CB in duplicate
4. Form FC-TRS in quadruplicate
5. Offer letter to shareholders
6. Consent letters from shareholders (for acceptance of buyback)
7. Share valuation certificate
8. Undertaking from Directors (clause xii of Schedule I as mentioned above)

One copy of FC-TRS counter signed by banker should be received back for company records

Destruction of shares

Once the shares are bought back, these shares should be destroyed and fresh share certificates should be issued (if required). Necessary Board resolutions need to be passed for this.

Maintenance of Registers

Share extinguishment register and Share buyback register should be maintained within 7 days of completion of buyback

Form 4B needs to be prepared and signed as per provisions of section 77A(9) of the

Companies Act, 1956

Stamp Duty implication

Buy back of shares does not come under the definition of “Transfer of Shares” under the Companies Act, 1956 and hence will not attract Stamp Duty.

Section 192A of Companies Act, 1956 – Passing of resolution by Postal Ballot

A Company is a perpetual entity owned by its members, who have delegated the powers of running the company to the Board of Directors. Members in turn exercise their ownership rights through various meetings AGM / EGM, which provide directions / authorizations to the Board of Directors.

But at times members (read shareholders) participation especially the non-promoter, non-institutional category read “Individual Investors” especially the “Small Individual Investors” is quite low and they do not exercise their rights as members but remain as passive members due to varied reasons like paucity of time or purchase of shares just for capital appreciation or due to locational disadvantages.

In order to bring about high level of participation of all members in critical decisions of the companies “The Companies (passing of the resolution by Postal Ballot) Rules, 2001” was formed, this has been superseded by “The Companies (passing of the resolution by Postal Ballot) Rules, 2011” from 30th May 2011.

The above rule mandates that certain business should be passed only through a Postal Ballot sent to all members. The following is the brief procedure:

1. Company has to send a notice to all members either through

      a. Registered Post Acknowledgement due or

      b. any other secured mode provided by Department of posts or

     c. through “E-mail” – provided the company has email addresses of all members

2. An advertisement in English and the Vernacular language newspaper of the state in which the company is registered stating that the notice has been dispatched

3. The notice should mention the date by which the postal ballot should reach the company beyond which it is not valid

4. Procedure for Postal Ballot should be clearly explained in the notice. In case of Electronic Voting the process should be explained as provided by the Electronic voting providing agency. At the moment the following are the 2 agencies authorized vide Ministry of Corporate Affairs Circular No.21/2011 dated 2.5.2011

     a. National Securities Depository Limited – NSDL

     b. Central Depository Services (India) Limited – CDSL

5. A scrutinizer is appointed to conduct the postal ballot

6. The scrutinizer being an independent person conduct the postal ballot and provide a report to the Board of Directors

The following are the salient features of Postal Ballot

1. All members will get a voting sheet at the convenience of their location and they can vote from wherever they are

2. Shareholders cannot appoint Proxies

3. Higher level of member participation in critical issues

4. Cost of conducting meetings is reduced

A company has an option to carry out as many businesses in postal ballot, however the following are mandatory to be conducted only through postal ballot

1. Alteration in the Object Clause of Memorandum;

2. Alteration of Articles of Associations in relation to insertion of provisions defining private company;

3. Buy-back of own shares by the company under sub-section (1) of section 77A;

4. Issue of shares with differential voting rights as to voting or dividend or other wise under sub-clause (ii) of clause (a) of section 86;

5. Change in place of Registered Office out side local limits of any city, town or village as specified in sub-section (2) of section 146;

6. Sale of whole or substantially the whole of undertaking of a company as specified under sub-clause (a) of sub-section (1) of section 293;

7. Giving loans or extending guarantee or providing security in excess of the limit prescribed under sub-section (1) of section 372A;

8. Election of a director under proviso to sub-section (1) of section 252 of the Act;

9. Variation in the rights attached to a class of shares or debentures or other securities as specified under section 106.

Having seen the legal provisions as above it is pertinent to discuss whether the objective of this postal ballot has been achieved. I was reading a research article which can be reached through http://www.lawyersclubindia.com/articles/Impact-of-Postal-Ballot-Mechanism-in-Improving-Shareholders--1381.asp which states that on an average around 5% of the shareholders participate in the postal ballot process however these 5% represent atleast 60% of the shareholding. This again brings to the fore that the “Small Individual Investors” for whom this postal ballot will be beneficial and for whose benefit this has been brought in are not utilizing the same for varied reasons. It is high time they realize their responsibilities and participate in the company affairs so that Corporate Governance issues in companies and upheld. Small investors should raise their voice in running the company affairs and should actively participate rather than leaving it to the Directors and majority shareholders.

Shareholder activism is one which will ensure that corporates uphold higher level of Corporate Governance and legal compliance, you may recall shareholders activism was the prime reason why Satyam scandal got broken inspite of the Board giving the nod for buyout of Matyas. This active participation will also help small investors to grow their investment value. Keeping away from corporate affairs will prove detrimental to value growth.

ATTENTION SMALL INVESTORS PLEASE PARTICPATE AND GROW.

Appointment of Whole Time / Managing Director

Section 269 of the Companies Act provides for appointment of Whole Time Director.

Section 316 of the Companies act prohibits a person to be Managing or Whole Time Director in more than one company. If he desires to be a Managing Director in another Company then the company should pass a special resolution in the board meeting for such appointment and all directors present in the meeting should provide their consent. At times Central Government by order permint any person to be appointed as Managing Director in more than 2 companies if they are satisfied and it is necessary for the companies proper working to have a common managing director (ie) companies in the same group can have one managing director.