Reverse Charge Mechanism on Director’s Remuneration: The Unintended Tax Burden on Closely-Held Private Companies

Introduction

There are very few provisions under the Goods and Services Tax framework that have managed to create as much practical difficulty for small and closely-held private companies as the application of the Reverse Charge Mechanism (RCM) on director’s remuneration. What appears straightforward on paper — that a company must pay GST when it receives services from a director — unravels quickly in reality. In many private companies, especially family-run or founder-led enterprises, the distinction between a “director” and an “employee” is not always drawn with legal precision. The director may be drawing a salary, filing income tax returns under the head “Income from Salaries,” and having TDS deducted by the company under Section 192 of the Income Tax Act, 1961, just like any other employee. Yet, GST law, through its notification framework, treats this person simultaneously as a service provider rendering taxable services to the company — a classification that triggers an 18% GST liability under RCM.

This article examines how RCM on director’s remuneration is structured under Indian GST law, what the statutory provisions and regulatory clarifications say, how courts and advance ruling authorities have approached the issue, and why the compliance burden falls most heavily on closely-held private companies that were never intended to be caught in this tax net.

The Statutory Foundation: Section 9(3) and the RCM Notification

The Reverse Charge Mechanism under GST is not a standalone provision — it flows directly from the Central Goods and Services Tax Act, 2017. Section 9(3) of the CGST Act empowers the Central Government to notify specific categories of goods or services on which the tax shall be paid by the recipient of those goods or services, rather than by the supplier. The provision reads: “The Government may, on the recommendations of the Council, by notification, specify categories of supply of goods or services or both, the tax on which shall be paid on reverse charge basis by the recipient of such goods or services or both.”

Acting on this power, the Central Government issued Notification No. 13/2017 – Central Tax (Rate) dated 28 June 2017. Entry No. 6 of the Table annexed to this notification specifically brings director’s remuneration within the RCM framework. It reads: “Services supplied by a director of a company or a body corporate to the said company or the body corporate.” [1] Under this entry, the company or body corporate is identified as the recipient, and the liability to pay GST at 18% falls squarely on it, not on the director.

This notification created the central tension: Schedule III of the CGST Act, 2017, which lists activities that are treated as neither supply of goods nor supply of services, includes at Clause 1: “Services by an employee to the employer in the course of or in relation to his employment.” If a director is an employee, the remuneration paid to them would be shielded from GST entirely under Schedule III. But Notification No. 13/2017 makes no such distinction — it speaks of “a director of a company,” irrespective of whether that director is also an employee. This ambiguity became the source of considerable litigation and compliance anxiety across India. [2]

Who Is a Director? The Companies Act Framework

To understand the scope of RCM applicability, one must first understand who qualifies as a director and what kinds of remuneration they can receive. Under Section 2(34) of the Companies Act, 2013, a “director” means a director appointed to the Board of a company. Section 2(94) defines a “whole-time director” to include a director in the whole-time employment of a company, and crucially, this is an inclusive definition, meaning a whole-time director may or may not necessarily be an employee in the classic sense. Section 2(78) defines “remuneration” as any money or its equivalent given or passed to any person for services rendered, including perquisites.

Section 149(6) of the Companies Act, 2013 defines an “independent director” as a director who is not a managing director, whole-time director, or nominee director; who has no pecuniary relationship with the company other than director remuneration; and who has not been an employee, partner, or proprietor of the company for at least three years prior to appointment, among other conditions. An independent director, by statutory design, cannot be an employee of the company. Similarly, Section 197(5) of the Companies Act, 2013 permits a company to pay sitting fees to directors, including independent and non-executive directors, for attending board or committee meetings.

The distinction between executive directors (managing directors and whole-time directors who are on the company’s payroll) and non-executive directors (independent directors and nominee directors who attend meetings and receive sitting fees or commissions) is therefore established in the Companies Act itself. GST law did not originally map its own categories onto this distinction, which created the problem. [3]

The Advance Ruling Controversy: Clay Craft and Alcon Consulting

The ambiguity inherent in the notification came to a head in 2019 and 2020, when two state-level Authorities for Advance Ruling delivered decisions that sent shock waves through the corporate community.

In M/s Alcon Consulting Engineers (India) Pvt. Ltd. (Advance Ruling No. KAR ADRG 83/2019, dated 25 September 2019), the Authority for Advance Ruling, Karnataka held that the remuneration paid to directors was not covered under Clause 1 of Schedule III of the CGST Act, 2017, because directors are not employees of the company. The consideration paid to the director was treated as payment for services, with the director as the supplier and the company as the recipient. Consequently, the company was held liable to pay GST under RCM as per Notification No. 13/2017. [4]

The Rajasthan AAR followed shortly after, in M/s Clay Craft India Pvt. Ltd. (Advance Ruling No. RAJ/AAR/2019-20/33, dated 20 February 2020). The facts here were different and more nuanced: Clay Craft had six directors who were functioning as whole-time executive directors, drawing regular salaries, with TDS deducted under Section 192 of the Income Tax Act, 1961, PF contributions being made, and their income reported as “Income from Salaries” in their personal income tax returns. Despite all this evidence of an employer-employee relationship, the Rajasthan AAR ruled that consideration paid to directors under “any head” was liable to GST under RCM as provided under Entry No. 6 of Notification No. 13/2017. [4]

The Clay Craft ruling was immediately recognised as a non-speaking order — a ruling that simply stated a conclusion without engaging with the substantial evidence of an employment relationship or the reasoning of the other side. As several commentators noted, the Supreme Court in Tata Engineering and Locomotive Co. Ltd. v. Collector of Central Excise (2006) (203) E.L.T. 360 (SC) had observed that it is not sufficient in a judgment to give a conclusion alone — it is necessary to give reasons in support of the conclusion. The Clay Craft ruling did not meet this standard. Moreover, the ruling was, by virtue of Section 103 of the CGST Act, 2017, binding only on the applicant and its jurisdictional officer. Yet its wider effect on industry sentiment was significant.

These two rulings, arriving from different state AARs, also created a situation of jurisdictional inconsistency. A taxpayer doing business in both Karnataka and Rajasthan was left uncertain about which interpretation applied to them — a problem the GST Council’s advance ruling mechanism, which lacks a central appellate tier with nationwide precedential value, was structurally ill-equipped to resolve.

CBIC Steps In: Circular No. 140/10/2020-GST

Faced with industry-wide confusion and an avalanche of representations, the Central Board of Indirect Taxes and Customs (CBIC) issued Circular No. 140/10/2020-GST dated 10 June 2020, specifically to clarify the levy of GST on director’s remuneration. The circular examined the issue under two distinct categories and established a test that has since become the operative standard. [2]

For directors who are not employees of the company — specifically, independent directors defined under Section 149(6) of the Companies Act, 2013, and any other directors who do not have an employer-employee relationship with the company — the circular clarified: “In respect of such directors who are not the employees of the said company, the services provided by them to the Company, in lieu of remuneration as the consideration for the said services, are clearly outside the scope of Schedule III of the CGST Act and are therefore taxable. In terms of entry at Sl. No. 6 of the Table annexed to notification No. 13/2017 – Central Tax (Rate) dated 28.06.2017, the recipient of the said services i.e. the Company, is liable to discharge the applicable GST on it on reverse charge basis.” The circular further added at paragraph 4.3: “Accordingly, it is hereby clarified that the remuneration paid to such independent directors, or those directors, by whatever name called, who are not employees of the said company, is taxable in hands of the company, on reverse charge basis.”

For directors who are employees of the company (such as managing directors and whole-time directors), the circular drew a nuanced line. If any part of the remuneration was declared as “Salaries” in the books of accounts and subjected to TDS under Section 192 of the Income Tax Act, 1961, it would not be taxable as it constitutes “services by an employee to the employer in the course of or in relation to employment” within the meaning of Schedule III. However, under paragraph 5.4, the circular clarified: “The part of employee Director’s remuneration which is declared separately other than ‘salaries’ in the Company’s accounts and subjected to TDS under Section 194J of the IT Act as Fees for professional or Technical Services shall be treated as consideration for providing services which are outside the scope of Schedule III of the CGST Act, and is, therefore, taxable.” In such cases, the company again bears the RCM liability. [5]

The circular thus introduced a simple TDS-based test: Section 192 TDS = salary = Schedule III = no GST; Section 194J TDS = professional fees = taxable service = RCM applies.

The AAAR Corrective: Clay Craft Revisited

The story of Clay Craft did not end with the AAR’s problematic ruling. The company appealed before the Rajasthan Appellate Authority for Advance Ruling (AAAR), which delivered a more calibrated decision. The AAAR, comprising Pramod Kumar Singh and Dr. Preetan B. Yashwant, held that remuneration paid to independent directors or those directors who are not employees of the company is taxable under RCM. However, the AAAR clarified that the part of director’s remuneration that is declared as salaries in the books of accounts and subjected to TDS under Section 192 of the Income Tax Act, 1961, is not taxable, being consideration for services by an employee to the employer within the meaning of Schedule III of the CGST Act, 2017. [4]

This ruling brought the appellate position broadly in line with the CBIC’s Circular No. 140/10/2020-GST, and significantly reduced the practical damage of the original AAR order. For executive directors of closely-held private companies who are genuinely employees — drawing salaries, having PF contributions deducted, and filing returns under “Income from Salaries” — RCM does not apply on the salary component. [6]

The Disproportionate Burden on Closely-Held Private Companies

The regulatory framework, taken as a whole, is workable for large public companies with dedicated tax departments, clear employment contracts, and meticulous book-keeping that separates salary income from professional fees. The problem is most acute for closely-held private companies — often founder-led, family-managed enterprises where the same individual may be a director, a shareholder, and the key operational person, all at once.

In such companies, the lines between salary, sitting fees, commission, and professional fees are often drawn informally or not at all. A promoter-director who draws a monthly “salary” may not have a formal employment contract that specifies whether this is compensation as an employee or as a director. If the company has not maintained the correct books of accounts or has inadvertently booked remuneration under a head other than “Salaries,” the TDS-based test of the CBIC circular can produce an unintended RCM liability. The company must then pay 18% GST on the amount — at a time when it is already under cash flow pressure — issue a self-invoice, declare the liability in Table 3.1(d) of GSTR-3B, and only then seek to recover the amount through Input Tax Credit. [1]

The ITC recovery, while theoretically available (since director services are used for business purposes), requires the company to be GST-registered and have sufficient output tax liability to offset. A company engaged primarily in exempt supplies, or a company whose registration was triggered solely by the RCM obligation under Section 24 of the CGST Act (which mandates registration for any person liable to pay tax under RCM), finds that the ITC route provides little real relief. Section 24 of the CGST Act makes registration mandatory for any person required to pay GST under RCM, irrespective of turnover thresholds, which means even a small private company that would otherwise not need a GST registration is pulled into the system the moment it becomes liable under the notification. [3]

Compliance Requirements and Obligations under RCM on Director’s Remuneration

A company that has identified an RCM liability on director’s remuneration must comply with a specific set of procedural obligations. First, it must issue a self-invoice for the transaction, since the director, being an unregistered person in most cases (or a registered person who is not charging GST on the supply), cannot issue a tax invoice to the company. Second, the GST amount computed at 18% must be paid in cash — ITC cannot be used to discharge RCM liability at the time of payment, though it can be claimed subsequently in the same or later tax periods. Third, the RCM liability must be declared in GSTR-3B under Table 3.1(d) — “Inward supplies liable to reverse charge” — for the relevant tax period. Fourth, the corresponding ITC, if eligible, can be claimed in Table 4 of GSTR-3B, subject to the conditions under Section 16 of the CGST Act. [7]

Non-compliance carries significant consequences. Interest at 18% per annum under Section 50 of the CGST Act accrues on delayed payment of RCM liability. Penalties under Section 73 or Section 74 of the CGST Act may apply depending on whether the non-payment is attributable to ordinary default or fraud. In audit and scrutiny proceedings, RCM on director’s remuneration has become a standard check-point, and companies that have not discharged this liability — particularly those where directors receive fees or commissions that are booked under heads other than salaries — face demand notices with interest and penalty.

The Continuing Ambiguity: What Still Remains Unsettled

Even after the CBIC circular and the AAAR decision, some areas remain genuinely unsettled. The question of directors who provide services in their professional capacity — for instance, a doctor who sits on a company’s board and also advises the company on medical matters, or a lawyer-director providing legal counsel — involves a dual-capacity analysis. The circular and notification speak of services “supplied by a director of a company… to the said company,” suggesting that the RCM applies to services rendered in the director’s capacity as a director. Services rendered in an independent professional capacity, where the director is effectively a third-party service provider, would attract GST under forward charge (if the director is registered) or RCM under the general unregistered supplier provisions, not under Entry No. 6 of Notification No. 13/2017. [8]

The question of guarantee commissions paid by companies to their directors has also generated discussion. As noted in the context of the Suessen Textile Bearings ruling, a guarantee commission is not remuneration for services rendered in the capacity of a director — it is commission for the director’s personal credit pledge — and therefore does not fall squarely within the Entry No. 6 framework. However, the GST authorities have not issued a formal clarification on this point, and the risk of a demand under RCM remains.

Conclusion

The application of the Reverse Charge Mechanism (RCM) to director’s remuneration under Entry No. 6 of Notification No. 13/2017 – Central Tax (Rate) reflects a legitimate policy intention: to bring director services within the GST net when they constitute genuine third-party service supply. The CBIC’s Circular No. 140/10/2020-GST has brought significant clarity, and the TDS-based test it prescribes — Section 192 for salary (no GST), Section 194J for professional fees (RCM applies) — is a workable bright-line rule. The AAAR’s corrective ruling in Clay Craft reinforced this position at the appellate level.

Yet the burden this creates on closely-held private companies is real and, in many cases, unintended. Where a founder-director draws a salary from the company they built, the mechanics of GST law, particularly the application of RCM on director’s remuneration, can treat that relationship as a service supply. This may trigger registration, self-invoicing, cash payment of tax, and return filing obligations that go far beyond what the law’s drafters likely contemplated for such arrangements. Proper book-keeping, clear employment contracts, correct TDS classification, and diligent GST filing remain the only defences available to companies navigating this landscape. Until legislative clarification narrows the scope of RCM applicability to genuinely non-employed directors, the compliance risk for closely-held companies will remain an unresolved pressure point in India’s GST architecture.

References

[1] Notification No. 13/2017 – Central Tax (Rate) dated 28 June 2017, Entry No. 6, Ministry of Finance, Government of India. Available at: https://cbic-gst.gov.in/pdf/Circular-GIC-Approval-Director-Renumeration.pdf

[2] CBIC Circular No. 140/10/2020-GST dated 10 June 2020, “Clarification in respect of levy of GST on Director’s Remuneration.” Available at: https://cbic-gst.gov.in/pdf/Circular-GIC-Approval-Director-Renumeration.pdf

[3] Central Goods and Services Tax Act, 2017 – Section 9(3), Schedule III (Clause 1), Section 24. Available at: https://www.indiacode.nic.in/handle/123456789/2255

[4] In re: M/s Clay Craft India Pvt. Ltd. (GST AAR Rajasthan), Advance Ruling No. RAJ/AAR/2019-20/33 dated 20 February 2020; and AAAR Rajasthan clarification. Discussed at: https://taxguru.in/goods-and-service-tax/gst-director-remuneration-view-recent-aar-ruling.html

[5] Analysis of Circular No. 140/10/2020-GST, Lakshmikumaran & Sridharan Attorneys. Available at: https://www.lakshmisri.com/newsroom/news-briefings/gst-liability-on-director-s-renumeration-clarified/

[6] M/s Alcon Consulting Engineers (India) Pvt. Ltd., Advance Ruling No. KAR ADRG 83/2019, dated 25 September 2019 (AAR Karnataka). Discussed at: https://taxguru.in/goods-and-service-tax/gst-director-remuneration-analysis-ruling-rajasthan-karnataka-aar.html

[7] RCM compliance obligations for director’s remuneration – GSTR-3B and self-invoice requirements. Discussed at: https://getswipe.in/blog/article/rcm-on-directors-remuneration-under-gst

[8] GST under RCM on fees or remuneration paid to director, Tax Guru. Available at: https://taxguru.in/goods-and-service-tax/gst-rcm-fees-remuneration-paid-director.html

[9] Companies Act, 2013 – Sections 2(34), 2(94), 2(78), 149(6), 197(5). Available at: https://www.indiacode.nic.in/handle/123456789/2319