Excessive remuneration to promoter/ directors should be disallowed.

[DEVKUMAR KOTHARI]

Promoters/ controlling directors:

Promoters and / or controlling directors in this context mean persons who are directly or indirectly through other associates controlling a company. They  make investments in company by taking shares , extending loans , providing  security and guarantees to financiers of controlled company.

Reward to promoters for their involvement and risks:

Promoters may get proper reward in different forms for their involvement. Rewards of promoters can be as follows:

Nature of involvement, investment, risk undertaken	Proper reward	Remarks
As equity shareholder.	Controlling company. Sharing prospects of company by way of appreciation in intrinsic value and market value of shares. Dividend.
As preference shareholders/ warrant holders etc.	Dividend, option to convert into equity.
As debenture holders.	Interest and option to convert into equity.
As a security provider.	Commission for security provided.
As a guarantor	Guarantee commission.
As a financier lending money	Interest.
Other risks taken or shared	Reward in form of business.

From above table we find that a promoter/ controller director get his rewards for investments, involvements, and risks undertaken in different proper form of rewards. Many of these rewards are associated with the growth, profitability and future prospects of company. And many rewards can be in accordance with normal market rates for similar services or facilities availed from others.

Remuneration for working should not be linked to other aspects:

Directors work for company. They work not only for salary or commission but for future prospects of company because future prospects of them are linked with company also. If company grows and its valuation increases, they will get benefit. Similarly for other risks they can take proper rewards as indicated in the above table. Therefore, for the activities and involvement (other than personal working) rewards are separate and they should not be tagged with remuneration by way of salary, bonus, perquisites and commission etc. The risk element should not also be tagged with remuneration for working.

Relevant factors for remuneration:

The important factors for determination of remuneration and perquisites should be considered as follows:

(a)   Qualifications,

(b)   Experience,

(c)  Time devoted – his hours of working and attendance etc. should also be considered.

(d)   Remuneration paid to other executives of similar qualifications and experience.

(e)  Perquisites provided to other similarly qualified and experienced executives.

(f)    The remuneration which he can get by working with other employer as simply an employee.

(g)   The remuneration paid to similar persons by similar companies. (A multinational company cannot be compared with a small family owned company).

(h)  Risks and initiatives undertaken for improvement in own working.

Irrelevant factors for remuneration:

The following factors are not relevant and should not be considered to determine remuneration:

1. A.   Number of shares held and stake held in percentage by him.
2. B.   Number of shares held and stake held in percentage by his relatives, associates and supporters. They can be supporter for electing him a director but in no way should be allowed to pay excessive remuneration.
3. C.   Risks undertaken- for this, reward in separate form is to be given.
4. D.   Remuneration not taken in past for nurturing company is also not a relevant consideration because; by forgoing remuneration or not taking remuneration they try to improve capital base of company. At best they can get remuneration for past also.
5. E.   Risks and initiatives undertaken for improvement in working of company- this will improve his rewards by way of appreciation in investments and prospects of getting better productivity linked bonus.

Reasonable remuneration and perquisites:

Reasonable remuneration and perquisites should be determined in accordance with relevant factors and without considering any irrelevant factor.

Excessive remuneration and perquisites should be disallowed:

Excessive remuneration and perquisites provided by company to director should be disallowed. In this regard the provisions are found in Section 37(1) (by applying principal of wholly and exclusively for the purpose of  business rule) and directly enabling provision for disallowance found in section 40A. Relevant portion of S.40A is reproduced with highlights for analysis.

[Expenses or payments not deductible in certain circumstances.

40A. (1) The provisions of this section shall have effect notwithstanding anything to the contrary contained in any other provision of this Act relating to the computation of income under the head "Profits and gains of business or profession".

(2)(a) Where the assessee incurs any expenditure in respect of which payment has been or is to be made to any person referred to in clause (b) of this sub-section, and the Assessing Officer is of opinion that such expenditure is excessive or unreasonable having regard to the fair market value of the goods, services or facilities for which the payment is made or the legitimate needs of the business or profession of the assessee or the benefit derived by or accruing to him therefrom, so much of the expenditure as is so considered by him to be excessive or unreasonable shall not be allowed as a deduction.

     (b) The persons referred to in clause (a) are the following, namely :—

(ii)   where the assessee is a company, firm, association of persons or Hindu undivided family

any director of the company, partner  of the firm, or member of the association or family, or any relative of  such director, partner or member;

      (iii) any individual who has a substantial interest in the business or profession of the assessee, or any relative of such individual;

Thus we find that the above provision has an overriding effect on all other provisions. Even otherwise, expenses incurred wholly and exclusively for the purpose of business are allowed. If a company, pays excessive remuneration or provide excessive perquisites to any person,  which are not as per prevailing market rate or normally paid to other similarly qualified and experienced persons, there is no justification to allow such salary and remuneration paid to directors who are controlling company. 

Request from companies:

Companies should pay reasonable remuneration and provide reasonable perquisites on due consideration of relevant aspects. In case of excessive perquisites provided to directors, company should recover compensation. For example, suppose an executive of similar qualification and experience is provided a bungalow carrying rent of Rs.50000/- per month. In case of Managing Director an extra add one of say 30% can be considered as reasonable for the post of MD, therefore rent up to say Rs.65000/- can be considered reasonable for the bungalow of MD.  If the Bungalow of MD is rented at rent of say Rs.1,00,000/- PM  then it can be said that Rs.35000/- per month is excessive or unreasonable.  In such cases company should recover Rs.35000/- Pm from MD.

The companies should have reasonable policies while remunerating directors and providing them facilities. The directors should not use property of company as their personal property. This will add to corporate governance.

Request from Auditors:

Auditors of companies are requested to point out excessive remuneration and perquisites provided to such directors in their reports to shareholders and tax audit report both.

 Request to CBDT  and Assessing Officers:

CBDT is requested to provide guidelines for determination of reasonable remuneration and perquisites and The Assessing Officers are also requested to look into excessive remuneration and perquisites provided to directors and disallow the same.

 A press report:

Recently we have come across that Shri Mukesh Ambani  has decided to forego Rs.23.75 crore for the last fiscal from his annual compensation as chief of Reliance Industries while keeping his salary capped at Rs.15 crore for the third year in a row. In its annual report for the fiscal, the company said that “The Chairman and Managing Director’s compensation has been set at Rs.15 crore as against Rs.38.75 crore that he is eligible as per the shareholders’ approval…”

This clearly shows that remuneration of Rs.38.75 crore or even Rs.15 crores is not in nature of real remuneration for the work done. The remuneration should not be fixed on consideration of irrelevant factors.  The fact that he controls company, he has invested capital in company or that he takes  initiatives and risks (on company account) should not be taken into consideration while fixing salary. In view of author, the AO will be justified to disallow the unreasonable portion of salary and perquisites paid to such directors. 

http://taxguru.in/general-info/mukesh-ambani-forgoes-rs-2375-crore-salary.html

Mukesh Ambani forgoes Rs 23.75 crore from salary

Billionaire industrialist Mukesh Ambani has decided to forego Rs.23.75 crore for the last fiscal from his annual compensation as chief of Reliance Industries while keeping his salary capped at Rs.15 crore for the third year in a row. At the same time, the company’s total remuneration for top management personnel, as also commission paid to non-executive directors, declined during 2010-11. In its annual report for the fiscal, the company said that

“The Chairman and Managing Director’s compensation has been set at Rs.15 crore as against Rs.38.75 crore that he is eligible as per the shareholders’ approval…”

Discussions to this article

[CA UMA KOTHARI]

As rightly pointed out by the learned author, when we consider reasonable remuneration, we must consider only what should be remuneration for work done. To some extent profits can be considered while considering bonus or performance based bonus that should be on the same line as considered for other employees of company. Merely becasue in some years company has earned excessive profit should not be consideration to pay excessively to promoter directors or other directors. It is noticed that many times companies pay hefty salary ( as commission or otherwise based on profit of company) but pay very little to other employees as profit sharing bonus, dividend to shareholders and plough back is alos reduced.

Many companies have policy to pay very little or no dividend for the reason to save funds for busienss needs but they pay hefty salary or directors remuneration or by way  of commission to promoter directors and/or other directors.

Only relevant factors should be considered while deciding remuneration. Profits of company should not be criterion. In this  regard, in years of super profits or exceptional gains there should also be upper limits otherwise than certain percentage of eligible profit of company. I remember a sugar company has some years ago increased remuneration of promoter directors about 20 times and some other directors by about 3-4 times. The reason given was in tune with remuneration paid by other companies company wanted to increase remuneration of directors. Suddenly remuneration should not  be increased on such grounds. There should be reasonable logic to increase salary- the logic should be based on remuneration theory- and that should be based on  reasonable remuneration considerign work done and performance and on the basis of rules similar to those followed while granting incrtement to other employees.

The remunearion to promoter directors/ other directors should also be absed on transfer pricing - what one can get by working at other place? What is his transfer price with some other employer?