R.R Kothandaraman v Commissioner of Income Tax

This piece just like prior case comments would attempt to give a critical analysis of the fact of the case, matters which arose and the judgment. This article also seeks to draw a distinction between a contract for service and a contract of service as well as whether the director could qualify as an employee, undergoing the same method of remuneration and appointment.
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Facts of the Case

The managing Director of a public limited company called ‘Transformer and Switchgear Ltd’ was the promoter of the company, having established contacts with German experts concerned in the type of business. By virtue of Article 106 of the memorandum and articles of association, it provided for the appointment of the managing Director in that capacity for the company for a period of 5 years subject to the control and supervision of the Board of Directors and upon the terms, provisions and conditions which is specified in the agreement that would be executed before parties involved. In line with the article, they did enter into an agreement dated 22nd May, 1957, where the agreement stipulated the services of the managing director and his duties and powers, amongst which a clause provided that a monthly remuneration be paid to him including commission of 5% on net profits made by the company which is to be paid yearly after the annual accounts of the company for each year was made and was certified by auditors of the company which would then be laid at the company’s general meetings. The managing Director also called the assessee included the receipt of his monthly remuneration in his income tax returns for the assessment years prior to the assessment year under the head ‘SALARY’. At the end of the accounting year, the company credited him a remuneration of Rs.1, 250 every month as discussed. However, the company debited him with a sum of Rs. 15,000 which served as his salary for the whole year.

It was claimed by the managing director that he was not entitled to remuneration for the whole year of 1959 by virtue of the resolution and that the credit entries made monthly did not entitle him to remuneration. This position was rejected and the sum of Rs. 11,250 which was credited to his account for the period of nine months was brought to tax. He succeeded in his appeal relating to this amount as the Appellate Assistant Commissioner was of the view that the assessee was compelled as a result of the resolution not to demand his remuneration amount. The Appellate Assistant Commissioner was also of the view that there was no surrender of remuneration seeing the assessee was not entitled to remuneration for that year. The tribunal however reversing the decision on appeal held that the assessee in evaluating the relationship between him and the company in the agreement, must be regarded as a salaried employee and the remuneration for the nine months which he received was salary chargeable to tax under Section 7 of the Income Tax Act, 1922. It also said that the company could not retract the right of the assessee under the agreement as the resolution of the company was passed long after the accounting year of the assesse. The resolution only had the effect of stopping the payment of remuneration.

The question from the above is not whether the remuneration for the nine months would fall under section 10 or section 12. The question is whether the sum is assessable for tax under section 7. This is observed in 2 posing questions;

  • Whether the sum represents salary; and
  • If it is salary, whether there was real income accrued to the assessee in that sum.

Issues for Court’s Determination and Analysis

  • Whether the assessee served as an employee or director from the terms of the agreement.
  • Whether the terms of the agreement provided a clear cut distinction in duty on his appointment and remuneration.

Contract of Service and Contract for Service

A contract of service which is the main fulcrum of discussion is an agreement between the employer and the potential employee. A contract for service however is quite the opposite which warrants no confusion to the former. Here, an independent contractor who is self-employed is engaged to perform a particular service.

In drawing up the distinction however, some factors that are put into consideration include control of the employee (level of autonomy), the skill of the employee as well as the ownership of the equipment provided for such service.

The managing director was employed by the board of Directors under a contract of service as this contract subsists between the employee (Managing Director) and the Company.

One thing to note here is there is nothing that prevents a Managing Director from accepting employment from the Company under a special contract of service which he may enter into with the company. Once he accepts employment from the company under such separate contract of service, he automatically becomes an employee, where with he is expected to be treated as an employee as well as the managing Director. Justice Hudson in Lincoln Mills (Aust) Ltd V Gough[1]posited thus;

“…the duties of a managing Director as such are those of an executive officer, and in relation to the performance of them, he is subject to the control and directions of the whole board….”

However, it is also important to note that the Director in most case will not always be referred to as an employee. There are exceptions that exist in that respect.[2] On the issue of remuneration, a more practical depiction was made in the case of Commissioner of Income Tax vs B. Naji Reddy[3] wherein the court posited that remuneration given to the Managing director was Salary. Having said that, Directors should be entitled to remuneration and other benefits which are entitled to employees, in addition to his remuneration as Director.

Now the question is who gives out the remuneration to the managing Director?

In the latter position of Justice Hudson in Lincoln Mills (Aust) Ltd vs Gough on the duty of the managing Director, he said;

“……..his remuneration and term of office are also matters to be fixed and determined by the whole board and as the cases shew the fixing and determination thereof will bind the company to the managing Director in contract, just as it would be bound to a manager or other executive officer not occupying the position of a director”.

Conclusion

The powers, responsibilities of the managing director of a company is ascertained from the article and memorandum of association. Whilst it has been emphasized that the Managing Director is an employee because he acts under the capacity of contract of service, it is important to note that Managing Directors are the face of the company, who are engaged in controlling the affairs of the company. They are viewed to be the wheel that drives the company. Hence, the question as to remuneration and title in a company should not be a determining factor. If the question of remuneration does come up, nothing should prevent the director from enjoying the same employment rights as an employee. This of course includes remuneration.


[1] (1964) VR 193 at 197-8

[2] Anderson vs James Sutherland (peterhead) Ltd (1941) SC 203

[3]1963 2 I.T.J 471

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