Strengthening the Power of Shareholder for approving Managerial Remuneration

By Taxscan Team - On May 7, 2020 1:33 pm - 6 mins read

Managerial Remuneration - Shareholders - Taxscan

Just as profits drive business, incentives drive the managers of the business. Not surprisingly then, in a fiercely competitive corporate environment, managerial remuneration is an important piece in the management puzzle. While it is important to incentivize the workforce to perform the challenging role of managing companies, it is equally important not to go overboard with the perks and the pay. In India, to keep a check on unnecessary profit squandering by companies and, at the same time, to ensure adequate and reasonable compensation to managerial personnel, the law intervenes to do the balancing act.

Section 197 of the Companies Act, 2013 is governing section for overall maximum managerial remuneration and managerial remuneration in case of absence or inadequacy of profits

Key Changes in Section 197 of the Companies Act, 2013:

MCA vide its notification dated September 12, 2018, brought into life some major changes in the various sections of the Act, 2013 which inter-alia include an amendment in the provisions of Section 197 which deals with limits on overall maximum managerial remuneration and managerial remuneration payable in case of absence or inadequacy of profits.

The new provision inserted in section 197 of the Amendment Act for making payment of remuneration by the company, in excess of the limits specified in section 197(1) to its directors, including managing director and whole-time director, and its manager has been notified.
The requirement of seeking approval of Central Government for making payment of remuneration beyond eleven percent of the net profits by the company to its managerial person has been omitted in the said amendment,
Approval of members by way of special resolution in case the remuneration paid exceeds the below-mentioned limits:

the remuneration payable to any one managing director; or whole-time director or manager shall not exceed five percent. of the net profits of the company and if there is more than one such director remuneration shall not exceed ten percent. of the net profits to all such directors and manager taken together;
the remuneration payable to directors who are neither managing directors nor whole-time directors shall not exceed, –

one percent of the net profits of the company, if there is a managing or whole-time director or manager;
three percent of the net profits in any other case.
The above amendment has been made more stringent by substituting ordinary resolution with a special resolution where approval of members by way of the ordinary resolution was required for making payment of remuneration in excess of the above limits.
Where a company has no profits or has inadequate profits, it shall not pay to its directors, including any managing or whole-time director or manager, any sum by way of remuneration except in accordance with the provisions of Schedule V.
In cases where the company was not able to comply with the provisions of Schedule V then the Act, 2013 provides that the company can pay remuneration to the directors with the previous approval of the Central Government. The provision related to seeking approval of the Central Government has been omitted which means that the company will now mandatorily be required to comply with the provisions of Schedule V for making payment of remuneration in case of no profits or inadequate profits.
Prior approval of the bank or public financial institution or the non-convertible debenture holders or other secured creditors for making payment of remuneration in excess of the limits specified in sub-section (1), in the case where the company has defaulted in payment of dues to any bank or public financial institution or non-convertible debenture holders or any other secured creditor, which shall be obtained before obtaining approval of the members’ in the general meeting.
The company can waive off the requirement of recovery of any sum refundable to the company by way of excess remuneration bypassing the special resolution. The company would, however, require to obtain prior approval of the bank or public financial institution or the non-convertible debenture holders or other secured creditors, in cases where any term loan of any bank or public financial institution is subsisting or the company has defaulted in payment of dues to non-convertible debenture holders or any other secured creditor.
The requirement to obtain approval of the Central Government for waiver off excess remuneration paid by the company is deleted.
Refund of excess remuneration received by the directors of the company within a maximum period of two years.
The time limit within which the excess remuneration shall be paid back to the company which in no case shall be more than two years has been notified by the MCA
The Amended Act, 2017 further inserted a new provision under section 197 requiring an auditor to make a statement in his report as to whether the remuneration paid by the company is in accordance with the provisions of section 197. This new provision puts an obligation on the auditors to ensure that the company is paying remuneration to its directors in accordance with the limits laid down in section 197 or where it exceeds the prescribed limits, necessary approvals are in place.
The requirement to obtain necessary approvals as are required under section 197 on and from the date of commencement of Companies (Amendment) Act, 2017 within a period of one year, in case of existing applications pending with the Central Government as prescribed by the Amendment Act has been notified by the MCA.
Remuneration payable by the Company to its directors, including managing director and whole-time director, and its manager exceeding eleven percent of the net profits of the company can be paid with the approval of members by way of ordinary resolution subject to the provisions of Schedule V.

Calculation of net Profit under section 198 of the Companies Act 2013

Sr. No. .	Particulars	Add		Less
	Profit before tax as per P&L Statement
1.	Bounties and subsidies received from any Government, or any public authority constituted or authorized in this behalf, by any Government. (Except as Central Government directs otherwise)	√
2.	Profits, by way of premium on shares or debentures of the company, which are issued or sold by the company. [unless the company is an investment company as referred to in clause (a) of the Explanation to section 186			√
3.	Profits on sales by the company of forfeited shares.			√
4.	Profits of a capital nature including profits from the sale of the undertaking or any of the undertakings of the company or of any part thereof.			√
5.	Profits from the sale of any immovable property or fixed assets of a capital nature comprised in the undertaking or any of the undertakings of the company. (unless the business of the company consists, whether wholly or partly, of buying and selling any such property or assets)			√
6.	Where the amount for which any fixed asset is sold exceeds the written- down value thereof, credit shall be given for so much of the excess as is not higher than the difference between the original cost of that fixed asset and its written down value.	√
7.	Any change in carrying amount of an asset or of liability recognized in equity reserves including surplus in profit and loss account on measurement of the asset or the liability at fair value.			√
8.	any amount representing unrealized gains, notional gains or revaluation of assets			√
9.	All the usual working charges			√
10.	Directors’ remuneration			√
11.	Bonus or commission paid or payable to any member of the company’s staff, or to any engineer, technician or person employed or engaged by the company, whether on a whole-time or on a part-time basis			√
12.	Any tax notified by the Central Government as being in the nature of a tax on excess or abnormal profits.			√
13.	Any tax on business profits imposed for special reasons or in special circumstances and notified by the Central Government in this behalf.			√
14.	Interest on debentures issued by the company			√
15.	Interest on mortgages executed by the company and on loans and advances secured by a charge on its fixed or floating assets.			√
16.	Interest on unsecured loans and advances		√
17.	Expenses on repairs, whether to immovable or to movable property, provided the repairs are not of a capital nature.		√
18.	Outgoings are inclusive of contributions made under section 181.		√
19.	Depreciation to the extent specified in section 123.		√
20.	The excess of expenditure over income, which had arisen in computing the net profits in accordance with this section in any year. in so far as such excess has not been deducted in any subsequent year preceding the year in respect of which the net profits have to be ascertained		√
21.	Any compensation or damages to be paid in virtue of any legal liability including a liability arising from a breach of contract.		√
22.	Any sum paid by way of insurance against the risk of meeting any liability such as is referred to in clause (20)		√
23.	Debts considered bad and written off or adjusted during the year of account.		√

After calculating the profit as said above the limits specified in the act in respect of managerial remuneration can be applied to know the maximum allowable remuneration.

Conclusion:

Since obtaining approval of the Central Government is a time-consuming process and therefore the amendment made under the Amendment Act, 2017 surely seeks to provide relief to the companies.

Further, the Companies (Amendment) Act, 2017 requires prior approval of the bank or public financial institution or the non-convertible debenture holders or other secured creditors for making payment of remuneration in excess of the limits specified in sub-section (1), where the company has defaulted in payment of dues to non-convertible debenture holders or bank or public financial institution or any other secured creditor.

All pending applications submitted to the ministry for approval of proposals for payment of managerial remuneration in excess of the limits laid down would automatically abate and companies are free to obtain requisite approvals for those proposals, from the shareholders within one year.

On the other hand, the provisions of the law have been amended to include the requirement of obtaining shareholder’s resolution by ordinary or super-majority based on the scales of remuneration. Also, where the company is unable to meet its financial obligations, the need for creditors’ approval seems reasonable. The piece which is still amiss is in case of professional directors, where the need for a special resolution seems superfluous. This is perhaps a product of drafting oversight.