Managerial Remuneration during period of inadequate profit


[NOTE: The law stated in this post is effective from 12th September 2018. For the law applicable from 1st April 2014 till 11th September 2018, please visit here and here.]

Any managerial remuneration exceeding 11% of net profit limit may be payable subject to compliance of conditions given in Schedule V.

Where a remuneration of managerial personal exceed respective limits of 1%, 3% 5%, or 10%  specified in section 197 in any manner, it becomes remuneration in case of the inadequate profit and attracts approval company in general meeting by special resolution, subject to the provisions of Schedule V.

We have discussed Section 197 as amended update 12th September 2018 earlier here. In this post, we will discuss managerial remuneration in case of inadequate profit as per Schedule V as on 12th September 2018.

It is important to understand how Schedule V comes into picture which deals with remuneration in case of inadequate profit. Let us assume an amount Rs. Z for managerial remuneration. The net profit to approve such remuneration under section 197(1) should be Rs. [Z*100/11]. Any amount which is less than Rs. [Z*100/11] is inadequate profit for this section. The similar calculation may be done for other thrash hold limits of 1%, 3% 5%, 10% or 11%. However, it is not required at all to calculate this amount unless one is going to prepare a note to the management.

If in any financial year, a company has no profits or its profits are inadequate, the company shall not pay to its directors, including any managing or whole-time director or manager, by way of remuneration any sum exclusive of any fees payable to directors under sub-section (5) hereunder except in accordance with the provisions of Schedule V. This may be noted carefully that profit of the financial year in which remuneration is being paid should be calculated not of the previous financial year. {Section 197(3)}

In cases where Schedule V is applicable on grounds of no profits or inadequate profits, following provision relating to the remuneration of any director which purports to increase or has the effect of increasing the amount thereof shall not have any effect unless are in accordance with the conditions specified in that Schedule:

  • the provision contained in the company’s memorandum or articles, or
  • in an agreement entered into by the company, or

in any resolution passed by the company in general meeting or its Board. {Section 197(11)}

Remuneration payable by companies having no profit or inadequate profit

Where in any financial year during the currency of tenure of a managerial person, a company has no profits or its profits are inadequate, it may pay remuneration to the managerial person not exceeding, the limits given in Item (A) and Item (B).

ITEM A – overall limits

This limit is given in the table hereinafter is for the amount mentioned to replace the overall 11 per cent limit on managerial remuneration. These limits may be applied on a pro-rata basis for a remuneration period less than one year.

Effective capital Maximum Yearly Remuneration
Negative or less than 5 crores 60 Lakhs
5 crores and above but less than 100 crores 84 Lakhs
100 crores and above but less than 250 crores 120 Lakhs
250 crores and above 120 lakhs plus 0.01% of the effective capital in excess of Rs. 250 crores

Such amount given in the table may be given by passing an ordinary resolution. However, any amount beyond the limited set out in the table may be given by passing a special resolution.

Effective Capital

“Effective Capital” means the aggregate of the paid-up share capital (excluding share application money or advances against shares); amount, if any, for the time being standing to the credit of share premium account; reserves and surplus (excluding revaluation reserve); long-term loans and deposits repayable after one year (excluding working capital loans, overdrafts, interest due on loans unless funded, bank guarantee, etc., and other short-term arrangements) as reduced by the aggregate of any investments (except in case of investment by an investment company whose principal business is acquisition of shares, stock, debentures or other securities), accumulated losses and preliminary expenses not written off.

Date of effective capital

Where the appointment of the managerial person is made in the year in which company has been incorporated, the effective capital shall be calculated as on the date of such appointment;

In any other case, the effective capital shall be calculated as on the last date of the financial year preceding the financial year in which the appointment of the managerial person is made.

Negative Effective Capital

“Negative effective capital” means the effective capital which is calculated in accordance with the provisions contained in Explanation I of this Part is less than zero.

ITEM B – Professional Director

In case of a managerial person who is functioning in a professional capacity, remuneration as per item (A) may be paid, if such managerial person is not having any interest in the capital of the company or its holding company or any of its subsidiaries directly or indirectly or through any other statutory structures and not having any, direct or indirect interest or related to the directors or promoters of the company or its holding company or any of its subsidiaries at any time during the last two years before or on or after the date of appointment and possesses graduate level qualification with expertise and specialised knowledge in the field in which the company operates.

“Statutory Structure” means any entity which is entitled to hold shares in any company formed wider any statute.

Any employee (read director) of a company holding shares of the company not exceeding 0.5% of its paid-up share capital under any scheme formulated for allotment of shares to such employees including Employees Stock Option Plan or by way of qualification shall be deemed to be a person not having any interest in the capital of the company.

I am not sure about the relevance of Item B after the recent amendment in Schedule V.

Availability of these limits

According to Second Proviso to Item B, these limits mentioned in Item A and Item B shall be available, if –

  • payment of remuneration is approved by a resolution passed by the Board and, in the case of a company covered under sub-section (1) of section 178 also by the Nomination and Remuneration Committee;
  • the company has not committed any default in payment of dues to any bank or public financial institution or non-convertible debenture holders or any other secured creditor, and in case of default, the prior approval of the bank or public financial institution concerned or the non-convertible debenture holders or other secured creditors, as the case may be, shall be obtained by the company before obtaining the approval in the general meeting.
  • an ordinary resolution or a special resolution, as the case may be, has been passed for payment of remuneration as per item (A) or a special resolution has been passed for payment of remuneration as per item (B), at the general meeting of the company for a period not exceeding three years.
  • a statement along with a notice calling the general meeting referred to in clause (iii) is given to the shareholders containing certain following information and disclosures, (Please refer end note 1 at the bottom of this post.) [i]

Remuneration payable by companies having no profit or inadequate profit in certain special circumstances

In the following circumstances, a company may pay remuneration to a managerial person in excess of the amounts provided in Section II above:—

(a) where the remuneration in excess of the limits specified in Section I or II is paid by any other company (The company other than the company under discussion) and that other company is either a foreign company or has got the approval of its shareholders in general meeting to make such payment, and treats this amount as managerial remuneration for the purpose of section 197 and the total managerial remuneration payable by such other company to its managerial persons including such amount or amounts is within permissible limits under section 197.

(b) where the company—

(i) is a newly incorporated company, for a period of seven years from the date of its incorporation, or

(ii) is a sick company, for whom a scheme of revival or rehabilitation has been ordered by the Board for Industrial and Financial Reconstruction for a period of five years from the date of sanction of the scheme of revival, or

(iii) is a company in relation to which a resolution plan has been approved by the National Company Law Tribunal under the Insolvency and Bankruptcy Code, 2016 for a period of five years from the date of such approval, it may pay any remuneration to its managerial persons,

(c) where remuneration of a managerial person exceeds the limits in Section II but the remuneration has been fixed by the Board for Industrial and Financial Reconstruction or the National Company Law Tribunal:

Additional Conditions in such certain special circumstances

The limits under this Section shall be applicable subject to meeting all the conditions specified under Section II and the following additional conditions:—

(i) except as provided in para (a) of this Section, the managerial person is not receiving remuneration from any other company;

(ii) the auditor or Company Secretary of the company or where the company has not appointed a Secretary, a Secretary in whole-time practice, certifies that all secured creditors and term lenders have stated in writing that they have no objection for the appointment of the managerial person as well as the quantum of remuneration and such certificate is filed along with the return as prescribed under sub-section (4) of section 196.

(iii) the auditor or Company Secretary or where the company has not appointed a secretary, a secretary in whole-time practice certifies that there is no default on payments to any creditors, and all dues to deposit holders are being settled on time.

Perquisites not included in managerial remuneration

General Exemption

A managerial person shall be eligible for the following perquisites which shall not be included in the computation of the ceiling on remuneration specified in Section II and Section III:—
(a) contribution to provident fund, superannuation fund or annuity fund to the extent these either singly or put together are not taxable under the Income-tax Act, 1961 (43 of 1961);
(b) gratuity payable at a rate not exceeding half a month’s salary for each completed year of service; and
(c) encashment of leave at the end of the tenure.

Special Exemption for expatriate managerial person

In addition to the perquisites specified in paragraph 1 of this section, an expatriate managerial person (including a non-resident Indian) shall be eligible to the following perquisites which shall not be included in the computation of the ceiling on remuneration specified in Section II or Section III—
(a) Children’s education allowance: In case of children studying in or outside India, an allowance limited to a maximum of Rs. 12,000 per month per child or actual expenses incurred, whichever is less. Such allowance is admissible up to a maximum of two children.
(b) Holiday passage for children studying outside India or family staying abroad: Return holiday passage once in a year by economy class or once in two years by first class to children and to the members of the family from the place of their study or stay abroad to India if they are not residing in India, with the managerial person.
(c) Leave travel concession: Return passage for self and family in accordance with the rules specified by the company where it is proposed that the leave be spent in home country instead of anywhere in India.

Family

‘‘family’’ means the spouse, dependent children and dependent parents of the managerial person.

Additional parameter for determination of remuneration

These points are added to the parameter mentioned in Rule 6 mentioned in the last post.

The Nomination and Remuneration Committee while approving the remuneration under Section II or Section III, shall—
(a) take into account, the financial position of the company, trend in the industry, appointee’s qualification, experience, past performance, past remuneration, etc.;

(b) be in a position to bring about objectivity in determining the remuneration package while striking a balance between the interest of the company and the shareholders.

Remuneration payable to a managerial person in two companies:

Subject to the provisions of sections I to IV, a managerial person shall draw remuneration from one or both companies, provided that the total remuneration drawn from the companies does not exceed the higher maximum limit admissible from any one of the companies of which he is a managerial person.

General Condition

Provisions applicable to Parts I and II of this Schedule
1. The appointment and remuneration referred to in Part I and Part II of this Schedule shall be subject to approval by a resolution of the shareholders in general meeting.
2. The auditor or the Secretary of the company or where the company is not required to appointed a Secretary, a Secretary in whole-time practice shall certify that the requirement of this Schedule have been complied with and such certificate shall be incorporated in the return filed with the Registrar under sub-section (4) of section 196.

Provision for Exemption

The Central Government may, by notification, exempt any class or classes of companies from any of the requirements contained in this Schedule.

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[i] The statement along with a notice calling the general meeting referred to in clause (iii) shall contain following information and disclosures:

  1. General information:

(1) Nature of industry

(2) Date or expected date of commencement of commercial production

(3) In case of new companies, expected date of commencement of activities as per project approved by financial institutions appearing in the prospectus

(4) Financial performance based on given indicators

(5) Foreign investments or collaborations, if any.

  1. Information about the appointee:

(1) Background details

(2) Past remuneration

(3) Recognition or awards

(4) Job profile and his suitability

(5) Remuneration proposed

(6) Comparative remuneration profile with respect to industry, size of the company, profile of the position and person (in case of expatriates the relevant details would be with respect to the country of his origin)

(7) Pecuniary relationship directly or indirectly with the company, or relationship with the managerial personnel, if any.

III. Other information:

(1) Reasons of loss or inadequate profits

(2) Steps taken or proposed to be taken for improvement

(3) Expected increase in productivity and profits in measurable terms

  1. Disclosures

The following disclosures shall be mentioned in the Board of Director’s report under the heading “Corporate Governance”, if any, attached to the Financial statement:

(i) all elements of remuneration package such as salary, benefits, bonuses, stock options, pension, etc., of all the directors;

(ii) details of fixed component. and performance linked incentives along with the performance criteria;

(iii) service contracts, notice period, severance fees; and

(iv) stock option details, if any, and whether the same has been issued at a discount as well as the period over which accrued and over which exercisable.

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