FAQs on Managerial Remuneration - Section 197 of Companies Act, 2013

Basics of Managerial Remuneration

Who is Managerial Personnel under Section 197 of the Companies Act, 2013 (“Act”)?

As per Section 197(1), following are covered under Section 197 of the Act:

Manager: An individual who, subject to the superintendence, control and direction of the Board of Directors, has the management of the whole, or substantially the whole, of the affairs of a company, and includes a director or any other person occupying the position of a manager, by whatever name called, whether under a contract of service or not. [Section 2(53) of the Act]

Managing Director: A director who, by virtue of the articles of a company or an agreement with the company or a resolution passed in its general meeting, or by its Board of Directors, is entrusted with substantial powers of management of the affairs of the company and includes a director occupying the position of managing director, by whatever name called.

Whole time Director: A director who is in the whole-time employment of the company.

Who is eligible for managerial remuneration?

• Managerial Personnel as mentioned in Section 197(1)
• Non-Executive Directors (“NED”) (w.e.f. March 18, 2021) as mentioned in Section 197(3)
• Independent Directors (w.e.f. March 18, 2021) as mentioned in Section 197(3)

What is remuneration under Section 197 of the Act?

As per Section 2(78) of the Act, “remuneration” means any money or its equivalent given or passed to any person for services rendered by him and includes perquisites as defined under the Income Tax Act, 1961. 

The phrase ‘Money or its equivalent’ makes it amply clear that remuneration in kind shall not be considered as remuneration under the Act. 

Perquisites shall inter-alia include the following:

• Vale of the rent free accommodation
• Value of securities as defined in Section 2(h) of the Securities Contracts (Regulation) Act, 1956 or sweat equity shares allotted by the company
• Any other fringe benefits 
• Insurance premium: As per Section 197 (13) of the Act, where any insurance is taken by a company on behalf of its managing director, whole-time director, manager, Chief Executive Officer, Chief Financial Officer or Company Secretary for indemnifying any of them against any liability in respect of any negligence, default, misfeasance, breach of duty or breach of trust for which they may be guilty in relation to the company, the premium paid on such insurance shall not be treated as part of the remuneration payable to any such personnel. Provided that if such person is proved to be guilty, the premium paid on such insurance shall be treated as part of the remuneration.
• Reimbursement of direct taxes: [Explanation VI to section IV of Part II of Schedule V

What is NOT remuneration?

As per Section197(2) of the Act, sitting fees paid to directors for attending meetings of the Board or Committee or for any other purpose as may be decided by the Board is not included in managerial remuneration.

As per Section 197(4) of the Act, remuneration received by the director for rendering professional services who possesses the requisite qualification for the practice of the profession. For instance, the director of a company is also a Chartered Accountant and in the capacity of Chartered Accountant he renders consultancy to the Board then such professional fee shall not be a part of remuneration.

Further, as per section IV of Part II of Schedule V, following perquisites shall not be included in the managerial remuneration in case of no profits: 

• 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;
• gratuity payable at a rate not exceeding half a month’s salary for each completed year of service; and
• encashment of leave at the end of the tenure.

What is the maximum limit on remuneration?

When company has adequate profits: 

Section 197 (1) provides the upper limit upto which remuneration can be paid to the directors. The limits are as follows:

Director of Public company	Upper limit (% of net profits)	Remarks
Total remuneration to all directors	11%	Limit can be exceeded by passing an ordinary resolution in general meeting. [First proviso to Section 197(1)]
Any 1 managing director or whole-time director or manager	5%
Total remuneration to all managing director or whole-time director and manager taken together	10%
Total remuneration to all Non-Executive Directors (if there is a managing or whole-time director or manager)	1%
Total remuneration to all Non-Executive Directors (in any other case)	3%
Remuneration payable to a director shall be inclusive of the remuneration payable to him for the services rendered by him in any other capacity. [Section 197(4)]

When company has no profits (Item B of Section II of Part II)

As per Section 197(3) of the Act, in case of no or inadequate profits, the company shall comply with Schedule V for payment of remuneration to its directors or manager. Section II of Part II of Schedule V states that where in any financial year during the tenure of a director or manager, a company has no profits or its its profits are inadequate, it may, pay remuneration to the managerial person not exceeding, the limits under (A) and (B) given below:-

Item (A)

Sl. No.	Effective capital (in rupees)	Limit of yearly remuneration (in Rupees)
		Managing Director, Whole Time Director, Manager	Non-Executive Director, Independent Director
(i)	Negative or less than 5 crores.	60 lakhs	12 lakhs
(ii)	5 crores and above but less than 100 crores.	84 lakhs	17 lakhs
(iii)	100 crores and above but less than 250 crores.	120 lakhs	24 lakhs
(iv)	250 crores and above.	120 lakhs plus 0.01% of the effective capital in excess of Rs. 250 crores	24 Lakhs plus 0.01% of the effective capital in excess of Rs. 250 crores]

Item (B)

Note:

• The remuneration in excess of above Limits may be paid if the resolution passed by the shareholders is a special resolution.
• For a period less than one year, the limits shall be pro-rated.

In case of a managerial person or Non-Executive Director (Including Independent Director) who is functioning in a professional capacity, remuneration as per item (A) may be paid, if such person, at any time during the last two years before or on or after the date of appointment:

• Does not have any interest in capital of the company or its holding company or any of its subsidiaries (directly or indirectly or through any other statutory structures) and
• Is not related to the Directors or promoters of the company or its holding company or any of its subsidiaries
• Possesses graduate level qualification with expertise and specialised knowledge in the field in which the company operates

Further, any employee of a company holding more than 0.5% of paid up share capital of the company under any scheme for allotment of shares to such employees including Employees Stock Option Plan or by way of qualification shall be deemed to be a person having any interest in the capital of the company.

The above limits specified under items (A) and (B) above shall apply, if-

(i) payment of remuneration is approved by a resolution passed by the Board or Nomination and Remuneration Committee, if any;

(ii) 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 creditor, as the case may be, shall be obtained by the company before obtaining the approval in the general meeting.

(iii) 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.

(iv) a statement along with a notice calling the general meeting is given to the shareholders containing the information mentioned in Schedule V.

What is the procedure of payment of remuneration? 

– When company has profits

• Pass Ordinary Resolution (if remuneration is within the aforesaid limits)
• Pass Special Resolution (if remuneration is exceeding the aforesaid limits)
• Also check the Articles of Association of the Company to confirm whether the articles requires Special Resolution irrespective of the above mentioned limits. If yes, then Special Resolution shall be passed.

When company has no profits (Item B of Section II of Part II)

• Payment of remuneration shall be recommended by the Nomination and Remuneration Committee, if any and approved by the Board
• Remuneration shall be approved by passing Ordinary Resolution/Special Resolution for a period not exceeding 3 years. [Note: The rationale behind the period of 3 years is that law makers expected that the company will recover in these 3 years and will not be a loss making company any more.]
• Condition: 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 creditor, as the case may be, shall be obtained by the company before obtaining the approval in the general meeting.

Whether Private companies are required to comply with the provisions of managerial remuneration under Section 197?

Ans: Section 197 applies only to Public Companies and not to Private Companies. Therefore, Private Companies are allowed to pay remuneration at any rate without any limit of 11% whether there is adequacy or inadequacy of profits.

Inadequacy of Profits

What is the meaning of the term “inadequacy” while determining the remuneration under the Act?

Ans: Inadequate remuneration simply means inadequacy of remuneration which the company intends to pay considering the aforesaid limits. For example, 5% of 100 crore (Net Profit as per Section 198) i.e. 5 crore is approved to be paid to the Managing Director. Subsequently in next year, the company proposed to pay 6 crore and the profits remain 100 crore, this is the case of inadequacy of profits. It means the company does not have adequate profits to pay proposed remuneration to the Director. 

In such a case, the company shall comply with the provisions of Section II of Part II of Schedule V.

In case of no profits or inadequate profits, whether the resolution passed for 3 years is passed for remuneration only or the appointment shall also end after 3 years? 

Ans: The resolution for 3 years under Schedule V is passed for approving remuneration whenever there will be inadequacy of profits during the tenure for which the director has been appointed. Therefore, if the appointment has been made for 5 years, that tenure shall continue even if in the subsequent year, a resolution for approving remuneration for maximum 3 years has also been passed.

However, practically it has been seen that companies generally pass resolution for a period of 3 years only and simultaneously approve remuneration in case of inadequate profits.

Approvals and Disclosure requirements

Which approvals are required for payment of remuneration to managerial personnel and other directors?

Ans: Following approvals shall be required on a case to case basis:

• Audit Committee shall consider and recommend to the Board (since it is a transaction with a related party of the Company)
• Nomination and Remuneration Committee, if any, shall also recommend
• Board Resolution shall be passed.
• Ordinary Resolution shall be passed (if remuneration is within the prescribed limits i.e. up to 5%, 10%, 1%, or 3%, as the case may be, or total 11%)
• Special Resolution shall be passed (to exceed the aforesaid limits)
• Special Resolution + Prior approval of bank or public financial institution concerned or the non-convertible debenture holders or other secured creditor (in case of defaulting company).

What are the disclosure requirements pursuant to appointment of managerial personnel?

Ans: Section 134 of the Act read with Rule 5 of the Companies (Appointment and Remuneration of Managerial Personnel) Rules, 2014 provides for the following disclosures in the board’s report:

A statement showing the names of the top ten employees in terms of remuneration drawn and the name of every employee, who-

• (i) if employed throughout the financial year, was in receipt of remuneration for that year which, in the aggregate, was not less than one crore and two lakh rupees;
• (ii) if employed for a part of the financial year, was in receipt of remuneration for any part of that year, at a rate which, in the aggregate, was not less than eight lakh and fifty thousand rupees per month;
• (iii) if employed throughout the financial year or part thereof, was in receipt of remuneration in that year which, in the aggregate, or as the case may be, at a rate which, in the aggregate, is in excess of that drawn by the managing director or whole-time director or manager and holds by himself or along with his spouse and dependent children, not less than two percent of the equity shares of the company.

The above statement shall also indicate the following-

• (i) designation of the employee;
• (ii) remuneration received;
• (iii) nature of employment, whether contractual or otherwise;
• (iv) qualifications and experience of the employee;
• (v) date of commencement of employment;
• (vi) the age of such employee;
• (vii) the last employment held by such employee before joining the company;
• (viii) the percentage of equity shares held by the employee in the company within the meaning of clause (iii) of sub-rule (2) above; and
• (ix) whether any such employee is a relative of any director or manager of the company and if so, name of such director or manager

Whether Rule 5(2) which requires companies to disclose top ten employees in terms of remuneration is applicable on Private Companies?

Ans: Since Section 197 of the Act is not applicable on Private companies, disclosure under the Rule shall also not be applicable on Private Companies. 

Remuneration to Non-Executive Directors (Including Independent Directors)

Why Non-Executive Directors (including Independent Directors) are being considered at par with the Managerial Personnel to get remuneration even during inadequate profits or loss?

Ans: Non-Executive Directors (including Independent Directors) bring a greater level of the corporate governance practices in the company. Not to forget they aid the Board of Directors in making crucial decisions for the benefit of the company. Therefore, the amendment was made considering the above factors and deciding that they should also be adequately compensated for their contribution in the growth in the company even if the company does not have adequate profits.

Will the company need to modify its Nomination and Remuneration Policy to allow remuneration in case of inadequate or no profits?

Ans: If there is any clause in the remuneration policy which talks about remuneration in case of inadequacy of profits, the policy need to be amended and include Non-Executive Directors (including Independent Directors) for such remuneration at the discretion of the Board of the Company

Practical Issues

Is the company required to enter into an agreement with the Managerial Personnel for its appointment or the resolution passed by the members of the company will suffice?

Ans: There is no provision in the Act which mandates the company for entering into an agreement with the managerial personnel. However, by entering into a contract with the managerial personnel, both the parties will be bound by the provisions of the Indian Contract Act, 1872. Therefore, if any term of the Agreement is violated by either of the parties, even if there is no remedy in the Companies Act, 2013, the same will come under the ambit of the Indian Contract Act, 1872. Therefore entering into an agreement is always recommended (if not mandated) for the safeguard of the protection of rights of both the parties.

What are the parameters which should be considered while fixing remuneration?

Ans: Section 200 of the Act provides for the following Parameters for consideration of remuneration:

• (1) the Financial and operating performance of the company during the three preceding financial years.
• (2) the relationship between remuneration and performance.
• (3) the principle of proportionality of remuneration within the company, ideally by a rating methodology which compares the remuneration of directors to that of other directors on the board who receives remuneration and employees or executives of the company.
• (4) whether remuneration policy for directors differs from remuneration policy for other employees and if so, an explanation for the difference.
• (5) the securities held by the director, including options and details of the shares pledged as at the end of the preceding financial year.

When the company is required to recover remuneration from its Managerial Personnel?

Ans: As per Section 199 of the Act, where a company is required to re-state its financial statements due to fraud or non-compliance with any requirement under this Act and the rules made thereunder, the company shall recover from any past or present managing director or whole-time director or manager or Chief Executive Officer (by whatever name called) who, during the period for which the financial statements are required to be re-stated, received the remuneration (including stock option) in excess of what would have been payable to him as per restatement of financial statements.

Whether “profit-linked” commission is a part of remuneration under Section 197?

Ans: Yes, profit‐linked Commission is a part of the remuneration and shall be paid within the monetary limit approved by the Board/ Shareholders of the Company subject to the limit of 1% or 3%, as the case may be, of the net profits of the Company. Reason being Non-Executive Directors are generally compensated only by way of sitting fees or profit based commission. Now, sitting fees is expressly excluded from remuneration, thus any other compensation shall become a part of remuneration and comply with limits under Section 197.

Whether the remuneration of the director appointed in place of profit as per Section 188 will be governed by the monetary limits under Section 197?

Ans: Yes, Section 197 is the charging section for any remuneration to directors and thus, shall be complied with along with Section 188 of the Act.

Is managerial remuneration a related party transaction under Section 188(1)(d) which talks about availing of services?

Ans: Section 197 is the charging section for managerial remuneration under the Act and therefore Section 188 which is the general section for related party transactions should not be looked into. However, even if managerial remuneration is not specifically mentioned under Section 188, it is anyway a transaction with related party of the company and will require consideration by the Audit Committee, if any.

Whether a director is allowed to receive remuneration from both holding and subsidiary companies?

Ans: Section V of Part II of Schedule V clearly provides that 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.