The Role of Independent Directors in Corporate Governance: Time to Reclassify Directorial Income?

Introduction

Over the last decade, the concept of Independent Directors (ID) has undergone a considerable transformation in India. This transformation can be seen in the introduction of legislation concerning the role of Independent Directors in company boards and the subsequent effects this has had on corporate governance. Despite the challenges, the institution of IDs has undeniably created a positive impact and served as a significant check when necessary. This article aims to explore the role of Independent Directors in-depth, primarily focusing on the classification of their income.

The Role of Independent Directors: More than Just a 'Sitting Fee'

Independent Directors play a pivotal role in maintaining the integrity of a company's operation. Their contribution to the board extends far beyond mere participation in board meetings. The role of independent directors often encompasses the responsibility to offer impartial advice, make unbiased decisions, and mitigate any potential conflicts of interest. Consequently, these functions demand a high level of professionalism and dedication, making the job anything but easy.

This high-level professionalism naturally leads to a debate concerning the characterisation of the fees earned by IDs. The crux of the matter is whether the income they earn should be classified as “Professional Income” or “Income from Other Sources?”

Distinguishing 'Professional Income' from 'Income from Other Sources '

As of now, sitting fees, along with commissions received by IDs, are typically classified under the category of “other sources.” This classification is mainly due to the Tax Deducted at Source (TDS) provision Sec 194J of the Income Tax Act, which segregates remuneration to directors from fees paid for professional services.

However, considering the extensive preparatory work before and after committee and board meetings and the necessity for continuous reading and updates, there is a strong argument for considering sitting fees as "Professional income." This reclassification is crucial for the directors as it allows them to claim legitimate expenses arising in the discharge of their duties.

The Benefits of Classifying Director Fees as 'Professional Income'

The merits of categorizing sitting fees and commissions as “professional income” are multi-fold. First, it allows the director to claim certain expenses incurred in fulfilling their responsibilities. These might include expenditures related to electricity, car maintenance, travel, and entertainment, among other things.

Second, it introduces the potential benefit of presumptive tax up to ₹50 lakh income, where a flat 50 per cent deduction is allowed as per Sec 44ADA of the Income-Tax Act. This provision was designed for situations where record keeping can be challenging, thereby providing a facility to claim a flat deduction.

Need for a Progressive System of Taxation for Independent Directors

Although a flat 50 per cent deduction seems unrealistic, a graded system of deductions—for instance, 25 per cent for income up to ₹50 lakh and 10 per cent over ₹50 lakh—could promote equity and a more progressive system of taxation. This approach necessitates an official clarification emphasizing that the demands of the role of independent directors require their fees to be classified as "professional income" and not "other sources".

However, one counterpoint to consider is that if it is treated as “professional income,” IDs will need to pay advance tax, which is not required if it's treated as “other sources.” But given the demands of the position and the extensive work involved, this seems a justified trade-off.

Conclusion

In the wake of the profound impacts made by Independent Directors on corporate governance, it seems apt that their compensation be viewed in the light of "professional income." This step will not only reinforce the seriousness and significance of the role of independent directors but also ensure a fairer system of income and taxation. As the role of independent directors continues to evolve, it is crucial to ensure that the regulatory framework keeps pace with these changes, ensuring equity, justice, and fairness in all aspects of this vital function.

In essence, understanding and acknowledging the role of independent directors and their professional income is not only a stride towards a fair income classification but a leap towards a more robust and effective corporate governance system. It is high time to professionalize the role of independent directors, and there's no better starting point than their income classification.

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