The Permissible Managerial Remuneration as Per Companies Act 2013

Managerial remuneration refers to the compensation paid to directors and key managerial personnel (KMP) for their services to a company. The Companies Act, 2013 provides a regulatory framework to ensure that such remuneration is reasonable, transparent, and aligned with the company's financial health.

In this blog, you will learn about permissible limits, computation methods, compliance requirements, and other key aspects related to managerial remuneration under the Companies Act.

What is Managerial Remuneration?

Managerial Remuneration refers to the compensation or payment made to directors and Key Managerial Personnel (KMP) of a company for the services they render. This encompasses salaries, commissions, bonuses, perquisites, and other benefits. The Companies Act, 2013, provides a comprehensive framework governing managerial remuneration to ensure transparency, accountability, and protection of stakeholders' interests.

Statutory Limits under Section 197

Under Section 197 of the Companies Act, 2013, the statutory limits on managerial remuneration for public companies are as follows:

1. Overall Ceiling: The total managerial remuneration a public company can pay to its directors, including the managing director, whole-time director, and manager, is capped at 11% of the company’s net profits for that financial year. This limit ensures that compensation remains reasonable and aligned with the company's financial performance.
2. Individual Limits: The remuneration for a Managing Director or Whole-Time Director cannot exceed 5% of the company’s net profits. If there are multiple Managing or Whole-Time Directors, their combined remuneration, along with the manager’s, is capped at 10% of the net profits. For Non-Executive Directors, the payment is limited to 1% of net profits if there is a Managing or Whole-Time Director or manager. Without such positions, the limit increases to 3% of the company’s net profits. These limits ensure fair and balanced compensation practices within a company.
3. Exceeding Limits: A company can pay remuneration beyond the specified limits if approved by a shareholder resolution in a general meeting. This approval must align with the guidelines outlined in Schedule V of the Companies Act. This ensures that any excess compensation is justified and legally compliant.
4. Inadequacy of Profits: When a company has no profits or earns inadequate profits, it is restricted from paying remuneration to its directors. This includes the managing or whole-time director and the manager. However, such payments can be made if they comply with the conditions in Schedule V of the Companies Act.
5. Disclosure: The company must mention in the Board's report how each director's pay compares to the median salary of its employees. It should also include any other required details as per the legal guidelines.
6. Recovery of Excess Remuneration: If a director receives more remuneration than allowed by law or without the required approval from the shareholders in a general meeting, they must return the extra amount to the company. Until the excess amount is fully refunded, the director is considered to be holding it in trust for the company. This rule helps ensure fairness, accountability, and proper financial conduct within the company’s management structure.
7. Penalties: If a company does not follow the rules related to managerial remuneration, it can face a penalty of Rs. 1 lakh. Additionally, each officer responsible for the non-compliance may also be fined Rs. 1 lakh. These penalties promote accountability and ensure adherence to legal provisions.

Computation of Net Profits (Section 198)

Section 198 of the Companies Act, 2013, explains how to calculate a company’s net profits. This calculation is important for deciding managerial pay under Section 197 and meeting CSR responsibilities under Section 135.

Key Provisions of Section 198

Here are the key provisions of Section 198:

1. Inclusions in Net Profit

Bounties and subsidies received from any government or public authority, unless directed otherwise by the Central Government.

2. Exclusions from Net Profit

Certain profits are excluded from a company's net profit calculation. This includes profits from issuing shares or debentures at a premium and gains from selling forfeited shares. Capital profits, such as those from selling business assets, are also excluded. Similarly, profits from selling immovable property are excluded unless it's part of the company’s normal business activities. Unrealized gains, notional gains, and asset revaluations are also not considered in net profit calculations.

3. Deductions Permitted

When calculating a company’s net profit, certain deductions are allowed. These include regular working expenses, directors' remuneration, and bonuses or commissions paid to employees. Taxes classified as excess profit tax and interest on loans or debentures can also be deducted. Additionally, non-capital repairs, depreciation under Section 123, legal compensation or damages, and written-off bad debts are permissible deductions. These help in reflecting the company’s true financial position.

4. Deductions Not Permitted

When calculating a company’s net profit, some deductions are not allowed. These include income tax and super-tax the company must pay, voluntarily paid compensation or damages, and capital losses from asset sales. Unrealized or notional losses are also excluded.

Practical Implications

Here are the practical implications:

• Managerial Remuneration: The net profits calculated under Section 198 are used to determine the maximum allowable managerial remuneration as outlined in Section 197. This ensures that the compensation aligns with the company's financial performance.
• Corporate Social Responsibility (CSR): Companies meeting specific criteria are required to allocate a certain percentage of their average net profits. These profits are calculated under Section 198. The funds must be directed toward Corporate Social Responsibility (CSR) initiatives. This supports social and environmental causes.

Remuneration in Case of No or Inadequate Profits (Schedule V)

Schedule V of the Companies Act, 2013, outlines guidelines for determining managerial remuneration when a company has no profits or insufficient profits. It ensures that managers are fairly compensated while also protecting the interests of shareholders and creditors. This maintains a balance between fairness and financial stability.

Key Provisions of Schedule V

Here are the key provisions of Schedule V:

1. Eligibility Criteria for Payment of Remuneration

A company is allowed to pay its managerial personnel even when it has no profits or its profits are inadequate. However, this is only possible if specific conditions are fulfilled. The company should not have any loan defaults. The proposed remuneration must stay within the limits mentioned in Schedule V, and approval from the Central Government is necessary if applicable.

2. Limits on Remuneration

Schedule V specifies the maximum permissible remuneration based on the effective capital of the company:

1. Effective Capital: Negative or less than Rs. 5 crore: If a company’s effective capital is negative or below Rs. 5 crores, it can pay up to Rs. 60 lakh annually to managerial personnel and up to Rs. 12 lakh per year to other directors.
2. Effective Capital: Rs. 5 crore to less than Rs. 100 crore: A company with effective capital ranging from Rs. 5 crore to under Rs. 100 crore is allowed to pay Rs. 84 lakh per year to a managerial person. Another director can receive up to Rs. 17 lakh annually.
3. Effective Capital: Rs. 100 crore to less than Rs. 250 crore

A managerial person can be paid up to Rs. 120 lakh per year with effective capital between Rs. 100 crore and Rs. 250 crore. Another director is eligible for a maximum annual remuneration of Rs. 24 lakh.

4. Effective Capital: Rs. 250 crore and above

For companies with effective capital of Rs. 250 crore or more, the managerial person is entitled to Rs. 120 lakh annually. Additionally, they can receive 0.01% of the capital exceeding Rs. 250 crore. Other directors can receive Rs. 24 lakh, plus the same percentage. These payments do not require Central Government approval, provided Schedule V conditions are met.

3. Additional Conditions

1. Approval by Board and Shareholders: The Board of Directors must approve the appointment and salary of managerial personnel. In certain cases, a special resolution passed by the shareholders at a general meeting is also required for final approval.
2. Agreement in Writing: A written agreement must be signed between the company and the managerial personnel. This document should clearly mention the terms of the appointment and payment details.
3. No Remuneration if Default Exists: When a company fails to repay any of its debts, it cannot pay remuneration to its managerial personnel under Schedule V. This rule ensures financial responsibility and protects creditors’ interests.

4. Role of Central Government

In some situations, companies need to get prior approval from the Central Government before paying remuneration that goes beyond the set limits. This is especially necessary if the company has defaulted on debt repayments or plans to pay more than the allowed amount.

5. Disclosures

The company must mention certain details in its Board’s report to maintain transparency. This includes how much each director is paid, the ratio of each director’s pay to the median employee’s salary, and other required information. These disclosures help promote fairness and accountability in the company’s pay practices.

Modes of Remuneration

The "Modes of Remuneration" under the Companies Act, 2013, specifically within Schedule V, refers to the different ways a company can pay its managerial personnel. It includes managing directors, whole-time directors, and managers. These payment methods are structured to align with the company’s performance and ensure compliance with legal guidelines. This promotes fairness and transparency in compensation.

Here are the modes of remuneration:

• Monthly Remuneration

A fixed and regular monthly salary is the most common type of compensation for managerial personnel. It is subject to the limits set in Schedule V of the Companies Act, 2013. The salary amount is determined by the company’s effective capital and must be approved by the Board of Directors. In certain cases, shareholder approval may also be required.

• Percentage of Net Profits

When a company has sufficient profits, remuneration can be paid as a percentage of its net profits, as calculated under Section 198. The percentage is determined according to the limits outlined in Schedule V. This remuneration must be approved by the Board of Directors and, in some cases, by the shareholders.

• Combination of Fixed Salary and Percentage of Net Profits

Companies may choose to offer a mix of a fixed monthly salary along with a percentage of net profits. This flexible approach ensures that managerial compensation is aligned with the company’s performance. However, the total remuneration must stay within the limits specified in Schedule V of the Companies Act.

• Commission Based on Performance

Companies may also pay commissions to managerial personnel based on performance metrics. This incentivizes managers to enhance company performance. The commission is subject to the overall limits on remuneration and must be approved by the Board and shareholders.

• Perquisites and Allowances

In addition to the above, companies may provide perquisites and allowances, such as housing, medical benefits, and company cars. These are considered part of the total remuneration and must be valued according to the Income tax Act 1961. The total value of perquisites and allowances is subject to the limits prescribed in Schedule V.

• Stock Options

Stock options are often part of a managerial compensation package, although they are not direct cash payments. These options are designed to align managers' interests with the company’s long-term performance. However, companies must ensure compliance with the provisions of the Companies Act and the regulations set by the Securities and Exchange Board of India (SEBI).

• Retirement Benefits

Companies may provide retirement benefits, such as provident funds, gratuity, and pension schemes, to their managerial personnel. These benefits are governed by the respective laws and are considered part of the total remuneration.

• Reimbursement of Expenses

Reimbursement for expenses like travel or entertainment incurred by managerial personnel is not considered part of their remuneration. However, such reimbursements should be reasonable. They must also be supported by proper documentation to ensure transparency and compliance.

Approval and Disclosure Requirements

The Companies Act, 2013, establishes a comprehensive framework governing the approval and disclosure of managerial remuneration to ensure transparency, accountability, and protection of stakeholders' interests.  Here are the approval and disclosure requirements:

Approval Requirements

1. Overall Remuneration Limits:

Section 197(1) of the Companies Act, 2013, states that a public company can pay up to 11% of its net profits in a financial year as total managerial remuneration. This includes payments to directors, managing directors, whole-time directors, and the manager. If the company wants to pay more than this limit, it must first get approval from its shareholders through a special resolution passed in a general meeting. This ensures transparency and accountability in compensation practices.

2. Remuneration to Individual Directors:

Under the Companies Act, a single managing director, whole-time director, or manager can receive a maximum of 5% of the company's net profits as remuneration. If the company has more than one of these individuals, their combined remuneration must not exceed 10% of the net profits. These limits help ensure fairness and prevent excessive payouts to top management.

3. Remuneration in Case of No or Inadequate Profits:

When a company does not earn any profit or earns too little, it can still pay remuneration to its directors by following the rules outlined in Schedule V of the Companies Act. However, if the company cannot meet the conditions set in Schedule V, it must obtain prior approval from the Central Government before making such payments to the directors.

4. Approval by Shareholders:

If a company wants to pay remuneration that exceeds the prescribed limits, it must get the approval of its shareholders by passing a special resolution. This resolution should be approved in a general meeting and filed with the Registrar of Companies.

Disclosure Requirements

1. Board’s Report:

Section 197(12) of the Companies Act, 2013, requires every listed company to disclose specific remuneration details. This includes the ratio of each director’s salary to the median salary of employees. The report must also include other prescribed information for transparency.

2. Annual Return:

According to Section 92 of the Companies Act, companies must file an annual return every year. This return should include details about the directors and key managerial personnel, along with their remuneration.

3. Financial Statements:

Section 129 of the Companies Act states that a company’s financial statements must present a true and fair view of its overall condition. This includes clearly reporting the remuneration paid to its directors and key managerial personnel.

4. Filing with Registrar:

Companies are required to submit returns to the Registrar of Companies that detail the appointment and remuneration of directors and key managerial personnel. These filings must be completed within the timelines set by law.

Consequences of Non-Compliance

The Companies Act, 2013, along with its later amendments, provides clear rules for appointing and paying managerial personnel. Failure to follow these rules can result in strict penalties and legal consequences for both the company and its responsible officers. Here are the consequences of Non-Compliance:

1. Non-Appointment of Key Managerial Personnel (KMP)

Section 203 of the Companies Act, 2013, requires specific types of companies to appoint full-time key managerial personnel such as a Managing Director (MD), Chief Executive Officer (CEO), Whole-time Director, Chief Financial Officer (CFO), and Company Secretary. If a company fails to meet this requirement, it may face penalties as stated under Section 203(5) of the Act.

Penalties:

If a company fails to comply with the provisions, it can be fined Rs. 5,00,000. Each responsible director and key managerial person may face a Rs. 50,000 penalty. If the violation continues, an extra Rs. 1,000 per day is charged, up to an additional penalty of Rs. 5,00,000.

Case Example:

M/s. XYZ Ltd.: The company failed to appoint a Whole-time Company Secretary as required under Section 203. The Registrar of Companies levied penalties on the company and its directors due to their failure to comply with statutory requirements

2. Payment of Remuneration in Violation of Section 197

Section 197 of the Companies Act, 2013, stipulates the maximum permissible managerial remuneration payable by a public company to its directors, including MD and Whole-time Director, and its manager. Exceeding these limits without necessary approvals constitutes a violation.

Penalties:

A company that violates the rules may face a penalty of Rs. 5,00,000. Additionally, any director or manager responsible for the default can be fined up to Rs. 1,00,000 for the offence.

Case Example:

M/s. ABC Ltd.: The company paid remuneration to its MD exceeding the limits prescribed under Section 197 without obtaining the necessary approvals. The Registrar of Companies imposed penalties on the company and the MD for this violation.

3. Additional Consequences

Here are the additional consequences:

• Disqualification of Directors: Persistent non-compliance may lead to the disqualification of directors under Section 164 of the Companies Act, 2013.
• Legal Proceedings: The Ministry of Corporate Affairs (MCA) may initiate legal proceedings against defaulting companies and officers, leading to further penalties and sanctions.
• Reputational Damage: Non-compliance can adversely affect a company's reputation, impacting investor confidence and stakeholder relationships.

Conclusion

The Companies Act, 2013, specifically through Sections 197 and 198 and Schedule V, establishes a clear framework for determining managerial remuneration. This framework ensures a balance between the company’s interests and those of its stakeholders. Compliance with these regulations is crucial for transparency, strong corporate governance, and avoiding any potential legal issues.

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