Managerial Remuneration and Net Profit under Section 198

Understand Managerial Remuneration and Net Profit under Section 198

Key rules to remember

Net profit under Section 198 (working format)

Profit before tax as per Statement of Profit and Loss + managerial remuneration charged + capital losses charged − profits of a capital nature credited

If you start from profit after tax, first add back the tax provision. Income tax is not a deduction in this computation. Capital losses are not deductible, so add them back if they were charged.

Overall ceiling for managerial remuneration

Maximum total remuneration = 11% × net profit

Applies to a public company, for all directors, managing director, whole-time directors and manager together. Paying more than 11% is allowed only by a special resolution in general meeting, and it must comply with Schedule V. Private companies are not subject to this limit.

Managing director, whole-time directors and manager

If there is one such person: up to 5% of net profit. If there is more than one: up to 10% of net profit together

These limits apply to the MD, WTD and manager only, not to directors generally. All remuneration must stay within the 11% overall ceiling. Paying above the 5% or 10% limit is allowed only with approval by a special resolution in general meeting.

Directors who are neither MD nor WTD

If company has MD, WTD or manager: 1% of net profit. If it has none of them: 3% of net profit

Sitting fees for attending meetings are treated separately. Follow the question's instruction on how to treat them. These amounts also fall within the 11% overall ceiling. Paying above the 1% or 3% limit is allowed only with approval by a special resolution in general meeting.

Items not credited in computing net profit

Premium on shares or debentures; profit on sale of forfeited shares; profits of a capital nature, including profit from sale of an undertaking or any part of it; profit on sale of immovable property or fixed assets, only where it is of a capital nature

Remove these from profit if they were credited in the Statement of Profit and Loss. If the company deals in such property or assets, the profit is a business profit and is not removed. Government bounties and subsidies stay in net profit unless the Central Government directs otherwise, so no adjustment is needed for them.

Inadequate profit or no profit

Remuneration payable as per Schedule V

Learn the effective-capital slabs from the latest ICAI material. Do not guess them.

How to solve Managerial Remuneration and Net Profit under Section 198 questions

1. 1Identify the starting figure: profit before tax, profit after tax, or a trial-balance based profit. If it is after tax, add the tax provision back.
2. 2Add back all remuneration to directors, managing director, whole-time directors and manager that has been charged in the profit.
3. 3Add back losses of a capital nature that were charged, such as loss on sale of fixed assets or loss on sale of an undertaking.
4. 4Deduct credited items that Section 198 does not allow: premium on shares or debentures, profit on sale of forfeited shares, profits of a capital nature (including profit from sale of an undertaking), and profit on sale of immovable property or fixed assets of a capital nature.
5. 5Leave items such as government subsidies as they are and do not make adjustments for ordinary business items.
6. 6Write the net profit clearly in a separate line. This earns the step marks.
7. 7Check which case applies: company with or without MD, WTD or manager. Then compute 11% overall, 5% or 10% for the MD, WTD and manager, and 1% or 3% for other directors, as asked.
8. 8Compare actual remuneration with the limit. State the excess or the permissible amount, and note that Schedule V applies if profits are inadequate.

Quickest way: Adjustment grid and percentage ladder

Common mistakes in Managerial Remuneration and Net Profit under Section 198

• Taking the profit shown in the Statement of Profit and Loss as the net profit for the limits.

  Students forget that Section 198 has its own method and use profit directly.

  Fix: Always write a net profit statement with additions and deductions before applying any percentage.

• Not adding back remuneration to directors that was already charged.

  The remuneration looks like an ordinary expense, so students leave it deducted.

  Fix: Add back all managerial remuneration. The base for the limit must be before that remuneration.

• Deducting income tax or starting from profit after tax without adding back the tax provision.

  Students are used to profit after tax as the bottom line figure.

  Fix: Start from profit before tax, or add the tax provision back if the question gives profit after tax.

• Including capital profits such as profit on sale of fixed assets or premium on securities in net profit.

  These items are in the Statement of Profit and Loss, so students assume they count.

  Fix: Remove profits of a capital nature and the other items Section 198 says are not to be credited. Add back capital losses if charged.

• Applying 1% for other directors when the company has no MD, WTD or manager, or applying 3% when it has one.

  Students memorise the two percentages without the condition.

  Fix: Check first whether the company has an MD, WTD or manager. If yes, 1%. If none, 3%.

• Applying the 5% and 10% limits to all directors, or adding the 5%, 10%, 1% and 3% figures on top of the 11% ceiling.

  Students treat the percentages as one ladder and add them together.

  Fix: The 5% or 10% limit is only for the MD, WTD and manager. The 1% or 3% limit is for directors who are neither MD nor WTD. All remuneration must stay within the 11% overall ceiling. Do not add the percentages to it.

Worked examples