1. Employment termination due to business reorganization — Receipt of shares as compensation for loss of employment — Taxability under Section 7(1) of the Income-tax Act, 1922. (Para 2 )
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1962 Supreme(SC) 430
SUPREME COURT OF INDIA
A.K.Sarkar : J.L.Kapur : Raghubar Dayal : S.R.Dass
Commissioner Of Income Tax, Bombay
Versus
E.D.Sheppard Bormbay
Case No. : 527 of 1961
Date of Decision : 12/12/62
Advocates Appeared: Mathur O.C. : Narain Ravindra : Palkhivala N.A. : Sachthey R.N. : Sastri K.N.R.
Advocates:
K.N.R.SASTRI, N.A.PALKHIWALA, O.C.MATHUR, R.N.SACH, Ravindra Narayan
K.N.R.SASTRI, N.A.PALKHIWALA, O.C.MATHUR, R.N.SACH, Ravindra Narayan
Payments made by an employer to an employee as compensation for loss of employment, whether voluntary or legally compellable, are capital receipts and not taxable as "profit in lieu of salary" under the Income-tax Act, 1922, provided they are not remuneration for past services.
Headnote:(A) Income-tax Act, 1922 - Section 7(1) and Explanation 2 - Compensation for loss of employment - Interpretation of "compensation" - The expression "compensation for loss of employment" used in Explanation 2 to Section 7(1) refers to any payment made, whether under a legal liability or voluntarily, to compensate or act as a solatium for the loss of employment suffered by the employee (Paras 10, 11). It is not necessary that the payment be the monetary equivalent of damages compellable at law (Paras 8, 12).
(B) Nature of Receipt - Capital vs. Revenue - A payment made solely as compensation for loss of employment is a capital receipt because it is in respect of the source of income, and therefore is not assessable as "profit received in lieu of salary" (Paras 13, 14). The fact that the employee secures another equally advantageous employment immediately after the termination of the previous one does not alter the nature of the payment (Paras 3, 5).
(C) Loss of Prospects - Compensation for loss of future prospects rooted in employment cannot be distinguished from compensation for loss of employment itself and remains non-taxable if made solely for that purpose (Paras 5, 14).
Facts of the case:
An employee of a partnership firm received shares upon the termination of his services resulting from the firm's reorganization into limited companies. The services were terminated with one month's notice as per the contract. The employee immediately joined one of the new companies on similar financial terms. The shares were allotted as compensation for loss of employment. The tax authorities sought to tax the value of these shares as remuneration for past services, while the assessee claimed they were a non-taxable capital receipt.
Findings of Court:
The payment was made solely as compensation for loss of employment and not as remuneration for past services. The evidence provided by the partners of the firm was accepted, confirming the intent of the payment. Consequently, the amount is not taxable as "profit in lieu of salary."
Issues: Whether a payment made by an employer to an employee upon termination, described as compensation for loss of employment, is taxable as "profit in lieu of salary" under Section 7(1) of the Income-tax Act, 1922, particularly when the employer had no legal liability to pay such compensation and the employee found alternative employment.
Ratio Decidendi: The court held that "compensation for loss of employment" includes voluntary payments made as a solatium for the deprivation of the source of income. Such payments are capital receipts and are specifically excepted from the definition of "profit received in lieu of salary" under Explanation 2 to Section 7(1), provided they are not remuneration for past services. The lack of a legal claim for damages does not disqualify a payment from being treated as compensation for loss of employment.
Result: Appeal dismissed with costs.
Act Referred
Legal Category Hierarchy
Table of Contents
2. Whether compensation for loss of employment must be legally compellable damages or can be a voluntary solatium — Taxability as profit in lieu of salary. (Para 7 , 17 , 18 )
3. Compensation for loss of employment includes voluntary payments or solatia for deprivation of profits, regardless of legal compellability or mitigation of loss through new employment. (Para 8 , 9 , 10 , 11 , 12 , 13 , 14 )
4. Payments made solely as compensation for loss of employment, including voluntary solatia, are capital receipts and not taxable as profits in lieu of salary. (Para 12 , 14 )
5. Appeal dismissed; payment held as non-taxable compensation for loss of employment. (Para 15 , 48 )
6. Does compensation for loss of employment under the Income-tax Act require the payment to be legally compellable as damages?
No. Compensation for loss of employment includes payments made whether under legal liability or voluntarily to act as a solatium for the loss of employment suffered by the employee. (Para 10 , 11 , 12 )
7. Does securing another advantageous employment immediately after termination affect the nature of a payment received as compensation for loss of employment?
No. If a payment is agreed upon as compensation for the loss of employment, the fact that the assessee did not actually suffer a financial loss by securing other employment does not alter the payment's nature. (Para 3 , 5 )
8. Is compensation for the loss of future prospects within a specific employment treated differently from compensation for the loss of the employment itself?
No. Expectations or prospects are rooted in the employment; therefore, it is difficult to distinguish between compensation for loss of employment and compensation for loss of prospects in that employment. (Para 5 , 14 )
9. When is a payment received from an employer upon termination of service considered a capital receipt rather than a revenue receipt?
A payment is a capital receipt when it is made solely as compensation for the loss of the source of income (employment/office), rather than as remuneration for past services. (Para 8 , 13 , 14 )
S.K. DAS, J.
(1) THIS is an appeal on a certificate of fitness granted by the High court of Bombay under s. 66-A (2) of the Indian Income-tax Act, 1922.
(2) THE relevant facts lie within a narrow compass. The Commissioner of Income-tax, Bombay, is the appellant before us and the assessee, E. D. Sheppard, is the respondent. Killick Nixon & Company was a partnership concern carrying on business on a fairly largescale in India. It owned various mills and managing agencies of a number of limited companies. This partnership firm used to employ officer- assistant mostly Europeans, on the basis of a contract for three years; if the services of the assistants, so employed were found satisfactory, extensions were invariably given after every three years on increased salary. Subject to their work being satisfactory, the assistants so employed expected to become partners of the firm one day. The assessee was one of such assistants who joined the firm in 1930. The original contract relating to the assessees employment was not placed on record. What was placed on record as a specimen copy of the initial agreement, was the contract with one W. J. Heygate. It was undisputed that the terms of employment regarding the assessee were the same as those of the contract with W.J. Heygate. Clause 10 of the said agreement provided that notwithstanding anything contained in it, the firm might terminate the agreement without assigning any reasons after giving the assessee one calendar months previous notice of its intention so to do. The assessee continued in the employment of the firm and his contract of service was renewed from time to time. On 1/11/1947, was made the last renewal. The terms of this last renewal were the same as those of J. G. Milne, a copy of whose renewed contract was placed on record. This renewal provided for a contract of service from November 1, 194 7/10/1950. Under this contract the assessee was to receive a salary of Rs. 1,200.00 per month plus a commission of 21 per cent on the net profits of the partnership. The Appellate tribunal found that if the partnership had continued to do business, the assessee would have got approximately Rs. 5,000.00 per annum. Sometime about the last quarter of the year 1947 the firm decided to reorganise its business and with that end in view two limited companies were floated: one was called the Killick Industries Ltd., which was a public limited company, and the other was called Killick Nixon and Company which was a private limited company. This private limited company was to take over the business previously carried on by the partnership. This arrangement necessitated the termination of the services of the firms employees and the assessee received a notice from the firm dated 29/12/1947. This notice stated that in view of the changes proposed, the assessees employment with the firm would terminate as from 31/01/1948. The assessee was then about 38 years old. There were in all sixteen officers including the assessee who were employed with the firm on `contract terms`. With the exception of one, all these sixteen officers were Europeans. The three years contracts expired on different dates depending upon the original date of employment in respect of these sixteen officers. So far as the assessee was concerned it appears that the new company styled Killick Industries Ltd., agreed to take over the services of the assessee on new terms under which his salary was increased but the commission was disallowed, but he was left in more or less the same position financially. The assessee entered the employment of Killick Industries Ltd. on these new terms on 1/02/1948. Killick Nixon and Company transferred their assets to the new companies and received shares of the new companies in lieu thereof. A large number of shares of Killick Industries Ltd. were put on the Indian market. The shares were of the face value of Rs. 100.00 only but were quoted in market at Rs. 130.00 per share.
