1. Employment contract termination — Payment of salary in lieu of notice — Taxability of receipt under Indian Income-tax Act, 1922. (Para 1 , 2 )
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1963 Supreme(SC) 88
SUPREME COURT OF INDIA
A.K.Sarkar : M.Hidayatullah : S.R.Dass
V.D.Talwar
Versus
Commissioner Of Income-tax, Bihar
Case No. : 673 of 1962
Date of Decision : 3/26/63
Advocates Appeared: Narasimhan M.S. : Sachthey R.N. : Sastri A.V.Viswanatha : Singh Gopal
Advocates:
A.V.VISHWANATHA SASTRI, Gopal Singh, M.S.NARASIMHAN, R.N.SACH
A.V.VISHWANATHA SASTRI, Gopal Singh, M.S.NARASIMHAN, R.N.SACH
Payment made in lieu of a contractual notice period upon termination of employment is considered remuneration (revenue receipt) and not compensation for loss of office (capital receipt), provided the payment is made according to the contract terms and no contractual rights are deprived.
Headnote:(A) Indian Income-tax Act, 1922 - Section 7, Explanation 2 - Payment received in lieu of notice - Revenue receipt vs. Capital receipt - Whether a lump sum payment made in lieu of the notice period stipulated in the employment contract constitutes compensation for loss of office or is taxable as salary - If the contract provides for termination by giving notice or paying salary in lieu thereof, and the employer opts for the latter, the employee is not deprived of any contractual rights - Such payment is essentially remuneration for the office and is liable to tax as revenue income. (Paras 5, 6, 8)
(B) Compensation for loss of office - Meaning - Payment to a holder of an office as compensation for being deprived of profits to which he would have been entitled but for an act of deprivation - Where the payment is made under the terms of the contract and the recipient surrenders no rights, it cannot be termed as compensation for loss of office. (Paras 5, 6)
Facts of the case:
An employee was appointed for a five-year term. The contract allowed termination by either party upon twelve months' notice or payment of salary in lieu thereof. The employer terminated the services before the expiry of the term without any misconduct, paying twelve months' salary in lieu of notice. The employee claimed this amount was compensation for loss of employment and thus a non-taxable capital receipt.
Findings of Court:
The payment was made exactly as per the terms of the employment contract. The employee was not deprived of any rights under the contract, as the option to pay salary in lieu of notice was a contractual provision. The amount received is effectively salary for the notice period, regardless of whether work was performed during that period.
Issues: Whether the sum received by the employee in lieu of the notice period was revenue income liable to tax under the Income-tax Act or a capital receipt not liable to tax.
Ratio Decidendi: The court held that for a payment to be "compensation for loss of office," there must be a deprivation of rights under the agreement. Where a payment is made pursuant to a contractual clause allowing termination via salary in lieu of notice, the employee receives exactly what they are entitled to under the contract. Such a payment is a profit of the office and constitutes remuneration, making it a revenue receipt taxable under the Act.
Result: Appeal fails and is dismissed with costs.
Act Referred
Legal Category Hierarchy
Table of Contents
2. Whether payment received in lieu of notice constitutes taxable revenue income or non-taxable capital receipt as compensation for loss of employment. (Para 3 , 4 )
3. Payment made under contractual terms for salary in lieu of notice does not constitute deprivation of rights or compensation for loss of office. (Para 5 , 6 , 7 , 8 )
4. Salary paid in lieu of notice under a contract of employment is remuneration for the office and taxable as revenue income, not capital compensation. (Para 6 , 8 )
5. Appeal dismissed; payment held to be taxable revenue income. (Para 9 )
6. What constitutes compensation for loss of office in the context of employment termination?
Compensation for loss of office is a payment made to an office holder for being deprived of profits to which they would have been entitled but for an act of deprivation by the employer or a third party. (Para 5 )
7. Is salary paid in lieu of notice considered compensation for loss of office?
No. If the contract provides for termination via notice or salary in lieu thereof, such payment is a contractual entitlement and not a result of deprivation of rights, making it taxable remuneration. (Para 6 , 8 )
8. How is the distinction between remuneration and a capital receipt determined upon termination of employment?
The court distinguishes between payments that are profits of the office (remuneration) and payments made in consideration for the total abandonment or surrender of contractual rights in respect of the office. (Para 5 , 6 )
S.R.DASS, J.
(1) V.D.TALWAR, who was assessee before the taxing authorities and whose legal representatives on his death are appellants before us, was employed as the General Manager of Messrs J. K. Iron and Steel Company Ltd., Kanpur. The terms of his employment as agreed upon by the assessee and the Company were incorporated in an appointment letter dated 7/02/1946. A formal memorandum of agreement was also executed between the parties on 9/02/1946. The assessee actually joined the service of the company on 1/05/1946. According to the service agreement the pay of the assessee was fixed at Rs. 200.00 per month with an increment of Rs. 100.00 p.a. subject to certain deductions for income-tax, absence of duty etc., which need not be set out in detail for the purpose of this case. According to the agreement the period of service was for five years. Clauses (5) and (6) of the appointment -letter read`(5) Period of agreement of service to be five years. (6) Termination of service if within five years to be on notice of twelve months on either side or salary in lieu thereof. ` Clause (1) of the memorandum of the agreement dated 9/02/1946 said that the employee shall serve the employer faithfully and diligently for a term of five years from the date he joins, and cl. 21 read as follows : `If during the currency of this agreement, the employee desires to leave the services of the employers for any reasons whatsoever, he shall be at liberty to terminate the agreement by giving twelve calendar months notice in writing only after repaying to the employer joining money and all expenses if they have been allowed to the employee, and the employers shall have full power to take all necessary steps in order to enforce such payment. The employers may terminate the service of the employee by giving twelve calendar months notice in writing or (in the case of breach of any of the terms or conditions contained herein at any time without any notice) or paying any salary in lieu thereof.`
(2) WE have stated earlier that the assessee joined his post as General Manager on 1/05/1946. The services of the assessee were however terminated with effect from 31/08/1947. It is the admitted case of the parties that the services of the assessee were not terminated for any default or misconduct on the part of the assessee, but the services were terminated because the company did not want to continue the assessee in their employment. It is also the admitted case that no notice of twelve Months for the termination of the service was given by the company to the assessee as required by the contract, In lieu of the notice the company paid to the assessee on 12/09/1947 a sum of Rs. 18,096.10 which was the amount computed as salary for twelve months after deduction of income-tax at the source. The company calculated the salary for the twelve months at Rs. 25,200.00 and deducted therefrom the sum of Rs. 7,103/15/0 as income-tax. The assessee gave a stamped receipt to the company for having received Rs. 18,096/1/0 `in full and final settlement of all his claims and dues against the employer company.`
(3) IN making the assessment for the year 1948-1949 the Incometax Officer held that the sum of Rs. 25,200.00 was a revenue receipt of the assessee liable to be taxed under the Indian Income-tax Act, 1922 and rejected the claim of the assessee that the said sum was compensation for loss of employment and the tax amounting to Rs. 7,103/15/0 should be refunded to him. The assessee took an appeal to the Appellate Assistant Commissioner who held that the sum of Rs. 2,520.00 , though calculated on the basis of twelve times his monthly salary, was nothing but compensation for the loss of service and was therefore not taxable as income in the shape of salaries. Then there was an appeal to the Income-tax Appellate tribunal which reversed the finding of the Appellate Assistant Commissioner and held that the amount of Rs. 25,200.00 paid to the assessee was really sala
