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Income‑tax Reference No. 55 of 1958, decided on 26th June 1959.
S. 7, Expl. 2‑Salary‑-Com pensation for termination of employment‑Provision in agreement of employment for payment of compensation ‑Assessee agreeing to give up all claims‑Not to accept employment for specified period against interests of employer‑Nature of compensation.
The assessee was appointed general manager of a textile mill company by an agreement dated October 15, 1949, initially for a period of five years, at a specified monthly salary, with certain perquisites, and a commission on the net profits. Under the agreement, if the assessee failed to establish the mills on a sound basis within 12 months from the date of his joining, i.e., from April 1, 1950, the company reserved its right to terminate his services by giving him six months' notice on April 1, 1951. It was further provided that neither party could terminate the contract except on account of continued illness or permanent incapacity and in the event of any one of the parties terminating the contract except, for those reasons the party terminating the contract was liable to pay to the other the balance of the monthly remuneration for, the un-expired period of the contract. On July 2, 1951, the company, served a notice upon the assessee termi nating his appointment on the grounds : (i) that he had for some time past been exciting the labour of the mills against the com pany ; (ii) that he had been acting in a manner prejudicial to the company; and (iii) chat he had failed to manage the affairs of the mills either efficiently or on a profit earning basis and had also failed to establish the mills on a sound basis within 12 months from April, 1, 1950. The assessee thereupon served a notice on the company demanding payment of Rs. 2,70,750 for termination of his employment. As a result of negotiations it was agreed that the services of the assessee shall be deemed to be terminated with effect from July 2, 1951, and that the com pany shall pay the assessee a sum of Rs. one lakh in full settlement of all his claims for compensation for termination of the agree ment. The assessee gave up all claims against the company what soever and undertook for a period of one year not to engage himself on his own account or on behalf of others, within a specified area, in any profession or business which might be detri mental to the interest of the company. The question was whether the sum of Rs. one lakh received by the assessee was taxable:
Held, that as the assessee's employment was terminated the payment made to him was not under the terms of the agreement of employment, but was made as compensation for termination of employment, and notwithstanding the fact that the assessee was being compensated for loss of employment and was also giving up all his claims against the company and binding himself to a covenant not to accept employment which may be detrimental to the interest of the company in a certain area, the payment was in the nature of capital and was not assessable in the hands of the assessee.
Guff v. Commissioner of Income‑tax (1957) 31 I T R 826 and Khosla, in re (1945) 13 I T R 436 ref.
By this application, Shri R, N. Agrawala, the assessee, requires the Appellate Tribunal to refer to the High Court a question of law which is said to arise, out of its order under section 33 (4) in I. T. A. No. 8438 of 1956‑57. Inasmuch as, in our opinion, a ques tion of law does arise we hereby draw up a statement of the case, agreed to by the parties, and refer it to the High Court of Judi cature at Bombay under section 66 (1) of the Indian Income‑tax.
2. This reference arises out of the assessment made for the assessment year 1952‑53 upon Shri R. N. Agrawala in regard to a sum of Rs. 1 lakh. Broadly stated, the assessee contended that it was a capital receipt whereas the Department contended that it was a taxable one. The material facts are as follows:
The assessee was appointed general manager by a limited concern known as "Orissa Textile Mills Ltd." (hereafter referred to as "the mills" or "the employer"). The terms and conditions of his appointment are contained in the letter of appointment dated October 15, 1949, addressed by the mills to Shri Agrawala. A copy of the said letter is marked annexure A' and forms part of the case. Initially, the appointment was for a period of five years "with option to renew for a future period of two years" (clause 1). Under clause 2 (a), the fixed monthly salary was Rs. 2,100 and then there were several perquisites in cash and kind. Clause 2 (f) provided:
"In addition to the above, you will be paid 3% commission on the net profits of the company, profits to be computed on the same basis as the managing agent's commission."
Clause 6 set out the duties, powers and responsibilities of Shri R. N. Agrawala as general manager. He was to be responsible "for the efficient and economic management of the mills, the accounts, office, sales and purchase." Clauses 7 and 11 stand as follows:
"(7) You have undertaken to manage the affairs of the mills efficiently and on a profit earning basis. Should you fail to establish the mills on a sound basis within 12 months from the date of your joining, i.e., 1st April 1950, the company reserves the right to terminate your services by giving you six months notice in writing on the 1st April 1951, stating the various grounds of inefficiency in writing."
"(11) Either party cannot terminate the contract except on account of continued illness, or permanent incapacity. In the event of any one of the parties terminating the contract except for reasons stated above, the party terminating the contract will be responsible to pay to the other the balance of the monthly remuneration for the un-expired period of the contract as provid ed for in condition 7 of this letter of appointment."
The assessee took charge of his post some time in October 1949.
3. On July 2, 1951, the mills gave notice terminating the assessee's appointment as general manager by its letter dated July 1, 1951. A copy of the said letter is marked annexure B' and forms part of the case. The letter begins as follows:
"The directors of the Orissa Textile Mills Limited have decided to dispense with your services and notice is hereby given termi nating your appointment as general manager of the company with immediate effect. The reasons which led to the decision inter alia are that for some time past you have been inciting the labour of the mills against the company and have been acting in a manner prejudicial to the interest of the company. Further you have failed to manage the affairs of the mills either efficiently or on a profit earning basis and have also failed to establish the mills on sound basis within 12 months from 1st April 1950. Particulars of some of the charges against you are as follows : "
Then follows a list of the charges, eight in number. The charges mostly related to "your inefficiency and want of foresight", "your negligence" and "no increase in efficiency of production etc." It was stated before the Tribunal that the assessee in his turn gave a notice to the mills and though the hearing of the appeal was adjourned more than once to enable the assessee to bring a copy of the said notice on record, Mr. Mulla, who then appeared for the assessee, informed the Bench that it could not be produced as it could not be traced. Mr. Mulla, stated that the department might secure it as it was the Department's appeal. He, however, accepted the fact that by the said notice, the assessee demanded payment of a sum of Rs.2,70,750. Mr. Mulla could not throw any light as to how the said sum was arrived at. The Tribunal was generally told that it was on account of loss of salary and loss of commission payable under the agreement of October 15, 1949, (annexure A') for the remaining period of five years of initial appointment together with future option of two years, damages for insulting him etc.
4. The last document that was considered by the Tribunal is the memorandum dated July 17, 1951, signed by the two parties, i.e., the assessee and the mills. A copy of the said memorandum is marked annexure 'C' and forms part of‑ the case. Clause 1 of it provided:
"The parties agree that services of Shri R. N. Agrawala as general manager of the company under the agreement dated 15th October 1949, have been terminated with effect from 2nd July 1951."
Clause 2 runs as follows:
"The company shall pay to Shri R. N. Agrawala the sum of Rs. 1 lakh in full settlement of all his claims for compensation for termination of the agreement."
Under clause 3, Shri R. N. Agrawala became entitled to an immediate payment of Rs. 38,675 on account of commission on profits for the period October 15, 1949, to June 1951. The annual commission on profits at the rate of 3% was about Rs. 30,000. Clauses 6 and 8 of the said memorandum stand as follows:
"(6) Save as hereinbefore mentioned Shri R. N. Agrawala has no claim whatsoever against the company either under the agree ment dated 15th October 1949, or arising out of the same or otherwise howsoever on any account whatsoever."
"(8) Shri R. N. Agrawala agrees that he will not for a period of one year from the date hereof engage himself in any profes sion or business either in his own account or in the services of others within 100 miles of Chowdwar which may be detrimental to the interest of the company."
According to clause 9 it was agreed that both the parties mutually withdrew the allegations made by them against each other.
5. As provided by clause 2 of the said memorandum of July 17, 1951, (annexure C'), the assessee received a sum of Rs. 1 lakh in the account year. It was contended before the income‑tax authorities on behalf of the assessee that the said sum of Rs. 1 lakh was exempt under the Explanation 2 to section 7 (1) as it stood before it was amended by the Finance Act, 1955. The material portion of the relevant section is as follows:
"7. (1) The tax shall be payable by an assessee under the head Salaries' in respect of any salary . . . . . commissions, perquisites or profits in lieu of, or in addition to, any salary . . . which are due to him from, whether paid or not, or are paid by' . . . . . a company . . . . . .
Explanation 2.‑A payment due to or received by an assessee from an employer . . . . . . is . . . . . . a profit received in lieu of salary for the purposes of this subsection unless the payment is made solely as compensation for loss of employment and not by way of remuneration for past services."
The assessee contended that the said payment of Rs. 1 lakh "is made solely as compensation for loss of employment." The Income‑tax Officer rejected this contention but the Appellate Assis tant Commissioner accepted it. A copy of the order passed by the Appellate Assistant Commissioner is marked annexure D' and forms part of the case.
6. The Department filed an appeal from the Appellate Assis tant Commissioner's order to the Tribunal and contended that the sum of Rs. 1 lakh was a taxable receipt for several reasons, viz.
(i) the real nature of it was not compensation for loss of employment but it represented either advance salary or "profits in lieu" of salary ;
(ii) there was no loss of employment as the assessee got what he otherwise would have got under the agreement of service for a period of five years ;
(iii) the amount was not paid solely as compensation for loss of employment, if there is any loss of employment;
(iv) The mills claimed the said sum of Rs. 1 lakh as a deduc tion in computing its income and the Income‑tax Officer allowed it on proportionate basis agreed over the balance of the period of initial service of five years.
Before the Tribunal, Mr. Mulla on behalf of the assessee sub mitted that the fact of termination of service was established and that on a true construction of the documents already made annexures 'A', B' and C', it must be held that the said payment was made solely as compensation for loss of employment and not by way of remuneration for past services and as such it was exempt under Explanation 2 to section 7 (1) of the Act.
7. For reasons given by the Tribunal in paragraph 6 of its order a copy of which is marked annexure 'E' and forms part of the case, the Tribunal came to the following conclusions:
(i) that having regard to clause 7 of the agreement dated Octo ber 15, 1949 (annexture A'), and the opening paragraph of the notice dated July 2, 1951 (annexure B'), given by the mills to the assessee, in giving the notice dated July 21, 1951, the employer was thinking more in terms of clause 11 than of clause 7, if not both ; and
(ii) that the said sum of Rs. 1 lakh was paid to the assessee under the service agreement and not for it.
It, therefore, rejected the contention of Mr. Mulla and allowed the Department's appeal.
8. On these facts, the following question of law arises:
"Whether the sum of Rs. 1 lakh received by the assesse from the employer mills is income liable to tax under the Indian Income -tax Act, 1922
N. A. Palkhivala and R. J. Kolah for the Assessee.
G. N. Joshi and, R. J. Joshi for the Commissioner.
‑By an agreement dated the 15th of October 1949, the assessee was appointed general manager of the Orissa Textile Mills Ltd. By that agreement, the appointment of the assessee was to be in force for a period of five years in the first instance with option of renewal for a further period of two years. The assessee was to be paid a monthly remuneration of Rs. 2,100 and a monthly allowance of Rs. 900 for entertainments, maintenance of car etc. Besides this remuneration he was to be paid commission ac 3% on the net profits of the company and was to be provided with a furnished bungalow, four servants, free use of the company's transport and separate allowance for entertainment on behalf of the company and free medical aid. The assessee undertook to manage the affairs of the mills efficiently and on a profit earning basis and if he "failed to establish the mills on a sound basis within 12 months from the date" of his joining, i.e., 1st April 1950, the company reserved its rights to terminate his services by giving him six months' notice in writing on the 1st of April 1951, stating the various grounds of inefficiency. It was further provided that neither party could terminate the contract except on account of continued illness or permanent incapacity (of the assessee). It was also provided that in the event of any one of the parties terminating the contract except for reasons "stated before", the party terminating the contract will be responsible to pay to the other the balance of the monthly remuneration for the un-expired period of the contract as provided for in condition 7 of the letter of appointment. This last condition is somewhat obscure, because there could evidently be no monthly remuneration being paid by the assessee to the company in the event of the assessee putting an end to the contract. In the context in which the condition is found, it must mean that in the event of the contract being terminated by the company for reasons other than those set out earlier, the company will pay to the assessee the balance of the monthly remuneration for the un-expired period of the contract. On the 2nd of July 1951, the company served a notice upon the assessee terminating his appointment as the general manager of the company with immediate. effect and three reasons were given in that notice : (1) that for some time past the assessee had been' inciting the labour of the mills against the company ; (2) that the assessee had been acting in a manner prejudicial to the interest of the company and (3) that the assessee had failed to manage the affairs of the mill either efficiently or on a profit earning basis and had also failed to establish the mills on a sound basis within 12 months from 1st April 1950. Eight particulars of the charges against the assessee were then set out in that notice. It is unneces sary to consider these particulars in detail in the view we take on this reference: It may be sufficient to observe that some of the particulars relate to the first reason, some others to the second reason and two more to the third reason. Thereafter, the assessee served a notice upon the company demanding payment of Rs. 2,70,750, for termination of his employment. Negotiations were then held and on the 17th of July 1951, it was agreed between the company and the assessee that the services of the assessee as the general manager were to be deemed to be terminated with effect from the 2nd of July 1951, and that the company shall pay to the assessee a sum of Rs. 1 lakh in full settlement of all his claims for compensation for termination of the agreement in the instalments specified. Besides this payment of Rs. 1 lakh certain amounts to which the assessee was entitled under the terms of the agreement were also agreed to be paid to him. It was then provided that the assessee had no claim whatsoever against the company either under the agreement dated the 15th of October 1949, or arising out of the same or otherwise howsoever on any account whatsoever and the assessee agreed that he will not for a period of one year from the date of the agreement engage himself in any profession or business either in his own account or" in the services of others within 100 miles of Chowdwar which may be detrimental to the interest of the company. It was finally agreed that the company withdrew all the allegations against the assessee and the assessee withdrew all the allegations against the company, its managing agents and directors.
The Income‑tax Officer brought the amount of Rs. 1 lakh to tax on the view that it was not received solely as compensation for loss of employment. In appeal to the Appellate Assistant Commissioner, the order made by the Income‑tax Officer was reversed. In appeal to the Income‑tax Tribunal, it was held that the termination of employment of the assessee was made in exercise of the powers vested in the company under clause 11 of the agree ment dated the 15th of October 1949, and that the amount of Rs. 1 lakh paid to the assessee was "under" this agreement and not "for" it. They further expressed the opinion that the assessee had received from the employer a certain sum of money which "went to fill the hole created in his salary' income by reason of premature termination of service contract, such premature termina tion of contract with consequent damages payable on account of it being provided by the agreement of service itself." On the view taken by the Tribunal, the appeal filed by the Commissioner was allowed.
The Tribunal has referred to this Court the following question:
"Whether the sum of Rs. 1 lakh received by the assessee from the employer mills is income liable to tax under the Indian Income‑tax Act, 1922 "
Evidently, the termination of employment of the assessee was not made on account of inefficiency of the nature that the assessee failed to establish the mills on a sound basis within 12 months from the date of his joining, nor was the employment terminated on account of continued illness or permanent incapacity of the assessee. Under the express agreement, when there was termina tion of the employment for reasons other than those of inefficiency, illness or incapacity, the company was liable to pay to the assessee the balance of the monthly remuneration for the unexpired period of the contract. The monthly remuneration for the unexpired period stipulated to be paid on termination of the contract was compensation for termination of employment. Even if the agree ment was terminated for reasons other than of inefficiency of the nature specified or of incapacity resulting from illness, the employ ment was to be terminated and for termination of employment, the assessee was to be paid compensation equivalent to the balance of the monthly remuneration for the unexpired period of the contract. It cannot be said that the amount or amounts agreed to be paid were to be paid on the footing that the contract was to continue to remain in force. Evidently the assessee was, on termination of employment for any reason, to cease to be an employee of the company whether the termination of the contract was for reasons of inefficiency or illness or permanent incapacity or other reasons. We are, therefore, unable to accept the agreement of Mr. Joshi for the Department that the payment made to the assessee in this case is a payment "under" the terms of the agreement. It is true that under the agreement a certain amount capable of being ascertained was agreed to be paid in the event of termination of the employment of the assessee in certain eventualities. But all the same, the payment was to be made as compensation for termination of the employment.
In Guff v. Commissioner of Income‑tax ((1957) 31 I T R 826), Chagla, C. J., in delivering the judgment of the Court referred to the scheme of section 7 and Explanation (2) before its amendment in the year 1955, and observed:
"In other words, did the Legislature merely contemplate the factual loss of employment and any amount paid for that loss, whether that payment was under a legal liability or not As we shall presently point out, the authorities to which our attention has been drawn have given to the expression com pensation' a wider connotation. It also seems to us, apart from the authorities, that it is the better view to take of this expres sion, because if an employee loses his employment which is the source of his income, any payment made by his employer for that loss should not be looked upon as income liable to tax, as in its very nature the payment is to compensate for or to act as a solatium for the very source which produced the income and in respect of which the employee is liable to tax."
The learned Chief Justice then proceeded to consider whether the compensation paid which was equivalent to six months' salary in lieu of notice was within the meaning of Explanation (2) o section 7 salary or remuneration for loss of employment.
Mr. Joshi for the Department contends that, in the present case, the compensation paid to the assessee was not solely for loss of employment and he invites our attention to the covenants contained in the agreement whereby the assessee had undertaken not to accept within a radius of 100 miles from Chardum, employ ment which was prejudicial to the interest of the company and the assessee had abandoned all his rights arising under the terms of the agreement of employment or otherwise. This, Mr. Joshi says, being also the consideration for payment of Rs. 1 lakh by the company, it could not be said that the compensation paid was "solely for loss of employment." Explanation 2 to section 7 as it stood before the Act was amended in 1955, in so far as it is material, provided that a payment due to or received by an assessee from an employer or former employer, unless the payment is made solely as compensation for loss of employment and not by way of remuneration for past services, is to be regarded as a profit received in lieu of salary for the purpose of subsection (1) of section 7, and profits in lieu of salary were to be regarded as "salary" and chargeable to tax. But, evidently on the Explana tion, it cannot be said that a payment which is made as compensa tion but not solely for loss of employment must always be regarded as revenue receipt. The Legislature regards a payment made solely for loss of employment, which is not made by way of remuneration for past services, as a capital payment. It is implicit in the Explanation that a payment made as remuneration for' past services is to be regarded as a revenue payment. But in the absence of any express provision about payments which are neither of the nature of compensation paid solely for loss of employment, nor as remuneration for past service it would be difficult to rely upon the Explanation to support the view that the payment is capital payment or revenue payment. The decided cases here have taken the view Guff's case ((1957) 31 I T R 826) to which we have already referred and Khosla In re ((1945) 13 I T R 436), that a payment made as compensation for loss of employment is to be regarded as a capital payment. If that be the correct view, in the present case notwithstanding the fact that for the payment of Rs. 1 lakh by the company to the assessee, the assessee was being compensated for loss of employ ment and was also giving up all his claims against the company and binding himself to a covenant not to accept employment which may be detrimental to the interest of the company out of a certain area, it would not in our judgment make any difference as to the nature of the payment made to him.
On that view of the case, we answer the question referred to us in the negative.
Commissioner to pay the costs of the reference.
Question answered in the negative.
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