Case: The Commissioner Of Income-Taxbombay Vs. E.D.Sheppard

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 large scale 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 November 1, 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, 1947 to October 31, 1950. Under this contract the assessee was to receive a salary of Rs. 1, 200/- 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. 50, 000/per annum. Sometime about the last quarter of the year 1947 the firm decided to re- organise 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 December 29, 1947. This notice stated that in view of the changes proposed, the assessees employment with the firm would terminate as from January 31, 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 February 1, 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/- only but were quoted in market at Rs. 130/- per share. Some of these shares were kept by the partners of Killick Nixon and Company. All the members of the covenanted staff in the partnership firm (who were officers), were given shares of Killick Industries Ltd. free of payment. The assessee received an allotment of 1, 700 shares of the face value of Rs. 2, 21, 000/-. The assessees case was that the shares were given by the partnership to the members of the staff as compensation for loss of employment resulting from premature termination of their services. The Income-tax Officer, however, sought to bring the shares of the value of Rs. 2, 21, 000/- to tax on the footing that the shares ( were allotted to the assessce in consideration of past services. The assessee produced before the Income-tax Officer a letter purporting to be written by one D.R.C. Hartley on October 1 , 1952, on behalf of the firm, in which the assessee was informed that the firm had caused 1, 700 shares in Killick Industries Ltd. to be allotted as "compensation for loss of employment". In appeal to the Appellate Assistant Commissioner, the order passed by the Income-tax Officer bringing to tax the amount of Rs. 2, 21, 000/was confirmed. Before the Income-tax Appellate Tribunal the assessee produced an affidavit dated February 22, 1954, sworn by five out of the six partners who constituted the firm in the month of January 1948, (the sixth partner having died in the meanwhile) which affirmed the terms of a memorandum submitted to the Income-tax Officer by Messrs Crawford Bayley & Co., on behalf of the assessee. It was recited in paragraph 8 of the affidavit that the partners had decided to discontinue the firm and prior to such discontinuance and on December 27, 1947, they wrote to each assistant who was then employed by the firm terminating his services from January 31, 1948, and stating that a further communication would be addressed to him regarding "the question of compensation for loss of employ- ment". It was further recited in paragraph 8 that the intention of the partners on the discontinuance of the firm in causing allotments of certain shares to be made to the assistants was to compensate them for loss of employment and it was "in no sense a reward for past services". It was then recited that all the assistants had accepted the allotment as "compensation for the loss of employment in terms of the fetter of December 27, 1947, and in view of such allotment no claim was made by any assistant against the firm" and that a confirmatory letter from the partnership to the assistants was some time thereafter written "for purposes of record." ( The two members of the Tribunal differed in their views as to the true character of the payment received by the assessee. The accountant member was of the view that the assessee suffered no loss as a result of the termination of his employment with the partnership firm, because from February 1, 1948, the day after the termination of his employment with the partnership, he was employed by Killick Industries, Ltd., which gave him almost the same emoluments; and furthermore, the payment was not made " solely for loss of employment" because the compensation was paid partly for loss of expectations and future prospects which the assessee had in the partnership firm. Lastly, the accountant member held that the employment of the assessee was terminable on one months notice and in any event the unexpired portion of his employment would not have amounted to Rs. 2, 21, 000/-; therefore, the payment could not be treated as compensation for loss of employment, and at best it was a payment "under the contract" and not for "loss of the contract". The judicial member disagreed, and expressed the view that the assessees services were determined by the firm which was ultimately dissolved and the allotment of shares was made to the assessee "at or in connection with the termination of his employment and solely as compensation for loss of employment" and there was no material in the record to support the view that the payment was in lieu of past services. Or) a difference between the two members of the Tribunal, the question was referred to the President who agreed with the judicial member and expressed the view that the payment was made to the assessee solely for loss of employment and it was immaterial that the assessee secured another employment, equally advantageous, under another employer on the next day after the termination of his employment with the partnership firm. Referring to the evidence adduced on behalf of the assessee, namely the affidavit filed by the partners, the President said that there was no ( camouflaging as suggested by the department, and both the judicial member and the President accepted the evidence given in support of his claim by the assessee.The present appellant then moved the Tribunal to refer the following question of law to the High Court: Whether on the facts and circumstances of the case, the sum of Rs. 2, 21, 000/-, being the value of the shares received by the assessee free of payment, is income of the assessee and assessable under section 7 of the Income-tax Act ? The Tribunal made a reference under s. 66 of the Income-tax Act, 1922. The reference was heard by Shah and Desai, JJ., of the Bombay High Court. The High Court referred to Explanation 2 to s. 7 (1) of the Income-tax Act, as it stood at the relevant time, and held that if by ail agreement between the assessee and his employer, a certain amount was estimated as compensation for the loss likely to be suffered by the assessee by reason of termination of his employment with the firm and was paid to him, the circumstance that the assessee did not in fact suffer any loss by reason of securing another employment would not, for income-tax purposes, alter the nature of the payment made. The High Court pointed out that the evidence given by the assessee in support of his claim having been accepted by the Tribunal, could not be questioned in the High Court on a reference under s. 66, such a reference being confined to the question of law arising out of the order of the Tribunal. The High Court said that the sole question which fell to be determined was whether the compensation paid to the assessee was to be regarded as an income receipt or a capital receipt in the hands of the assessee. With reference to Explanation 2 of sub-s. (1) of s. 7 an argument ( was advanced before the High Court to the effect that the payment made to the assessee was not stated to have been made solely for loss of employment but as inclusive of compensation for loss of future prospects. The High Court met this argument by stating that the expectations or prospects were rooted in the employment and it would be difficult to distinguish between compensation for loss of employment and compensation for loss of prospects in that employment. The High Court then said: "It is true that by the Explanation a payment which is due to or received by an assessee from an employer or a former employer is to be regarded as profit received in lieu of salary for the purposes of sub- section (1) of Section 7 ; but in our judgment the payment must be made because of the relation between the employee and the employer. If the object of the payment is unrelated to the relation between the employer and the employee, it will not fall within the expression "profit received in lieu of salary" in Explanation 2 to Section 7 (1). Assuming, therefore, that a part of the compensation paid to the assessee was not solely for loss of employment but was attributable to the loss of future prospects which the assessee had of becoming a partner in future in the firm, that will not, in our judgment, be regarded as "profit received in lieu of salary" within the meaning of Section 7 (1) or the Explanation thereto : and if such payment is not regarded as salary or profits in lieu of salary, there is no other head of income, profits or gains under which it will fall so as to make it taxable. In the ultimate analysis, we have to decide in this reference whether the payment can be regarded as a capital receipt or a revenue receipt in the hands of ( the assessee; and if, on the view we have taken, it is not a revenue receipt, then it must be regarded as not liable to tax." We shall presently consider the contentions urged before us on behalf of the appellant. But before we do so, it is necessary to say that s. 7 of the Income-tax Act, 1922, was completely recast by the Finance Act, 1955, and we are concerned with the section as it stood prior to its amendment in 1955. We may now read s. 7 (1) and Explanation 2 thereto (so far as it is material for our purpose) as they stood at the relevant time-- "S. 7 (1) The tax shall be payable by an assessee under the head "Salaries" in respect of any salary or wages, any annuity, pension or gratuity, and any fees, commissions, perquisites or profits in lieu of, or in addition to, any salary or wages, which are due to him from, whether paid or not, or are paid by or on behalf of the Government, a local authority, a company, or any other public body or association, or any private employer ; and for the purposes of this sub- section advances by way of loan or otherwise of income chargeable under this head shall be deemed to be salary due on the date when the advance is received: x x x x x x Explanation 2.-A payment due to or received by an assessee from an employer or former employer or from a provident or other fund, is to the extent to which it does not consist of contributions by the assessee or interest on such contributions a profit received in lieu of salary for the purposes of this sub- section, ( unless the payment is made solely as compen- sation for loss of employment and not by way of remuneration for past services : xx xx xx xx xx" Now, learned counsel for the department has urged two main contentions before us. His first contention is that the word "compensation in Explanation 2 means what is payable or compellable at law as compensation, that is, monetary equivalent of the damage suffered consequent on the injury caused. He has submitted that the assessee in this case suffered no injury for which the partnership was compellable at law to pay any damages. According to learned counsel for the department, compensation for loss of employment means the monetary equivalent for the loss of earnings under the existing contract without reckoning the loss of future prospects, and such loss must also be mitigated in the way known to law. His argument is that judged from that standpoint, the payment of Rs. 2, 21, 000/- to the assessee was not compensation solely for loss of employment within the meaning of Explanation 2. His second contention is that under the Explanation any payment received by an assessee from his employer or former employer (save payment from a provident or other fund mentioned therein) is profit received in lieu of salary for the purpose of sub-s. (1) of s. 7 unless the payment is made solely as compensation for loss of employment. He has submitted that the Explanation creates as it were an artificial definition of profits in lieu of salary and if the payment is not compensation in the sense of payment compellable at law, no further question arises as to whether the payment is related or unrelated to employment, or whether it is capital or revenue in the hands of the assessee. The argument of learned counsel is that the High Court was in error with regard to both the points stated above and therefore its answer to the question referred was not correct. ( We consider that both the points urged on behalf of the department are without substance and are not supported by decisions including decisions of this Court. Let us first examine the first point. As Romer, L.J., said in Henry v. Arthur Foster compensation for loss of office or employment is a well-known term; it means a payment to the holder of an office as compensation for being deprived of profits to which as between himself and his employer he would, but for an act of deprivation by his employer or some third party such as the Legislature, have been entitled. It should be obvious that when the deprivation is by the Legislature, there can be no question of liability or compellability to pay damages at law. The emphasis is on the act of deprivation............... which may or may not give rise to any liability at law. In Chibbett v. Joseph Robinson & Sons the assessees were employed by a certain steamship company as ship managers and their remuneration was fixed at a percentage of the companys annual profits. The company went into liquidation and the general meeting of the company authorised the liquidators to transfer to the assessee a sum of pound 50, 000 which was in certain bonds as compensation for loss of office. The question that arose before Rowlatt, J., was whether the sum of pound 50, 000 received by the assessees was capital or income. At p. 60 of the judgment the learned judge said : "As Sir Richard Henn Collins said, you must not look at the point of view of the person who pays and see whether he is compellable to pay or not; you have to look at the point of view of the person who receives, to see whether he receives it in respect of his services, if it is a question of an office, and in respect of his trade, if it is a question of trade, and so on. You have to look at this point of view to see whether he receives it in respect of those considerations. ( That is perfectly true. But when you look at that question from what is described as the point of view of the recipient, that sends you back again, looking, for that purpose, to the point of view of the payer: not from the point of view of compellability or liability., but from the point of view of a person inquiring what is this payment for." It is worthy of note that on the question of whether a receipt is capital or income in the hands of the assessee, the learned judge made no distinction between office or trade. The income arising from an employment is taxable as "salaries" under s. 7; the profits of a business are taxable under s. 10; while the income arising from an office which does not involve employment would be taxable under s. 10 as business profits, e. g. in the ordinary case of managing agents or selling agents, where the activities amount to the carrying on of a business, and in other cases, e. g. an ordinarY director of a company, it would be taxable under s. 12 as income from other sources. The question whether compensation received for loss of employment or office or for cessation of business is taxable under any of the three sections will fall to be considered, prior to the amendments of 1955, with reference to the general principle of income-tax law, which is to tax income. In other words, the question would be whether it is income or capital in the hands of the assessee.The same view was expressed by the Privy Council in Commissioner of Income-tax v. Shaw, Wallace and Company ((1932) L.R. 59 I. A. 206), where it held that a sum of money received as compensation for loss or cessation of oil distributing agencies was not income, profits or gains within the meaning of the Indian Income-tax Act. There is nothing in the judgment of the Privy Council which suggests that the compensation that was received by the assessee was a compensation which was compellable at law. It ( was pointed out that the object of the Indian Income-tax Act was to tax "income" a term which it did not define. Income however connoted a periodical monetary return "coming in" with some sort of regularity, or expected regularity, from definite sources. The ratio of the decision was thus stated in the judgment: "But when once it is admitted that they were sums received, not for carrying on this business, but as some sort of solatium for its compulsory cessation, the answer seems fairly plain." The same question arose before the Bombay High Court in W. Guff v. Commissioner of Income tax, Bombay City There the assessee joined in the service of a companyon May 27, 1946, as an executive in charge of a new department of the company under an agreement which provided that his services could be terminated by giving six months time. On March 23, 1948, he received the communication from the company that the department could not function any more, but the assessee continued to serve until November 10, 1948, for winding up the department. On November 30, 1948, the company paid the assessee a sum of Rs. 12, 000/- as compensation equivalent to six months salary for the termination of his employment owing to the closure of the department. The question was whether the amount of Rs. 12, 000/- received by the assessee was a capital receipt or a revenue receipt taxable as salary under s. 7 of the Income- tax Act. It was argued before the Bombay High Court that if there was-no legal liability to pay the compensation, then any payment made by the employer would not come within the expression "compensation used in Explanation 2; because if a proper notice was given to the assessee as found by the Tribunal in that case, he was not entitled to any compensation when his services were terminated after the lapse of six months from the ( date when the notice was given. The High Court dealt with this argument and repelled it. Chagla, C. J., who delivered the judgment of the court referred to the decisions in Shaw, Wallace and Company v. Commissioner of Income-tax ((1932) L.R. 59 I.A. 206.) and Chibbett v. Joseph Robinson & Sons ((1924) 9 Tax Cas. 43. ) and then said: "We are, therefore, of the opinion that the expression "compensation for loss of employ- ment" used in explanation 2 to section 7 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." Now, we come to a decision of this Court, Commissioner of Income-tax, Hyderabad v. Vazir Sultan and Sons ([1959] Supp. 2 S.C.R 375.). The assessee there, a registered firm, was appointed the sole selling agent and sole distributor for the Hyderabad State for the cigarettes manufactured by the company. The assessee was allowed a discount on the gross selling price. In 1939 another arrangement was arrived at between the assessee and the company whereby the assessee was given a discount not only on the goods sold in the Hyderabad State but on all goods sold outside the Hyderabad State. In 1950 the assessee and the company reverted to the old arrangement confining the sole agency of the assessee to the Hyderabad State and the assessee was paid a sum of Rs. 2, 19, 343/by way of compensation for the loss of the agency outside the Hyderabad State. The question was whether the money received by the assessee was a revenue receipt assessable to income-tax or a capital receipt not so assessable. One of the points canvassed before this Court with some force was that there was no enforceable agreement as between the assessee and the company which could be made the subject matter of a legal claim for damages for compensation at his instance in the event of its termination or cancellation by the company. The agency agreement in that case was terminable at the will of the company and if the company chose to do so, the assessee had no remedy at law in regard to the same. The argument was that therefore there was no enforceable agreement between the assessee and the company which could be made the subject matter of a legal claim for compensation. This argument was repelled and this Court said that in all such cases one has really to look to the nature of the receipt in the hands of the assessee irrespective of any consideration as to what was actuating the mind of the other party. This Court referred with approval to the observations made by Rowlatt, J., in Chibbett v. Joseph Robinson and Sons ((1924) 9 Tax Cas. 48), which we have earlier quoted. This Court also referred with approval to the decision of W. A. Guff v. Commissioner of Income-tax ([1957] 31 I.T.R. 826.), and said that it was immaterial whether the amount paid was compensation for which the employer was liable at law or was a payment made ex gratia.In view of these decisions we must over-rule the first contention urged on behalf of the appellant that compensation in Explanation 2 to s. 7 (1) means compensation which is payable or compellable at law.2a. We now turn to the second contention. Prior to the amendments introduced by the Finance Act, 1955, Explanation 2 to s. 7 (1) made it clear that a payment which was made solely as compensation for loss of employment was not assessable, while a payment which was made as remuneration for past services was taxable as income. The principle was that compensation for wrongful repudiation of a service agreement or for loss of office or employment or cessation of business was a capital receipt, though the payment might be entirely voluntary and the recipient might have no legal right to any compensation at all. In such cases the compensation was ( deemed to be a capital receipt because it was in respect of the source of income. The argument of learned counsel for the department however is that Explanation 2 treated any payment received by an assessee from an employer or former employer as a profit in lieu of salary (except where the payment was from a provident or other fund mentioned therein) ; therefore, the explanation was an artificial definition which treated any payment received by an assessee from his employer or former employer as income and no consideration as to whether the payment related to employment or not or whether it was capital or income need be considered, though learned counsel for the department concedes that a payment made solely as compensation for loss of employment does not come within the artificial definition of the Explanation. We do not think that the proposition put in the very wide form in which learned counsel for the department has put it, can be accepted as correct. In Mahesh Anantrai Pattani v. The Commissioner of Income-tax, Bombay North, Ahmedabad this Court had to consider s. 7 (1) of the Act and Explanation 2 thereto, as they stood prior to the amendments in 1955. The facts of that case were these. M. A. Pattani who was Dewan of the State of Bhavnagar was granted a monthly pension of Rs. 2, 000/- by the Maharajah of the State by an order dated January 15, 1948. On March 1, 1948, the State of Bhavnagar merged in the United States of Saurashtra and the Maharajah ceased to be the ruler of the State. Subsequently on May 31, 1950, the Maharajah directed his banker in Bombay to pay Pattani a sum of Rs. 5, 00, 000/- and said that the payment was made in consideration of the loyal and meritorious services which Pattani had rendered to the State. The question which arose for decision was whether the aforesaid payment of Rs. 5, 00, 000/- was liable to tax under s. 7 (1) read with Explanation 2. This Court held that the sum ( of Rs. 5, 00, 000/- was given to Pattani not as a payment in consideration of the services already rendered by Pattani as the Dewan of the State but merely as a gift in token of the Maharajahs affection and regard for the assessee.Therefore, it was held the payment was not liable to be assessed to tax under s. 7 (1), Explanation 2. The ratio of the decision was that the payment was a capital receipt, and not income assessable to income-tax, in the bands of the assessee. Apparently, this Court did not accept the proposition that every payment to an assessee by his employer or former employer was income and no question of treating such payment as capital in the bands of the assessee need be considered.3. Once it is held that the payment in the present case was a payment made solely as compensation for loss of employment, there is an end of the appeal; because Explanation 2 in clear terms excepts such payment from being treated as a profit received in lieu of salary. The Tribunal held on the evidence before it that the payment was made solely as com- pensation for loss of employment. The High Court rightly took the view that no distinction could be made between compensation for loss of employment and compensation for loss of prospects rooted in that employment. The High Court also rightly pointed out that if the object of the payment was unrelated to the relation between the employer and the employee, it would not fall within the expression "profit received in lieu of salary" in Explanation 2. We think that the High Court committed no error in answering the question referred to it.

Decision:
0[ds]We consider that both the points urged on behalf of the department are without substance and are not supported by decisions including decisions of thisview of these decisions we mustthe first contention urged on behalf of the appellant that compensation in Explanation 2 to s. 7 (1) means compensation which is payable or compellable atdo not think that the proposition put in the very wide form in which learned counsel for the department has put it, can be accepted as correct.Once it is held that the payment in the present case was a payment made solely as compensation for loss of employment, there is an end of the appeal; because Explanation 2 in clear terms excepts such payment from being treated as a profit received in lieu of salary. The Tribunal held on the evidence before it that the payment was made solely as compensation for loss of employment. The High Court rightly took the view that no distinction could be made between compensation for loss of employment and compensation for loss of prospects rooted in that employment. The High Court also rightly pointed out that if the object of the payment was unrelated to the relation between the employer and the employee, it would not fall within the expression "profit received in lieu of salary" in Explanation 2. We think that the High Court committed no error in answering the question referred to it.