Taxability of Amount received by prospective employee for loss of employment

A) Facts of the case:

a. Assessee filed return of income on 28th July, 2008 declaring total income of Rs. 1,65,70,750/- and also claiming a refund of Rs.1369/-.

b. The return was processed under Section 143(1) on 26th August, 2009 determining a refund of Rs.860/-.

c.  The Assessing Officer (AO) noticed a credit entry of Rs.1,70,90,650/- received from M/s. ACEE Enterprises (ACEE)

d. In terms of the said Employment Agreement, the Assessee was to be employed as Chief Executive Officer (‘CEO’) and the employment was to commence from 1st July, 2007. Either party at its option could terminate the employment by giving six months’ notice to the other party in writing. In case the notice period was less than six months, then compensation equivalent to the shortfall of the notice period was payable by the party concerned.

e. ACEE informed the Assessee that “as a mark of goodwill/gesture” it was pleased to announce a payment of Rs.1,95,00,000/- to the Assessee subject to income tax compliances as “a one-time payment to you for non-commencement of employment as proposed.”

f. Under Section 17 (3) (iii) of the Act the receipt by the Assessee of a sum from any person prior to his joining with such person was taxable.

g. The AO concluded that the payment was taxable under the head ‘salary’. The addition of Rs.1.95 crores was added to the returned income and penalty proceedings were also directed to be initiated.

h. The CIT (A), after analyzing the documents on record, came to the conclusion that there was no master and servant relationship between the Appellant and ACEE.

i. No payment had been made by ACEE to the Appellant from the date on which the contract was signed till the date when the offer of employment was withdrawn

j. The CIT(A) concluded that the payment was made by the prospective employer as compensation towards breach of promise and not for any services rendered or to be rendered. Such payment could not be taxed under Section 17(3)(iii) of the Act. Nor could it be taxed under some other head.

Issue put before (Delhi High Court):

On the facts and circumstances of the case and in law whether the Ld. CIT (A) was correct in deleting the addition of Rs.1,95,00,000/- taxed as revenue receipts by the AO since the same was not offered to tax by the assessee?

On the facts and circumstances of the case and in law, whether the Ld. CIT (A) was correct in allowing the credit of TDS of Rs.22,09,350/- on Rs.l.95 crore to the assessee?”

Contention by Revenue:

a. since the wording of Section 17(3)(iii) of the Act was that “any amount received from any person”, it was not necessary that the amount had to be received only from an employer in order that such sum be brought to tax in the hands of an assessee under the head ‘profits in lieu of salary’.

b. “Any person” could include a prospective employer as in the present case.

c. The clauses of the Employment Agreement showed that the Assessee had in fact been employed as a CEO and the Assessee had also accepted such employment.

d. Therefore, notwithstanding that the employment was to commence at a later date, the relationship of employer and employee had been brought into existence by the Employment Agreement.

Ruling of Honorable (Delhi High Court):

a. The Employment Agreement itself mentions that the employment shall commence ‘latest by 1st July, 2007’.

b. The employee “shall Endeavour to join the company as early as possible”, the intention and expectation of the parties was that the employment would commence not earlier than 1st July 2007.

c. the employment did not commence from the date of the Employment Agreement is further evident from the fact that ACEE stated in its letter dated 25th August 2007 that it was making the payment of Rs. 1.95 crores as “a one-time payment to you for non-commencement of employment as proposed.”

d. Section 17 (3) (iii) (A) pre-supposes the existence of an employment, i.e., a relationship of employee and employer between the Assessee and the person who makes the payment of “any amount” in terms of Section 17 (3) (iii) of the Act.

e. The Court accordingly concurs with the concurrent view of the CIT (A) and the ITAT that this was a case where there was no commencement of the employment and that the offer by ACEE to the Assessee was withdrawn even prior to the commencement of such employment.

f. The amount received by the Assessee was a capital receipt and could not be taxed under the head ‘profits in lieu of salary’.

g. The other plea of the Revenue that the said amount should be taxed under some other head of income, including ‘income from other sources’, is also unsustainable.

h. The appeal is dismissed but without any order as to costs.

i. Assessee is entitled to the refund of the TDS paid on Rs. 1,95,00,000/- and that the refund of TDS may be adjusted against tax demand if any arising on appeal effect being given to the said order of the CIT (A) is upheld.

Key Take Away

Amount received by prospective employee for loss of employment offer is a capital receipt and is neither taxable as “salary” or as “other sources”