# 16:J THE COMMISSIONER OF INCOME·TAX BOMBAY v. E. D. SHEPPARD

- **Citation:** [1964] 1 S.C.R. 163
- **Court:** Supreme Court of India
- **Decided:** 1964
- **Case number:** Civil Appeal No. 527 of 1961
- **Bench:** S. K. Das, J. L. Kapur, A. K. Sarkar, Raghubar Dayal
- **Source:** https://unisonlegal.in/judgment/supreme-court-of-india/16-j-the-commissioner-of-income-tax-bombay-v-e-d-sheppard-2881
- **Pages:** 37

## Headnote

Income Tax-Partnership terminating service• of employ••
by notice-Transfer of assets of partnership to new compani .. -
Firm giving shares of new company to employee-Such shar .. , if
compensation for loss of employment-Employee, if liable to
tax-Indian Income-tax Act, 1922 (11 of 1922), •· 7 (1)
Explanation 2.
In 1930 the respondent assessee was employed as an officer·assistant in a partnership concern on the basis of a contract
fo,· three years. The agreement provided that the firm might
terminate the contract after giving the assessee one calendar
month's notice of its intention to do so. Subject to his work
being satisfactory. the assessee, like other aasistants employed in
the firm, expected to become a partner of the firm one day. The
assessee continued in the employment of the firm and his contract of service was renewed from time to time.
In I 94 7 the
firm decided to re-organise its business and with that end in
view two limited companies were floated, Killick Industries
Ltd. which was a public iimited company, and Killick Nixon
and Company, a private limited company, which was to take
over the business previously carried on by the partnership. On
December 29,1947, the respondent received a notke from the
firm stating that in view of the changes proposed the assessee'•
employment with the firm would terminate as fromJanuary 31,
I 948. The new company Killick Industries Ltd., agreed to
take over the services of the assessee an:l on February 1,1948,
he entered their employment. The partnership firm transferred
their assets to the new companies and received shares of the new
companies in lieu thereof.
All the members of the covenanted
staff in the partnership firm were given shares of Killick Industries Ltd., free of payment, and the assessee received an
allotment of I, 700 shares of the fase value __ of Rs. 2 ,21,000j-.
The assessee's case was that the shares were given by the partner ..
ship to the members of the staff as co-npensation 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 1- to tax on the footing
1901
1962
T Iii Ccmmissionn of
lnc"1Tl1·ta:c, Bctdqf
••
I:.' D. Sl.1pprnd
164
SUPREME COURT REPORTS [1964] VOL.
that the shares were allotted to the assessec in consideration of
past services. The Appellate Tribunal held on the evidence
before it that the payment was made solely as compensation
for loss of employment, and was not liable to tax in view of
Explanation 2 to s. 7 (I) of the Indian Income-tax Act, 1922.
It was contended for the Commissioner of Income-tax that
under the Explanation, the word "compensation" meant what
wM payable or compellable at law as compen«1tion, and any
payment received by an assessec from his employer or former
employer was profit received in lieu of salary, and that judged
from that point of view, the payment of Rs. 2,21,000/- to the
assessee was not compensation solely for loss of employment.
Held (Raghubar Dayal,]., di .. w1ling), that the expression
ucompensation for loss of employment" in Explanation 2 to
•· 7 (I) of the Indian Income-tax Act, 1922, referred to any
payment made, whether under a legal liability or voluntarily,
to compensate or act as a Solatium for the lo" of employment
suffered by the employee, and was not restricted to compensation which was payable or compellable at law; and that the
payment of Rs. 2,21,000/ ., found by the Tribunal to be a
payment made solely a> compensation for lo<S of employment
was not liable to tax, because the Explanation excepted such
payment from
being treated as a profit received In lieu
of salary.
Chibbet v. JoReph Robinaon & So118, (1924) 9 Tax Cas. 49,
Commis8ioner of Inwme-tax v. Shaw Wallau and Company,
(193~) L. R. 59 I. A. ?.06,
W. A. Guff v. Commi•.ioner of
Income-tax, Bombay City, (19571 31 I. T. R. 826, Commissioner
of Income-tax Hyderabad v. Va:ir Sultan and Sona, [1959]
Supp. 2 S. C. R. 375 and Mahesh
An

## Text

_Characters 0–39,881 of 73,987. This is a partial read: ask again with offset=39881 for what follows._

..
I S.C.R.
SUPREME COURT REPORTS
16:J
THE COMMISSIONER OF INCOME·TAX
BOMBAY
v.
E. D. SHEPPARD
(S. K. DAS, J. L. KAPUR, A. K. SARKAR,
and RAGHUBAR DAYAL, JJ.)
Income Tax-Partnership terminating service• of employ••
by notice-Transfer of assets of partnership to new compani .. -
Firm giving shares of new company to employee-Such shar .. , if
compensation for loss of employment-Employee, if liable to
tax-Indian Income-tax Act, 1922 (11 of 1922), •· 7 (1)
Explanation 2.
In 1930 the respondent assessee was employed as an officer·assistant in a partnership concern on the basis of a contract
fo,· three years. The agreement provided that the firm might
terminate the contract after giving the assessee one calendar
month's notice of its intention to do so. Subject to his work
being satisfactory. the assessee, like other aasistants employed in
the firm, expected to become a partner of the firm one day. The
assessee continued in the employment of the firm and his contract of service was renewed from time to time.
In I 94 7 the
firm decided to re-organise its business and with that end in
view two limited companies were floated, Killick Industries
Ltd. which was a public iimited company, and Killick Nixon
and Company, a private limited company, which was to take
over the business previously carried on by the partnership. On
December 29,1947, the respondent received a notke from the
firm stating that in view of the changes proposed the assessee'•
employment with the firm would terminate as fromJanuary 31,
I 948. The new company Killick Industries Ltd., agreed to
take over the services of the assessee an:l on February 1,1948,
he entered their employment. The partnership firm transferred
their assets to the new companies and received shares of the new
companies in lieu thereof.
All the members of the covenanted
staff in the partnership firm were given shares of Killick Industries Ltd., free of payment, and the assessee received an
allotment of I, 700 shares of the fase value __ of Rs. 2 ,21,000j-.
The assessee's case was that the shares were given by the partner ..
ship to the members of the staff as co-npensation 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 1- to tax on the footing
1901
1962
T Iii Ccmmissionn of
lnc"1Tl1·ta:c, Bctdqf
••
I:.' D. Sl.1pprnd
164
SUPREME COURT REPORTS [1964] VOL.
that the shares were allotted to the assessec in consideration of
past services. The Appellate Tribunal held on the evidence
before it that the payment was made solely as compensation
for loss of employment, and was not liable to tax in view of
Explanation 2 to s. 7 (I) of the Indian Income-tax Act, 1922.
It was contended for the Commissioner of Income-tax that
under the Explanation, the word "compensation" meant what
wM payable or compellable at law as compen«1tion, and any
payment received by an assessec from his employer or former
employer was profit received in lieu of salary, and that judged
from that point of view, the payment of Rs. 2,21,000/- to the
assessee was not compensation solely for loss of employment.
Held (Raghubar Dayal,]., di .. w1ling), that the expression
ucompensation for loss of employment" in Explanation 2 to
•· 7 (I) of the Indian Income-tax Act, 1922, referred to any
payment made, whether under a legal liability or voluntarily,
to compensate or act as a Solatium for the lo" of employment
suffered by the employee, and was not restricted to compensation which was payable or compellable at law; and that the
payment of Rs. 2,21,000/ ., found by the Tribunal to be a
payment made solely a> compensation for lo<S of employment
was not liable to tax, because the Explanation excepted such
payment from
being treated as a profit received In lieu
of salary.
Chibbet v. JoReph Robinaon & So118, (1924) 9 Tax Cas. 49,
Commis8ioner of Inwme-tax v. Shaw Wallau and Company,
(193~) L. R. 59 I. A. ?.06,
W. A. Guff v. Commi•.ioner of
Income-tax, Bombay City, (19571 31 I. T. R. 826, Commissioner
of Income-tax Hyderabad v. Va:ir Sultan and Sona, [1959]
Supp. 2 S. C. R. 375 and Mahesh
Ananlrai Pattani v. Th•
Commisaioner of Income-tax,
Bomhay North, Ahmedabcul,
[1961] 2 S. C.R. 742, relied on.
Per Das, Kapur and Sarkar, JJ.-No distinction could be
made between compensation for lo's of employment and
compensation for loss of prospects rooted in that employment.
If the object of the payments was unrelated to the relation
between the employer and employee, it would not fall within the
expression "profit recei•1ed in lieu of salary" in Explanation 2.
Per Raghubar Dayal, .J.-( I) Any sum paid by an empl~yer or former employer to an employee at the termination of
his services would be a "payment made solely as rompcnsation
for loss of employment" only when it was made in consideration
•
of what the tmployec could claim " such compensation under
+ -
law or the terms of the contract of service.
In the prC1Cnt
1 S.C.R.
SUPREME COURT REPORTS
Hi5
case, the assessee's
services were terminated by giving one
months's notice in accordance with the service contract.
IIe
had no claim for compensation. The payment of Rs. 2,21 ,000/-
by his employer firm could not therefore be said to have been
made as compensation for loss of employment.
(2) The payment was made by the firm as employer to the
assessee as employee and was received by the latter a day before
termination of his srrvices. The sum therefore came within
the language of the first p>rt of Explanation 2 to s. 7 (1) and
amounted to "profits in lieu. of service."
CIVIL APPELLATE JURISDICTION: Civil Appeal
No. 527 of 1961.
Appeal from the judgment and order dated
July 6, 1959, of the High Court at Bombay in
Income Tax Reference No. 64 of 1958.
K. N. Rajagopal Sastri and R. N. 81whthey,
for the appellant.
N. A. Palkhivala, J. B. Dadachanji, 0. G.
1]1fothur and Ravinder Narian, for the respondent.
1962. December 12.-The followin;; judgments
were delivered. The judgment of S. K. Das, J. L.
Kapur and A. K. Sarkar, JJ., was delivered by
S. K. Das, J., Raghubar Dayal, J., delivered a separate
judgment.
1962
TTM Commission1r 'J
'1rco·n1~tox, Bombf:!V
v.
E.D. Sl,8/f/rrl
S. K. DAs, J .-This is an appeal on a certiD111, 1.
ficate of fitness granted by the High Court of Bombay under s. 66·A (2) of the Indian Income-tax
Act, 1922.
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
1962
Tiu CommU1i011tr of
lt1com1·tax. 8tm1bay
v.
E.D. S/r,pp<nd
DoJ, J.
166
SUPREME COURT REPORTS [1964) VOL
mostly Europeans, on
the
basis of a
contract
for three years; if the sci vices 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 partntrs of
the firm one day. The assessee was one of such assistants who joined the firm in 1 o:m.
The original
contract relating to the assessee's 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 rcga~ding the assessee
· were the same as those of the contract with W . .J.
Heygate. Clause l 0 of the said agreement provided
that notwithstanding anything contained in it, the
firm might terminate the agreement without assigning
any reasons after giving the asscssce one calendar
month's previous notice of its intention so to do.
The
assessce continued in the employment of the firm and
his contract of service was renewed from time to time.
On November I, I !lli, 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
:'\ovcmber I,
l!Hi to
October 31, 1950.
Under this contract the assessee
was to receive a salary of Rs. 1,200/- per month plus
a commission of 2! 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 l!l4 7 the firm decided to re-organise its business
and with that end in view two limited companies
were floated: one was called the Killick Industri~s
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 ovrr the business previously
•
..
1 S.C.R.
SUPREME COURT REPORTS
I6i
carried on by the partnership.
This arrangement
necessitated the ·termination of the services of the
firm's employees and the assessec received a notice
from the firm dated December 29, 1947.
This notice
stated that in view of the changes proposed, the assessee's 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 assessee's 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
)
1962
The Cnmmissinnu of
ln:ome-to \', Bombay
v.
E.n. Si11ppaid
Dar, /.
1961
Tl·t QJmmiSJiontr of
lncorM-!ffx, Bomba,
Y.
E. D. Sluf'P"'d
04". J.
168
SUPREME COURT REPORTS (1964] VOL.
were allotted to the assessee in consideration of past
services.
The assessee produced before the Incometax Officer a let~er purporting to be written by one
D.R.C. Hartley on October I, 1952, on behalf of
the firm, in which the asscssee 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 asscssee produced an affidavit dated
February 22, l!J54, sworn by five out of the six partners who constituted the firm in the month of
Jar.uary W48, (the sixth partner having died in the
meanwhile) which affirmed the terms of a memoran·
dum submitted to the Income-tax Officer by Messrs
Crawford Baylc:y & Co., on behalf of the asscssce.
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, 1!)47, they wrote to each assistant who was
then employed by the firm terminating his services
from January :ll, I !J48, and stating that a further
communication would be addressed to him regarding
"the question of compensation for loss of rmploy·
ment".
It was furthfl" recited in paragraph 8 that
the intention of the partnc1 s 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
letter of December 27, I !J4 7, 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
thereaft~r
written "for purposes of record."
•
1 S.C.R.
SUPREME COURT REPORTS
169
The two members of the Tribunal differed in
11162
thei~ views as to the true character of the payment . Th• co-:.issiomr •f
received by the assessee.
The accountant member
Income-tax, Bomb~•
was of the view that the assessee suffered no loss as
ED si.,pp rd
a result of the termination of his employment with
· ·
•
the partnership firm, because from February 1, 1948,
Das, J.
the day after the termination of his employment with
the partnership, he was employed by Killick Industries, Ltd., which gave him almost the same emoh.1 ·
ments; and furthermore, the payment was not made
"solely for loss of employment" because the compen·
sation was paid partly for loss of expectations and
future prospects which the assessee had in the part·
nership firm.
Lastly, the accountant member held
that the employment of the assessce was terminable
on one month's 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 compensatio~ 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 assessee's services were determined by the
firm which was ultimately dissolved and the allot·
ment of shares was made to the assessee "at or in
connection with the termination 0f 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.
On 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 tht assessee
solely for loss of employment and it was immaterial
that the assessee secured another employment, equally
advantageous, under
~.nother 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
1961
Tlt1 Commi•·iovr 'f
/ntOtM•ta 1. IJ'lmbn;r
v.
r: D .. \hrppa• d
}),,.. J
I iO
SUPREME COURT REPORTS (1!164] VOL
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 asscssee free of
paymeut, is income of the assessee and assessable under section 7 of the Income-tax Act ?
The Tribunal made a reference under s. 6(i of
the Income-tax Act, UJ22.
The reference was heard
by Shah and Desai, JJ., of the Bombay High Court.
The High Court referred to Explanation 2 to s. 7 (I)
of the Income-tax Act, as it stood at the relevant
time, and held that if by an 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 asscssee did not in fact
suffer any loss by reason of securing another employment would not, for income· tax purposes, alter the
nature of the
payr.1ent made.
The High Court
painted out that the evidence given by the assessee
m 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 mb·s. (I) of s. 7 an argument
•
..
1 S.C.R.
SUPREME COURT REPORTS
171
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
lo~s 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 employ·
ment 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
unrelate:l 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 ~ (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 Expla·
nation 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
11161
n.~~
/rteomt-W, B••
y,
E.D. SfwH<ml
1961
n, CcmmW;..,, .of
f,.eorrw-ltsx, Bomt4_1
•..
E.D. Shtppa•J
DM, J
172
SUPREME COURT REPORTS [HHH] VOL.
the assessec; 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
Urt!;ed before us on. behalf of the appellant. But
before we do so, fit is necessary to say that s. 7 of
the Incom"<!-tax' Act, 1922, was completely recast by
the Finance' Act, 1955, and we arc 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 sto~d at the relevant time.:_
.• "S. ·7'.(l) The tax shall be payable by an
assessee under the head "Salaries" in respect
of any salary or wages, any annuity, pension or
grat~ity, 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
associat10n, 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
. '
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,
•
I S.C.R. SUPREME GOUR T REPORTS
173
unless the payment is made solely as compensation for loss of employment and not by way
of remuneration for past services :
xx
xx
xx
xx
xx "
Now, learned counsel for the clepartment has
urged two main contentions before us.
His first con·
tention is that the word 'compensation' in Explanation 2 means what i~ 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. (I) of s. i unless the
payment is made solely as compensation for loss of
employment.
He has submitted that the Explana·
tion 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 agrument 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.
1962
Thi CommissitWT of
lnc6m1-ta:<, Bombay
•.
E.IJ. Sh,ppard
Das, J.
1961
n. C..r•lll11U..1f' ".{
'-"""'• Bomlo.l
••
E.D.SM/IFI
Dlu, /.
174
SUPREME COURT REPORTS[l964]VOL.
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 Chibbetl v. Joseph
RobiMon &: Sons (') the assessees were employed by a
certain steamship company as ship managers and
their remuneration was fixed at a percentage of the
company's annual profits. The company went into
liquidation and the general meeting of the company
authorised the liquidators to transfer to the ass~ee a
sum of £ 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
£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 per3on 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 rC!lpect 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.
(I) (1991) 6 Tn Cai. 605. 634.
(2) (1921) 9 Tax Cu. 48•
•
1 S.C.R.
SUPREME COURT REPORTS
175
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 receiv·
ed 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 ('), 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
(I) (IP32J L.R. 59 J. A. 206.
n1Cootmiui-of
1_,,,., .. , Bordo7
v.
E.D. Sli#<J'd
Das, J.
1962.
TM Commissi:nur uf
/n,()1Tlt- 1ax, 8omh~-,i
••
E.D. Shtf>P!Ud
Dru, J.
176 SUPREME COURT REPORTS [1964] VOL
was pointed out that the object of the Inctian Incometax 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 af solatium for its compulsory
cessation, the answer seems fairly plain."
The same q ucstion arose before the Bombay
High Court in W. A. Guff v. Commissioner of lnr,ometax, Bombay City('). There the assessce joined in the
service of a company on May 27, HJ!(), 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
.l\farch 2~l, Hl-!8 he received the communication from
the compauy that the department could not funct.on
any more, but the asscsscc continued to serve un1til
November IO, HHS, for winding up the department.
On ~ovcmber 30, Hll8,
the company paid the
assessee a sum of Rs. I ~,000/ ·as compensation equivalent to six months' salary for the termination of
his employment owing to the closure of th~ 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
tbc 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
ctl [t957J 311.T.R azr..
..
..
1 S.C.R. SUPREME COURT REPORTS
177
date when the notice was given. The High Court
dealt with this argument a.nd repelled it. Chagla,
C. J., who delivered the judgment of the court
referred to the decisions in Shaw, Wallace and Company v. Commissioner of Jncom~-tax (') and Chfbbett
v. Joseph Robinson & Sons (')and then said :
"We are, therefore, of the opinion that the
expression "compensation for loss of employment" 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 ofcmployment suffered
.
"
by the employee."
·
Now, we come to a decision of this Court, Com·
missioner of Income-tax, Hyderabad v. Vazir Sultan
and 8ons ('). The assessee there, a registered firm, was
appointed the sole selling agent and sole distributor
for the Hyderabad State for the cigarettes. manufac-
.tured 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-fax 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
(I) \1932) L.R. 59 I.A. 206.
(2 1 (1924) 9 Tax Cas, 48.
(SJ [1959] Supp. 2 s.c.R. 375.
1961
Th• Gammill- •!
Jmam•-taJ<, S-N,
v.
E.D. S""""d
Dos, I.
nr c.
',rl
r •/
,..., ... s.u.,
••
E.D.~d
-
!Mi, /.
178 SUPREME COURT REPORTS[I964] VOL.
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 asscssee irrespective of
any consideration as to what was actuating the mind
of the other party. This Court refrrrcd with
approval to the observations made by Rowlatt, J..
in Chtbbetl 11. Joaeph Robinsan and Sons ('), which
we have calitr quoted. This Court also referred with
approval to the decision of W. A. Guf! v. Commiarioner of Income-lax ('), and said that 11 was immattrial whether the amount paid was compensation for
which the employer was liable at law or was a
payment made u gmlia.
In view of these decisions we must over-rule
the fint 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.
We now tum to the second contention. Prior
to the amendments introduced by
the Finance
Act, 1955, Expla!'lation 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
(I) (1924) 9 Tu Ou. 4i.'
\2) [11157) SI J.T.R. 828.
.t
1 S.C.R.
SUPREME COURT REPORTS
179
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
a&Sessee 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
Patlani
v.
The
Commissioner of
Income.tax,
Bomhay
North, Ahmedabad ('),
this Court had
to considers. 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
dedsion was whether the aforesaid payment of
Rs. fi,00,000/- was liable to tax under s. 7 (1) read
with Explanation 2. This Court held that the sum
<•> [19GIJ 2 s.c.R. 742.
1962
Thi C.mmissioRlf' of
lncwu-tax, B1mba,1
•.
E.D. Sheppard
Las, J.
/962
Tiu CommiJsiontr ef
lruomt·ltl.t, Bomba)
v.
f.'. D. ShtpparJ
/Jai, J.
180 SUPREME COURT REPORTS [1964] VOL.
of Rs. 5,00,000/· was given to Pattani r:ot as a
payment in consideration of the services already
rendered bv Pattani as the Dewan of the State but
merely as ·a gift in token of the \faharajah's
affection and regard for the assessee.
Therefore, it
was held the payment was not liable to be assessed
to tax under s. 7 (!), Explanation 2.
The ratio of
the decision was that the payment was a capital
receipt! and not income assessable to income-tax, in
the hands of the assessee.
AppJrently, 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 hands of the asscssee need be considered.
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·
pcnsation 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 emplo·
yee, 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.
For the reasons given above, we have come
to the conclusion that there is no substance in this
appeal.
The appeal is accordingly dismissed with
costs.
&,hobar DaJal, J.
RAGIIUBAR DAYAL, j.-1 have had the advan·
tage of perusing the majority judgment of my learned
l S.C.R.
SUPRE:'v1E COURT REPORTS
181
brother S. K. Das, J., but regret that I am unable to
agree that the sum of Rs. 2,21,000/- was paid solely
as compensation for loss of employment and did not
amount to 'profit in lieu of salary'.
Mr. Rajagopal Sastri, for the appellant, concedes that the impugned sum received by the assesseerespondent, is not liable to income-tax unless it can
be considered to be profit received in lieu of salary,
in view of Expl~.nation :l to s. 7 ( l) of the Incometax Act, as it stood prior to the amendment in 191\.~.
Section 7 deals with the tax payable by an assessee
under the head 'salaries'. It is not necessary to read
the entire section. The relevant portion of Explanation 2 to s. 7(1) reads:
"A payment due to or received by an assesscc
from an employer or former employ1,r ...... is ......
a profit received in lieu of salary for the purposes of this sub-section, unle's the payment
is made solely as compensation
for
loss of
employment and not by way of remuneration
for past services."
Mr. Sastri contends that the sum of Rs. :l,21,000/-
was received by the assessee from his
employer
Killick Nixon & Co., on J auuary 30, a day before
the termination of his services by that company, that
it will be deemed to be profit received in lieu of
salary unless the payment can be said to be made by
the employer solely as compensation for loss of
employment and not by way of remuneration for
past services and that the amount was not paid
solely as compensation for loss of employment.
He
has submitted that the expression 'compensation'
means what is legal! y payable as a monetary equivalent of the damage suffered by the wrongful termination of service, that the amount of compensation
is usually equivalent to the loss of earnings under the
contract which had come to an end minus the expected reimbursement from any fresh employment.
/962
The C:ommissirmer rJ.f
Income-fax, Bombay
v.
E.D. lluppa<d
Ra"'hubar Dayal, J.
1962
Tiu CommUJiorur q/
l11tam1·/a:r, Bombay
v.
F..D. Shtf>la'd
Iiaghubnr Dayal, J.
182 SUPREME COURT REPORTS [1964] VOL
Mr. Palkhivala, for the assessee, has urged that
the intention of the parties is the main thing for
determining the nature of the amount paid by the
employer to the employee at the termination of the
service and that compensation, for the purpose.of
thi~ provision of the Income-tax Act, need not be
equivalent to what Courts of law would allow as
damages for injury caused to the person claiming
compensation.
It is urged that the word 'compcn·
sation' has got a well-established meaning for the
purpose of the Act, the meaning being as stated by
Romer, L. .J., in Henry (II. 1lf. ln3pector of Taxea)
v. Arthur Foster; Henry (H. JI. Inspector of Taus)
v. Jo.~eph Foster('),
It has not been disputed that by virtue of the
contract between the asscssee and the company the
services of the assessee could have been terminated
by giving him one calendar month's notice.