V.D. Talwar (Dead) And After Him His... vs The Commissioner Of Income-Tax, Bihar
Rewritten Version Notice: This is a rewritten version of the original judgment.
Court: Supreme Court of India
Case Number: Civil Appeal No. 673 of 1962
Decision Date: 26 March 1963
Coram: S.K. Das, A.K. Sarkar, M. Hidayatullah
In this matter the Supreme Court of India examined an appeal brought by the estate of the deceased Mr V D Talwar and his heirs against the Commissioner of Income‑Tax, Bihar. The judgment was delivered on 26 March 1963 by a bench consisting of Justice S K Das, Justice A K Sarkar and Justice M Hidayatullah. The case is reported in 1963 AIR 1583 and 1964 SCR (2) 519. The dispute arose under the provisions of the Indian Income‑Tax Act, 1922 (Section 7), and concerned whether a sum paid to the assessee upon termination of his employment constituted taxable income or compensation for loss of employment.
According to the service agreement, Mr Talwar had been engaged as General Manager of a company with a monthly salary of Rs 2,000 and an annual increment of Rs 100. The contract allowed deductions for income tax, absence from duty and similar items. The agreement was for a period of five years but provided that the employer could terminate the contract earlier by either giving twelve months’ notice or by paying salary in lieu of such notice. Mr Talwar entered into service on 1 May 1946. His employment was terminated effective 31 August 1947, not because of any default or misconduct on his part but because the company elected not to retain him. The employer failed to give the twelve‑month notice required by the contract.
In place of notice, the company paid the assessee Rs 18,096, which represented the salary for twelve months after deduction of income tax at source. The Income‑Tax Officer treated a larger amount of Rs 25,200 as a revenue receipt of the assessee and therefore subject to tax, rejecting the assessee’s claim that the amount represented compensation for loss of employment. The officer also ordered that tax of Rs 7,103.15, which had been levied on the larger sum, be refunded to the assessee.
The assessee appealed, and the Appellate Assistant Commissioner allowed the appeal. However, the Income‑Tax Appellate Tribunal reversed that decision. The tribunal then referred a question of law to the High Court, asking whether the sum of Rs 25,200 was revenue income of the assessee. The High Court decided against the assessee, and the matter reached this Court by way of special leave.
The Supreme Court held that the amount paid to the assessee was his salary in lieu of notice and not compensation for loss of employment. The Court observed that no notice had been given for termination and that the payment corresponded precisely to the salary for twelve months, which the contract expressly permitted as a substitute for notice. Consequently, the assessee received exactly what he was contractually entitled to and was not deprived of any rights under the service agreement. The payment therefore constituted taxable salary under Section 7 of the Act.
It was held that the sum paid to the deceased could not be described as compensation for loss of office and, therefore, the amount was subject to tax under section seven of the Income‑Tax Act. The Court indicated that the authorities cited in support of this view included Henry (H. M. Inspector of Taxes v. Arthur Foster) and Henry (H. M. Inspector of Taxes v. Joseph Foster) (1932) 16 T.C. 605; The Commissioner of Income‑tax, Bombay City v. E. D. Sheppard, Bombay [1964] 1 S.C.R. 163; Henley v. Murray (H. M. Inspector of Taxes) (1950) 31 T.C. 35; Date (H. M. Inspector of Taxes) v. de Soissons (1950) 32 T.C. 118; and Duff (H. M. Inspector of Taxes v. Barlow) (1941) 23 T.C. 633, all of which were expressly referred to in the judgment.
The matter before the Court was a civil appeal numbered 673 of 1962, taken on special leave from a judgment and decree dated 22 November 1960 delivered by the Patna High Court in miscellaneous judicial case number 740 of 1958. The appellants were represented by counsel comprising A. V. Viswanatha Sastri and M. S. Narasimhan, while the respondent was represented by counsel Gopal Singh and R. N. Suthery. The judgment was pronounced on 26 March 1963, and the opinion was delivered by Justice S. K. Dab, who recorded that the deceased, V. D. Talwar, had been the assessee before the tax authorities and that his legal representatives, appointed after his death, were now the appellants in the proceeding.
V. D. Talwar had been employed as the General Manager of Messrs J. K. Iron and Steel Company Limited, situated in Kanpur. The conditions of his employment were set out in an appointment letter dated 7 February 1946, and a formal memorandum of agreement was executed by the parties on 9 February 1946. He actually entered the service of the company on 1 May 1946. Under the service agreement, his salary was fixed at rupees two thousand per month, with an annual increment of one hundred rupees, subject to deductions for income tax, absence from duty, and other items, though the detailed deductions were not required for the purpose of this case. The agreement stipulated that the term of service would be five years.
Clause 5 of the appointment letter read, “Period of agreement of service to be five years,” and clause 6 stated, “Termination of service if within five years to be on notice of twelve months on either side or salary in lieu thereof.” Clause 1 of the memorandum of agreement, dated 9 February 1946, required the employee to serve the employer faithfully and diligently for a period of five years commencing from his date of joining. Clause 21 further provided that if, during the currency of the agreement, the employee wished to leave the service for any reason, he could terminate the agreement by giving twelve calendar months’ written notice, after repaying any joining money and allowable expenses to the employer, and that the employer retained full power to enforce such repayment. The clause also empowered the employer to terminate the employee’s service by giving twelve calendar months’ notice in writing, or by paying salary in lieu of such notice.
The contract between the employer and the employee provided that either party could terminate the service by giving twelve months’ written notice, or, in the event of a breach of any term, could terminate without notice by paying salary in lieu of the notice period. The employee, who was appointed General Manager, joined his post on 1 May 1946. His employment was terminated effective 31 August 1947. Both parties admitted that the termination was not caused by any default or misconduct on the part of the employee; rather, the employer simply chose not to continue his services. The employer did not provide the twelve‑month notice required by the contract. Instead, on 12 September 1947, the employer paid the employee a sum of Rs. 18,096/1/0, representing the amount that would have been his salary for twelve months after deduction of income tax at source. The employer had calculated the twelve‑month salary at Rs. 25,200/‑ and had deducted Rs. 7,103/15/‑ as income‑tax. The employee issued a stamped receipt acknowledging that he had received Rs. 18,096/1/0 “in full and final settlement of all his claims and dues against the employer.”
When the assessment for the financial year 1948‑1949 was made, the Income‑Tax Officer held that the amount of Rs. 25,200/‑ was a revenue receipt of the employee and therefore taxable under the Indian Income‑Tax Act, 1922. The officer rejected the employee’s contention that the sum represented compensation for loss of employment and that the tax of Rs. 7,103/15/‑ should be refunded. The employee appealed this assessment to the Appellate Assistant Commissioner, who reversed the officer’s view. The Commissioner observed that although the sum had been computed on the basis of twelve times the monthly salary, it was in fact compensation for loss of service and consequently not taxable as salary income. The employee then appealed to the Income‑Tax Appellate Tribunal. The Tribunal set aside the Commissioner’s finding and held that the amount paid was salary in lieu of the twelve‑month notice, and therefore liable to tax under the Indian Income‑Tax Act, 1992. Invoking section 66(1) of the Act, the Tribunal referred the question of law to the High Court, asking whether the sum of Rs. 25,200/‑ received by the employee during the previous year constituted revenue income liable to tax under the Act. By its judgment dated 22 November 1960, the High Court answered the question against the employee. The employee then obtained special leave to appeal to this Court, and the present appeal has been filed. The precise issue before this Court is whether the sum of Rs. 25,200/‑ received under the circumstances described constitutes revenue income taxable under the Indian Income‑Tax Act, or whether it should be treated as a capital receipt exempt from tax.
The question that arose was whether the sum of Rs 25,200 received by the assessee in the circumstances described earlier constituted revenue income that was liable to tax under the Indian Income‑Tax Act, or whether it was a capital receipt that fell outside the scope of taxation under that Act. The Court expressed agreement with the view adopted by the High Court. In the earlier decisions of Henry (H M Inspector of Taxes) v Arthur Foster and Henry (H M Inspector of Taxes) v Joseph Foster, Justice Romer observed that the expression “compensation for loss of office” is a well‑known term which signifies a payment made to a holder of an office as compensation for being deprived of the profits that, absent such deprivation by the employer or by a third party such as the Legislature, the holder would have been entitled to receive. The present Court accepted the same interpretation in the case of The Commissioner of Income‑Tax, Bombay City v E D Sheppard, emphasizing that the critical factor is the act of deprivation, which may or may not create any legal liability. Applying this principle to the present facts, it became clear that the two clauses numbered five and six in the appointment letter and clauses one and twenty‑one in the memorandum of agreement had to be read together. When read conjointly, these provisions revealed that the contract of service allowed V D Talwar either to serve for a period of five years at the monthly salary specified in the contract, or, at the company’s election, to serve for a shorter period subject to the conditions laid down in clause twenty‑one. If the conditions of clause twenty‑one were observed, it could not be said that V D Talwar had relinquished any contractual rights or had been deprived of any such rights. The Court of Appeal had examined the two Foster cases together with a third case, Hunter (H M Inspector of Taxes) v Dewhurst. In all three cases the Court reached the same conclusion, although the facts in the Dewhurst case differed slightly. In that case the respondent wished to retire from active management, while his co‑directors wanted to retain his advisory services; consequently he agreed to resign as Chairman and to receive a lump‑sum “compensation” in lieu of the benefit provided under article 109, thereby waiving any future claim under that article, and he remained on the Board at a reduced remuneration. That decision was appealed to the House of Lords, where Lord Dunedin observed that, assuming the Court of Appeal’s view in the Foster cases was correct when the question was framed solely on the basis of rights arising under article 109, a different issue emerged in the Dewhurst case because the payment was made not for ceasing to be a director but for giving up potential claims under article 109, a payment which, according to his Lordship, did not constitute income.
In the Dewhurst matter, the Court observed that Mr. Dewhurst did not receive any sum pursuant to article 109. Instead, he entered into a fresh arrangement whereby he was paid the sum of ten thousand pounds. The payment was made not because he ceased to be a director—indeed he continued in that capacity—but because he agreed to relinquish any prospective claims that might arise under article 109. The Lordship pronounced that a payment made to obtain the surrender of such potential claims did not constitute income within the meaning of the statute. This feature, reported in (1) (1932) 16 T.C. 605, distinguished the case of Hunter v. Dewhurst from the two Foster decisions previously cited, and it highlighted the existence of two distinct categories of cases. The first category comprises situations where there is a deprivation of rights under the contract, which therefore falls within the realm of compensation. The second category comprises situations where no such deprivation occurs.
Sir Raymond Evershed, M.R., when delivering judgment in Henley v. Murray (H.M. Inspector of Taxes) (2), explained that the law recognises two kinds of cases for the purpose of consideration under this head. The first kind involves cases in which the entitlement of one party to require performance of the contract may be altered or even wholly abandoned, yet the corresponding right to receive a payment—whether the entire amount or a reduced figure—remains preserved and is payable under the contract. The second kind involves cases where the contract itself is terminated altogether and a sum becomes payable as consideration for the total abandonment of all contractual rights that the other party previously possessed. In the former class the contract continues to exist and the amount is payable as part of that contract; in the latter class the contract is completely abandoned and the payment is made in consideration of that abandonment. The Court held that the present case fell within the first of these two classes.
The High Court correctly pointed out that the principle applicable to the present facts is the one laid down in Dale (H.M. Inspector of Taxes) v. de Soissons (3). In that case the respondent was employed as an assistant to the managing director of a company. His remuneration consisted of a fixed salary of three thousand pounds per annum together with a commission calculated on profits. Under the terms of his service agreement, his appointment was to last for three years beginning on 1 January 1945, but the company retained the right to terminate the agreement on 31 December 1945 or on 31 December 1946, subject to the payment of ten thousand pounds or six thousand pounds respectively as compensation for loss of office. The company exercised its right to terminate on 31 December 1945 and paid the respondent the sum of ten thousand pounds. The Court held that the payment was compensation for loss of office. Roxburgh J, who dealt with the case at first instance, pointed out that the
The Court explained that the service agreement had to be interpreted as an integrated document, and that, under its terms, the respondent’s employment was to continue for three additional years only unless it was curtailed pursuant to clause 4 or clause 5. The agreement also stipulated that the respondent was to receive, as profit from his employment, the payments enumerated in the contract, including the amount specified in clause 5. Consequently, the Court held that the respondent never acquired a vested right to remain employed for the full three‑year period and therefore possessed no legal claim that would justify any payment as compensation.
Accordingly, the Court observed that the respondent had surrendered no rights under the agreement and had received exactly what the contract entitled him to receive. Under one provision of V D Talwar’s service agreement, he was required to serve for five years; however, another provision authorized the employer to terminate his service by giving twelve calendar months’ written notice or by paying “any salary” in lieu thereof. The expression “any salary” was read in the context of the appointment letter, which stated that if Mr Talwar’s service were terminated within the five‑year period, he would be entitled either to a twelve‑month notice or to salary in lieu of such notice. In the present circumstances, no formal notice of termination was served, but the employer paid Talwar twelve months’ salary. The Court therefore concluded that Talwar obtained precisely the benefit he was contractually owed and that no deprivation of his contractual rights occurred. Because there was no deprivation, the payment could not be characterized as “compensation for loss of office” within that phrase’s meaning. The Court cited Jenkins, L.J., in Henley v. Murray (1), observing that “as the many cases on the topic show, it is often very difficult to determine the character of a payment made to the holder of an office when his tenure of the office is determined or the terms on which he holds it are altered, and the question in each case is, whether, on the facts of the case, the lump sum paid is in the nature of remuneration or profits in respect of the office or is in the nature of a sum paid in consideration of the surrender by the recipient of his rights in respect of the office.” The Court noted that, had Talwar been served with a notice of termination, he would have worked for twelve months, received his salary, and then his service would have lawfully ended. Instead, the employer chose to pay twelve months’ salary in lieu of notice. Thus, the true position was that Talwar received twelve months’ salary for his office despite performing no work during that period, and by no stretch of imagination could the sum be said to represent consideration for the surrender of any rights.
In discussing the relevant authority, the Court observed that the case of Henley v. Murray (1) (1950) 31 T, C. 351 established that the amount paid to the appellant there was compensation for surrendering the right to continue in service and to receive remuneration until the contractual end date. In that case, the appellant had a contractual right to remain in service until 31 March 1944 and could be terminated only by giving three months’ notice after that date. Nevertheless, he resigned earlier, on 2 September 1943, at the request of the Board of Directors. Consequently, the principle articulated in Henley v. Murray was deemed inapplicable to the present facts. The appellant’s counsel then relied upon Duff (H. M. Inspector of Taxes) v. Barlow (1). That case involved an agreement that was intended to continue until 1945, although no precise percentage of remuneration was stipulated. The arrangement was terminated prematurely in November 1937, and, in consideration of that early termination, the employee received remuneration for services rendered up to November 1937 and an additional sum of £4,000 as compensation for the loss of his future entitlement under the 1935 agreement. The Court in Duff held that the £94,000 received by the respondent was not payment under the contract of employment nor remuneration for services performed or to be performed; rather, it was compensation for relinquishing a right to future remuneration. The Court found that this precedent did not assist the appellant in the present case. It was clear, the Court said, that the appellant had not surrendered any contractual rights. The amount he received was paid strictly under the terms of his contract as salary that he would have earned had he been given twelve months’ notice. Because no notice was served, he was treated as if he remained in service and was therefore entitled to twelve months’ salary, which was the amount paid. The Court found it difficult to regard such payment as compensation for loss of office. The Court further noted that the present case resembled the two decisions of Henry v. Arthur Foster and Henry v. Joseph Foster (2), and differed from Hunter v. Dewhurst (1). In the former two cases, the respondents were directors of a limited company who held office for at least five years and resigned or ceased to hold office for reasons other than misconduct, bankruptcy, lunacy or incompetence. Article 109 of the company’s articles stipulated that in such circumstances the company should pay to the director or his representatives, as compensation for loss of office, a sum equal to the total remuneration received by the director in the preceding five years. The Court contrasted this situation with the present case, emphasizing that the payment in the present matter was salary in lieu of notice rather than compensation for loss of office.
In the earlier cases the articles of association provided that in the event of bankruptcy, lunacy or incompetence the company should pay to the director or his representatives a sum as compensation for loss of office equal to the total remuneration the director had received in the preceding five years. In both of those earlier cases the respondents resigned from their offices as directors and, relying on Article 109, the company paid them a sum described as “compensation.” The Court of Appeal held that this payment was a profit derived from the office of director and was therefore properly assessable to income‑tax. Lord Hanworth, MR, explained at page 629 that the argument advanced was that the sums payable under Article 109 were compensation for loss of office. He questioned whether that was the true substance of the matter, observing that a man who dies is not compensated for the loss of his life, and a man who resigns voluntarily should not be compensated for the loss of his office. He suggested that the wording in the article might have been inserted to attempt to avoid tax, but emphasized that the substance of the payment was that it formed part of the director’s remuneration, calculated according to his service over a certain period, and was payable in addition to the amount under clause 104, with a further sum to be paid under clause 109.
Lord Lawrence L. J., at page 632, added that the decisive factor was that the payment to the respondent, irrespective of the label chosen by the parties, was a sum that the company had contracted to pay as part of the respondent’s remuneration for his services as a director. He acknowledged that this portion of remuneration was deferred until the director’s death, retirement or cessation of office, and that the articles called it “compensation for loss of office.” Nevertheless, he held that the sum was agreed to be paid in consideration of the respondent accepting and serving in the office of director and consequently constituted remuneration for those services.
The Court applied the same principle to the present case. It held that the amount paid to the appellant was his salary in lieu of notice. If that characterization is correct, the amount falls within the definition of taxable income under section 7 of the Indian Income‑Tax Act, 1922, and it is not “compensation for loss of employment” within the meaning of Explanation 2 to that section. Consequently, the Court concluded that the High Court had correctly answered the question presented. The appeal was therefore dismissed with costs, and the order of the High Court was affirmed.