THE COMMISSIONER OF INCOME-TAX BOMBAY vs. E. D. SHEPPARD

CIVIL APPEAL No. 527/1961Supreme Court[1964] 1 S.C.R. 16312 December 1962Bench: 4 JudgesAuthor: S.K. DAS, J.L. KAPUR, A.K. SARKAR, RAGHUBAR DAYAL I S.C.R. SUPREME COURT REPORTS37 pages
AI SummaryDismissed

What did the Supreme Court hold?

The Supreme Court, in a majority decision (Justices S.K. Das, J.L. Kapur, and A.K. Sarkar), held that the expression 'compensation for loss of employment' in Explanation 2 to Section 7(1) of the Indian Income-tax Act, 1922, encompasses any payment made, whether under legal liability or voluntarily, to compensate or act as a solatium for the loss of employment. The Court found that the Tribunal's finding that the payment of Rs. 2,21,000/- was made solely as compensation for loss of employment was supported by the evidence. Therefore, this payment was not liable to tax as it was excepted by Explanation 2 from being treated as profit received in lieu of salary. The majority also noted that no distinction could be made between compensation for loss of employment and compensation for loss of prospects rooted in that employment. The object of the payment, if unrelated to the employer-employee relationship, would not fall under 'profit received in lieu of salary'. Justice Raghubar Dayal, dissenting, held that 'compensation for loss of employment' only applies when it is claimable under law or contract. Since the assessee's services were terminated with one month's notice as per contract, he had no claim for compensation. He further held that the payment was made by the firm as employer to the assessee as employee, received a day before termination, thus falling under the first part of Explanation 2 as 'profits in lieu of service' and was taxable.

What were the facts?

The respondent, E.D. Sheppard, was employed by the partnership firm Killick Nixon & Company. His contract, initially for three years, was renewed multiple times. The firm decided to re-organize its business by floating two limited companies, Killick Industries Ltd. and Killick Nixon and Company. On December 29, 1947, Sheppard was notified that his employment with the firm would terminate on January 31, 1948. He then joined Killick Industries Ltd. on February 1, 1948. The partnership transferred its assets to the new companies and received shares. Sheppard, along with other members of the covenanted staff, received 1,700 shares of Killick Industries Ltd. valued at Rs. 2,21,000/-. Sheppard contended these shares were compensation for loss of employment due to premature termination. The Income-tax Officer sought to tax these shares as consideration for past services.

What were the issues?

1. Whether the shares received by the assessee, valued at Rs. 2,21,000/-, constituted 'compensation for loss of employment' as contemplated by Explanation 2 to Section 7(1) of the Indian Income-tax Act, 1922, thereby exempting them from tax. Assessee's contentions: The shares were received as compensation for the loss of employment resulting from the premature termination of services. This compensation is not taxable under Explanation 2 to Section 7(1). Revenue's contentions: The shares were allotted to the assessee in consideration of past services. Under Explanation 2, 'compensation' implies a legal or contractual obligation. Any payment received from an employer or former employer is profit in lieu of salary. The payment of Rs. 2,21,000/- was not solely for loss of employment.

Which sections of the Income-tax Act were involved?

Section 7(1), Explanation 2

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.. 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 offi- cer·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 cont- ract 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

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