VEERASWAMI J. - This is a petition under article 226 of the Constitution to quash an order of the Income-tax Officer dated November 21, 1958, made under section 18(7) of the Income-tax Act, 1922. By that order he directed the petitioner to pay on or before December 30, 1958, a sum of Rs. 37,408 88 as tax which it should have deducted but failed to do so on a sum of Rs. 1,00,000 paid to one A. Subbiah on April 16, 1945, in accordance with the agreement dated April 11, 1945. The Income-tax Officer himself in his order described the circumstances in which this payment came to be made to Subbiah. It appears that he was formerly in the employ of the Imperial Bank of India and, under the terms of his services there, he would be entitled on his retirement to pensioner benefits. The petitioner, which is the Indian Overseas Bank Ltd., Madras, requistioned his services as its general manager but his acceptance of service under the petitioner would involve sacrifice of the benefits which he would otherwise have been entitled to from the Imperial Bank of India. An agreement was entered into on April 11, 1945, between the petitioner and Subbiah which provided that, in consideration of Subbiah agreeing to accept service with the petitioner, the latter undertook to pay him a sum Rs. 1,00,000 on his joining service on specified terms and conditions. Subbiah was to serve the petitioner for a period of seven years from the date of his assuming office as general-manager and was to be paid a salary of Rs. 1,100 per month during the period of his service. But if at any time during that period Subbiah should die or voluntarily tender his resignation from service of the petitioner, in that case a sum as calculated therein should be payable by Subbiah or from his estate to the petitioner. A schedule was drawn up for this purpose according to which the sum so payable at any particular time would be the sum of rupees one lakh with accrued interest reduced by Rs. 1,200 per month for every completed month during the first year of service, Rs. 1,250 for the second year and so on which rose up to Rs. 1,500 for every completed month during the seventh year of service. Provisions was made for running of interest on the sum of rupees one lakh at three and half per cent. Per annum and Subbiah was to furnish security for the same. Under the agreement, this sum of rupees one lakh should become the absolute property of Subbiah free from any claim from the petitioner and all securities held thereof should of released in his favour but only on the happening of any of the events, to wit, (a) upon the completion of seven years of service under the agreement, (b) Subbiah becoming totally incapacited from service in the bank, and (c) in the event of the bank terminating his services earlier. To complete the facts, Subbiah served the petitioner for the full period and became absolutely entitled to a sum of rupees one lakh which had been placed to his credit by the petitioner on April 16, 1945.
In Commissioner of Income-tax v. Indian Overseas Bank Ltd., the petitioner claimed for the assessment years 1948-49 to 1952-53, five sums of money each deductible in each of the assessment years. This was on the basis that the amounts represented items of expenditure necessary for carrying on the business of the petitioner. The claim was disallowed by the revenue on the ground that the sum of rupees one lakh had been paid for acquisition of the services of Subbiah and represented an expenditure of capital nature. The petitioners claim that any portion of the amount could be regarded as an outgoing of a revenue nature was rejected. The petitioner having failed in the departmental appeal, preferred successfully a further appeal to the Tribunal. The Tribunals view was that though a lump sum of rupees one lakh was placed to the credit of Subbiah it is not a case of payment made in advance always remained the property of the assessee. On that view, its conclusion was that the amount written off every year represented the expenditure of the assessee for that year. On a reference to this court at the instance of the Commissioner of Income-tax under section 66(1) of the Act, this court held that the payment of rupees one lakh was an outright payment on the taking up of service by Subbiah, he begin only placed under an obligation to pay to the petitioner certain sums on his failure to fulfill his part of the contract and that on that view it was obvious that there was no expenditure at all incurred during any of these years to the extent claimed. The learned judges considered that the expenditure in the sum of rupees one lakh had already been incurred in 1945 when the payment was made to Sibbiah and the writing off of any sum during any of the years by the bank had no legal effect. Before the reference was made to this court, the Income-tax Officer had written to the petitioner on August 6, 1958, inviting its attention to the fact that its claim in respect of the sum of rupees one lakh as expenditure year after year had been allowed and asking it to show cause against action being taken as provided in the Act for non-compliance with the provisions of section 18(2) of the Act. The petitioner in reply took up the stand that, having regard to the terms of the agreement the payment of rupees one lakh was in the nature of an advance and there was therefore no question of deduction of tax at sources at the time of such payment. Then followed the order of the Income-tax Officer dated November 21, 1958. The officer replied on the petitioners statement that the payment of rupees one lakh was advance but disagreed with its view that it did not amount to a payment to Subbiah should be treated as income chargeable under section 7(1) and as no tax was deducted at source by the petitioner he held it to be in default of the tax due on the sum of rupees one lakh. Thereafter the petitioner moved the Commissioner of Income-tax under section 33A(2) of the Act but in vain. The Commissioner was of opinion that, since this court in Commissioner of Income-tax v. Indian Overseas Bank Ltd. had observed that the payment of rupees one lakh was an outright payment on the taking up of service by Subbiah it should be regarded as salary under section 7.
It should be apparent by now that the question we are called upon to decide turns on the character of the receipt by Subbiah of the sum of rupees one lakh. Before us the contention for the petitioner is : (i) that it was compensation paid to Subbiah for loss of employment with the Imperial Bank and the pensioner benefits he would have been entitled to if he had not joined the petitioner service and (ii) that in any case the payment did not represent salary within the meaning of section 7 but was a capital receipt. As the payment was prior to the coming into force of the Finance Act, 1955, we have to take Explanation 2 to section 7 as it stood then. Under this Explanation a payment made solely as compensation for loss of employment and not by way of remuneration for past services is excluded from the extended purview of the definition of 'Salaries' under section 7(1). That provision includes within the ambit of 'Salaries' a variety of things. Any perquisites or profits in lieu of or in addition to any salary or wages will also be regarded as salary under section 7(1). While, on the one hand, it is contended for the petitioner that the payment was compensation for loss of employment, on the other, for the revenue it is stated that the payment flowed from the agreement between Subbiah and the petitioner and related to his employment and should, therefore, be regarded as a payment in addition to his salary. We have no difficulty in rejecting the contention that the receipt in the hands of Subbiah was compensation for loss of employment. For a payment to have that character, the presence of three elements is essential. There should be an employment which necessarily implies relationship of employer and employee. Secondly, there must exist a loss of such employment which means a cessation or termination of service putting an end to the relationship of employer and employee. Thirdly, the amount a paid must be connected with or related to such loss and should be with a view to compensate for the loss. Unless there is a nexus between each of the three requirements it cannot in our opinion be said that a given payment has the character of compensation for loss of employment. In each case, the question has to be tested in the light of particular facts. The test will not merely be as to what the payment represented as a receipt in the hands of the employee. It has to be ascertained as to what for the payment was made by the employer. It is in the light of answers to both the tests, can the question as to the character of a given receipt be satisfactorily decided. In Chibbett v. Joseph Robinson and Sons, Rowlatt J. observed :
'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 persons 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 its is a question of trade so on. You have to look at his 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 the person inquiring what us this payment for.'
This extract has been quoted with approval by the Supreme Court in Commissioner of Income-tax v. E. D. Sheppard. As pointed out by Rowlatt J., where payment has been made in relation to or in connection with cessation of service, it will not be decisive to inquire whether he could have been compelled to make the payment or even that a loss in fact by reason of termination or cessation of service or office had occurred. But as we mentioned earlier it is essential in connection with the payment that there must be a termination or cessation of office or service and it is in that sense loss in the send Explanation of section 7 has to be understood. What may appear to be a compensation in the recipients hands in the sense of a quid pro quo may not really be so, if tested in the light of the what the payment was made for by the person who did it. Such payment made by 'X', who is the employer, to 'Y' who is the employee, in connection with or in relation to cessation or termination of the latters service with or under a third party cannot in any sense be regarded as having the character of compensation. This is because so far as the person who pays the amount is concerned the payment is not for any termination or cessation of service with or under him. Though in a sense from the point of view of the recipient it may be a quid pro quo for loss of his service with third party, it is nevertheless not a payment by 'X' for loss of service with or under him. The payment in a such a case is made by 'X' not for loss of service but for other consideration. The instant case before us is a typical illustration of such a case.
It may that by joining the petitioners service, Subbiah had necessarily to leave the Imperial Bank of India with the consequence that he would no more be entitled to pensioner benefits from his former employer. In a loose sense, Subbiah may regard the sum of rupees one lakh received by him as wholly or in part compensation for loss of his benefits from the Imperial Bank of India. But what was the payment made for by the petitioner There was no relationship of employer or employee prior to the agreement between the petitioner and Subbiah and there could, therefore be no question of cessation or termination of such a service. It follows that so far as the petitioner was concerned, it was not a payment for loss of employment in the statutory sense we earlier indicated. Looking at both the aspects, therefore from the point of view of the petitioner as well as that the recipient Subbiah we reach the conclusion that it was not compensation paid by the former for loss of employment within the meaning of Explanation 2 to section 7.
The question then is whether the sum of rupees one lakh represented salary for the purpose of section 7. Strong reliance is placed for the petitioner on the view expressed by this court in Commissioner of Income-tax v. Indian Overseas Bank Ltd. that the payment was an outright payment and not as an advance. It seems to us that the contention is partly correct. In Commissioner of Income-tax v. Indian Overseas Bank Ltd. all that this courts had to decide was whether the payment could be regarded as a deductible expenditure in the particular years and the view expressed in that case by this court was that it was not of that character. This court, therefore had not further to decide as to what precisely was the character of the outright payment though of course, the decisions itself would imply as we think, that it was not a payment in the nature of advance salary in the years there in question. The Tribunal in that case had taken that view but this court did not accept it. Apart from that we are inclined to think, having regard to the terms of the agreement and the circumstances in which it was entered into and the sum of rupees one lakh was paid that it was a payment partly for acquiring the services of Subbiah. He had to be persuaded to leave his job in the Imperial Bank and take up service with the petitioner which would mean loss of certain benefits which he would have received had he continued in the service of the Imperial Bank and retries. Naturally, therefore, Subbiah would stipulate for making good that loss and if the petitioner wanted to secure his services, it had perforce to agree to his terms. From that standpoint, a part of the payment partakes the character of capital expenditure. We do not entirely accept the contention for the revenue that because the payment flowed from the agreement and related to the services of Subbiah with the petitioner, the payment was in the nature of an addition to Subbiahs emoluments. Part of the payment begin of for procuring the services of Subbiah for a period of seven years, to that extent in our view it was capital expenditure. It cannot at the same time be denied that the other part did relate to the service of Subbiah under the petitioner for a period of seven years. Though the payment was a lump sum, that fact by itself is not determinative of the character of the payment. The terms of the contract make it quite clear that if Subbiah failed to serve the petitioner for the full period of seven years, a proportionate sum would be recoverable from him out of the sum of rupees one lakh. That shows that the payment of rupees one lakh was not merely for the purpose of procuring the services of Subbiah but also for retaining him in service for the entire period. In that sense, part of the payment related to the future service of Subbiah and could only be regarded as we consider as an addition to the salary. In fixing Subbiahs monthly salary, this part payment included in the lump sum of rupees one lakh was presumably taken into account. That part of the payment which we hold to relate to future service flowed from the service agreement and related to the employment under the petitioner and the emoluments attached thereto.
A problem would then arise, how to apportion the payment which is partly of a capital character and partly in the nature of salary within the extended definition of that term under section 7. On a rough estimate, the benefits which Subbiah would have for from the Imperial Bank had he continued in its service would be somewhere about Rs. 50,000. Even if this is not a proper basis for apportionment in the absence of any other basis, we should think that it would be fair and reasonable to fix the proportion as 50 : 50. The result is one half of the outright payment of rupees one lakh will not be salary and section 18(2) cannot therefore, be invoked in respect of it. With regard to the other half, the petitioner should have deducted the tax due thereon. To that extent the demand made by the Income-tax Officer has to be upheld. The impugned order of the Income-tax Officer is quashed only in so far as it related to the sum of Rs. 50,000 which represents capital receipt. To that extent the order of the Commissioner too is quashed. In other respects the direction of the Income-tax Officer will stand and he will be entitled to recompute and make a modified demand of tax in the light of our judgment.
The petition is allowed in part but, in the circumstances, we make no order as to costs.
Petition allowed in part.