1967 (3) TMI 31 - HC - Income Tax

Failure to deduct tax at source - order of the Income-tax Officer made under section 18(7) of the Income-tax Act 1922 - Whether the sum of rupees one lakh represented salary for the purpose of section 7

Summary

Issues Involved:
1. Characterization of the payment of Rs. 1,00,000 to Subbiah.
2. Determination of whether the payment was compensation for loss of employment or salary under section 7 of the Income-tax Act, 1922.
3. Applicability of section 18(2) of the Income-tax Act, 1922, regarding tax deduction at source.

Issue-wise Detailed Analysis:

1. Characterization of the Payment of Rs. 1,00,000 to Subbiah:
The petitioner, Indian Overseas Bank Ltd., Madras, made a payment of Rs. 1,00,000 to Subbiah upon his joining as the general manager, as per an agreement dated April 11, 1945. The payment was made to compensate Subbiah for the loss of pensionary benefits he would have received from his former employer, Imperial Bank of India. The agreement stipulated that Subbiah would serve for seven years, and the payment would become his absolute property upon completion of the term or under certain conditions such as incapacitation or termination by the bank.

2. Determination of Whether the Payment was Compensation for Loss of Employment or Salary under Section 7 of the Income-tax Act, 1922:
The court had to decide whether the payment was compensation for loss of employment or salary. The petitioner contended that the payment was compensation for Subbiah's loss of employment with the Imperial Bank and not salary under section 7. The revenue argued that the payment was related to Subbiah's employment with the petitioner and should be considered salary.

The court rejected the contention that the payment was compensation for loss of employment, noting that such compensation requires the presence of an employer-employee relationship, termination of such employment, and a payment related to this loss. Since there was no prior employment relationship between Subbiah and the petitioner, the payment could not be considered compensation for loss of employment.

3. Applicability of Section 18(2) of the Income-tax Act, 1922, Regarding Tax Deduction at Source:
The court then examined whether the payment constituted salary under section 7. It was noted that the payment was partly for acquiring Subbiah's services and partly for retaining him for seven years. The court determined that part of the payment was capital expenditure for procuring services, while the other part was an addition to salary for future services.

The court estimated that Rs. 50,000 of the payment was capital expenditure and the remaining Rs. 50,000 was salary. Consequently, the petitioner should have deducted tax on the Rs. 50,000 considered as salary under section 18(2).

Conclusion:
The court quashed the Income-tax Officer's order to the extent that it related to the Rs. 50,000 considered as capital receipt. The Commissioner's order was similarly quashed in part. The Income-tax Officer was directed to recompute and make a modified tax demand based on this judgment. The petition was allowed in part, with no order as to costs.