Introduction
In a crucial judgment, the Income Tax Appellate Tribunal (ITAT) Ahmedabad has ruled in favor of the assessee, Mr. Sudhakar Ratan Shanker Gautam, by holding that severance compensation received due to employment termination is a capital receipt and not taxable under Section 17(3) of the Income Tax Act, 1961. This decision provides clarity on the taxability of termination compensation and reinforces the distinction between salary income and capital receipts.
Case Background
The assessee, an individual, was employed with You First Money Express Private Limited, which was subsequently acquired by Ebix Money Express Private Limited. Following this acquisition, the assessee’s employment was terminated on 26th October 2017, and he received a severance compensation of Rs.15,50,905/- which was claimed as a capital receipt not chargeable to tax in the return of income filed for AY 2018-19 on 31/08/2018. The return of income declared a total income of Rs.7,29,790/-, and the return was processed under Section 143(1) on 01/05/2019.
The AO, in the order dated 19/01/2021, treated this amount as “profits in lieu of salary” under Section 17(3) of the Act, and added it to the total income of the assessee, leading to an assessed income of Rs.22,80,695/-. The CIT(A), in confirming the addition made by the AO, relied on the provisions of Section 17(3) of the Act, which defines “profits in lieu of salary.” The CIT(A) observed that since the compensation received by the assessee was related to the termination of employment, it should be treated as “profits in lieu of salary” under Section 17(3)(i) of the Act. The CIT(A) rejected the assessee’s contention that the amount was a capital receipt, not chargeable to tax. Furthermore, the CIT(A) disregarded the assessee’s reliance on various judicial precedents, stating that those rulings were not applicable to the facts of the case.
Arguments Presented
Appellant’s Arguments
- Nature of Severance Compensation: The appellant argued that the compensation received was not for services rendered but for the termination of employment, making it a capital receipt, not taxable under Section 17(3) of the Act.
- Precedents Cited: The appellant relied on several judicial precedents, including:
- Arunbhai R. Naik vs. ITO (Gujarat High Court) – Ruled that voluntary severance compensation is a capital receipt.
- Ashok Raghunathrao Kulkarni vs. ITO (Pune ITAT) – The AR contended that even after insertion of section 56(2)(xi) of the Act with effect from 01-04-2019, the Pune Bench of the Tribunal has decided in favour of assessee in case of Ashok Raghunathrao Kulkarni Vs. ITO [2024] 165 taxmann.com 680.
- Shamik Pankajbhai Parikh vs. ITO (Ahmedabad ITAT) – Reinforced the non-taxability of severance compensation.
- Section 56(2)(xi) Not Applicable: The appellant contended that the amendment under Section 56(2)(xi) of the Act, which deals with the taxation of compensation received due to termination, was applicable only from AY 2019-20. Since his case pertained to AY 2018-19, this provision was not applicable.
Revenue’s Arguments
The Revenue contended that since the severance compensation was paid due to employment termination, it should be classified as “profits in lieu of salary” under Section 17(3) and taxed accordingly.
Tribunal’s Observations & Verdict
- Nature of Compensation: We note that the assessee was employed as the Zonal Business Head with You First Money Express Private Limited, which was subsequently acquired by Ebix Money Express Private Limited. Following the acquisition, the assessee’s employment was terminated effective from 26th October 2017, on account of redundancy. As per the letter placed before us, the assessee received a severance compensation of Rs.18,00,000/-, which included pay for notice days, monthly CTC of October 2017, and ex-gratia.
- Judicial Precedents Favoring Assessee: We have carefully considered the facts of the case, the grounds raised, the submissions of both sides, and the judicial precedents cited. The primary issue in dispute is whether the compensation of Rs.15,50,905/- received by the assessee constitutes a capital receipt or profits in lieu of salary under Section 17(3) of the Act. The assessee has argued that the compensation was voluntary and due to the termination of employment for redundancy, and thus, it is a capital receipt not chargeable to tax. We have reviewed the judicial precedents relied on by the AR. These judicial precedents overwhelmingly support the assessee’s case that the severance compensation of Rs.15,50,905/- should be treated as a capital receipt, not taxable under Section 17(3) of the Act. Both the Gujarat High Court and various ITAT decisions have consistently held that voluntary severance payments made without contractual obligation are capital receipts and not subject to tax as profits in lieu of salary. In the present case the severance payment received by assessee was due to redundancy and job termination which should not be taxable as profits in lieu of salary under Section 17(3). The compensation was paid for the loss of employment, not for past services. It is consistently held that payments, when not tied to services rendered, are capital in nature and not taxable as salary income. Since the employer had no obligation to pay further amounts upon termination, the compensation should be deemed a capital receipt and thus not taxable under Section 17(3). The Act distinguishes between receipts that are taxable as salary income and those that are considered capital receipts, which are generally not taxable unless explicitly brought within the tax net by specific provisions of the Act. Under Section 17(3), “profits in lieu of salary” is a key provision that seeks to tax certain payments received by an employee in connection with the termination of employment. On the other hand, capital receipts, especially in the context of employment, typically relate to compensation for the loss of a source of income and are generally not taxable, unless specified.
- Applicability of Section 56(2)(xi): This distinction is critical in determining whether a severance payment or other termination-related compensation is subject to tax as salary income or can be treated as a non-taxable capital receipt. Section 56(2)(xi), introduced w.e.f. 1st April 2019, deals with compensation received or receivable in connection with the termination or modification of terms of employment contracts. However, this amendment applies to assessment years starting from AY 2019-20 onwards. Since the current assessment year is AY 2018-19, the amendment has no bearing on the current case.
- Conclusion: The tribunal ruled in favor of the appellant, treating the severance compensation of Rs.15,50,905/- as a capital receipt and directing the deletion of the addition made by the AO and confirmed by the CIT(A).
- Interest & Penalty Proceedings: Since the addition was set aside, consequential interest levies under Sections 234A/B/C/D and penalty proceedings under Section 270A were also annulled.
Implications of the Judgment
This verdict reinforces the distinction between salary income and capital receipts, providing clarity on the taxability of severance payments. Key takeaways from the judgment include:
- Tax Treatment of Severance Compensation: Payments made to employees due to redundancy or voluntary retirement can be considered capital receipts, provided they are not tied to past services.
- Judicial Consistency: The ruling aligns with existing judicial precedents, strengthening the position that severance payments are not necessarily taxable under Section 17(3).
- Section 56(2)(xi) Applicability: The case clarifies that the newly inserted provision applies prospectively from AY 2019-20 and does not impact cases from prior assessment years.
Final Words
The ITAT Ahmedabad’s ruling in Sudhakar Ratan Shanker Gautam vs. ITO ITA No.1033/Ahd/2024 Assessment Year : 2018-19 sets a significant precedent regarding the taxability of severance compensation. Employees receiving termination-related payouts should evaluate whether such receipts qualify as capital receipts based on the nature and circumstances of the payment. This case serves as a guiding reference for similar disputes in the future, ensuring that genuine compensation for loss of employment is not unjustly taxed.
