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Severance pay is not taxable

A recent high court judgement classifies such income as capital receipt

Tapati Ghose & Prakash Hegde 

Severance pay is not taxable

The taxation of severance pay has many a times been a point of dispute between the recipients and the Income Tax authorities. While the professional feels that the compensation for loss of income should not be taxed, the taxman takes the view that the severance pay is a gain to the professional as there's no loss of competence to earn further professional income if one employment contract is terminated.

The taxation of such payment depends on whether the assessing officer is classifying it as a capital receipt or revenue receipt. We generally think that any money received is subject to income tax in the hands of the recipient unless specifically exempted by income tax (I-T) laws. In reality, a receipt has to be classified as capital receipt or revenue receipt to determine whether it is taxable under the I-T laws. A revenue receipt is taxable but a capital receipt is not.



To tax or not

The IT laws do not clearly distinguish what kind of receipts are capital receipts and what are revenue receipts. A capital receipt is considered to be an amount which is received for loss of capital, for example, the amount received on loss of a source of income. On the other hand, a revenue receipt is an amount which is received as a gain or profit in a transaction, such as profit in trading by a trader. But there are many instances where difficulty arises in ascertaining whether the amount received is for loss of a source of income or profit in a transaction. Such borderline cases give rise to vexing problems and litigation with the tax authorities.

Generally, any amount received by a professional from his principal who has engaged him to perform professional activities is considered as revenue receipt and is therefore taxable. For example, the fee received by a doctor, chartered accountant, lawyer or journalist from the person to whom he has rendered his services is considered as taxable receipts.

The court case

Recently, the Delhi High Court had an occasion to examine the taxability of a sum of money received by a professional journalist from a foreign publisher as compensation upon termination of contract (in the matter of CIT vs. Sharda Sinha).

The journalist had been working in India exclusively for a German news magazine for almost 23 years. During the time he was working with that magazine, he was paid a flat honorarium in addition to further payments for any published contribution. The news magazine decided to terminate the contract with him. Due to loss of work place and consideration of long time association, the German magazine paid him a compensation of 3,00,000 Deutsche Mark, that is, approximately Rs 54 lakh.

The income tax officer who assessed the journalist's income tax return studied this transaction and took the view that the journalist did not lose his right of authorship in future; he was free to contribute his articles and stories to other magazines or publications; therefore, the receipt is in the nature of a revenue receipt which should be considered as income from profession.

On appeal, the Commissioner of Income Tax (Appeals) or CIT-A, considered the payment to be an ex-gratia payment made by the news magazine in addition to the regular remuneration already paid. CIT-A was of the view that the compensation cannot be treated to constitute future profit remuneration; the payment had fatally injured the journalist's only source of income for the last 23 years; therefore, the compensation received is a capital receipt and is non-taxable.

The income tax authorities appealed against the order of the CIT-A to the Income Tax Appellate Tribunal (ITAT). The ITAT agreed with the decision of the CIT-A and passed an order in favour of the journalist.

The income tax authorities then took the matter to the Delhi High Court (HC). The HC heard both the parties. The income tax authorities argued that the journalist had not permanently lost the right to contribute to other magazines in future. The compensation received by him was only for termination of the present contract with the German news magazine. He was free to contribute to other magazines and publications in future and earn his income.

The counsel for the journalist argued that compensation was due to loss of his work place and in consideration of his long time association. This was a compensation for loss of an income generating asset, that is, loss of source of income.

The HC referred to similar other cases in the matter. It noted that the same court in the matter of Khanna and Annadhanam vs. CIT had held: "If the receipt represents compensation for the loss of a source of income, it would be capital and it matters little that the tax payer continues to be in receipt of income from other similar operations."

The HC also referred to a couple of Supreme Court (SC) decisions in similar circumstances wherein the SC had held that where a compensation is paid for termination of an arrangement which was in vogue for a fairly long period of time, the compensation has to be considered as a substitute for the source. Therefore, such receipts are not taxable.

Relying on the above decisions, the HC held that the amount received by the journalist from the German magazine is not taxable.

Positive ruling for taxpayers

This is a very important and welcome decision by the Delhi High Court affecting the taxability of compensation received by professionals. The law relating to this matter is settling down with the view that a person should be taxable only for the income which he earns in the course of the profession. An amount received by him as compensation for loss of work or termination of long-term contract should not be taxable. Thus, this case law emphasises that the loss of a source of income is in the nature of a capital receipt and should not be taxable.

A word of caution here. The facts and circumstances of each case have to be analysed before arriving at a view whether the compensation received by a professional is taxable or not. Note that the compensation received for a professional engagement which may be temporary may be viewed by the courts as a revenue receipt and hence be taxable.

DISPUTE RESOLUTION
  • There have often been disputes on classification of severance pay for those hired on contract
     
  • Being a loss of income, recipient classifies it as capital receipt, which is not taxable
     
  • Assessing officer asks receiver to pay tax as they can still earn income from using their professional skills
     
  • A recent landmark verdict from High Court clarifies on the classification and lays ground for resolving such disputes
     
  • The court ruled any amount received as compensation for loss of work or termination of long-term contract shouldn't be taxed


Tapati Ghose is partner and Prakash Hegde is director, Deloitte Haskins & Sells

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Severance pay is not taxable

A recent high court judgement classifies such income as capital receipt

A recent high court judgement classifies such income as capital receipt The taxation of severance pay has many a times been a point of dispute between the recipients and the Income Tax authorities. While the professional feels that the compensation for loss of income should not be taxed, the taxman takes the view that the severance pay is a gain to the professional as there's no loss of competence to earn further professional income if one employment contract is terminated.

The taxation of such payment depends on whether the assessing officer is classifying it as a capital receipt or revenue receipt. We generally think that any money received is subject to income tax in the hands of the recipient unless specifically exempted by income tax (I-T) laws. In reality, a receipt has to be classified as capital receipt or revenue receipt to determine whether it is taxable under the I-T laws. A revenue receipt is taxable but a capital receipt is not.

To tax or not

The IT laws do not clearly distinguish what kind of receipts are capital receipts and what are revenue receipts. A capital receipt is considered to be an amount which is received for loss of capital, for example, the amount received on loss of a source of income. On the other hand, a revenue receipt is an amount which is received as a gain or profit in a transaction, such as profit in trading by a trader. But there are many instances where difficulty arises in ascertaining whether the amount received is for loss of a source of income or profit in a transaction. Such borderline cases give rise to vexing problems and litigation with the tax authorities.

Generally, any amount received by a professional from his principal who has engaged him to perform professional activities is considered as revenue receipt and is therefore taxable. For example, the fee received by a doctor, chartered accountant, lawyer or journalist from the person to whom he has rendered his services is considered as taxable receipts.

The court case

Recently, the Delhi High Court had an occasion to examine the taxability of a sum of money received by a professional journalist from a foreign publisher as compensation upon termination of contract (in the matter of CIT vs. Sharda Sinha).

The journalist had been working in India exclusively for a German news magazine for almost 23 years. During the time he was working with that magazine, he was paid a flat honorarium in addition to further payments for any published contribution. The news magazine decided to terminate the contract with him. Due to loss of work place and consideration of long time association, the German magazine paid him a compensation of 3,00,000 Deutsche Mark, that is, approximately Rs 54 lakh.

The income tax officer who assessed the journalist's income tax return studied this transaction and took the view that the journalist did not lose his right of authorship in future; he was free to contribute his articles and stories to other magazines or publications; therefore, the receipt is in the nature of a revenue receipt which should be considered as income from profession.

On appeal, the Commissioner of Income Tax (Appeals) or CIT-A, considered the payment to be an ex-gratia payment made by the news magazine in addition to the regular remuneration already paid. CIT-A was of the view that the compensation cannot be treated to constitute future profit remuneration; the payment had fatally injured the journalist's only source of income for the last 23 years; therefore, the compensation received is a capital receipt and is non-taxable.

The income tax authorities appealed against the order of the CIT-A to the Income Tax Appellate Tribunal (ITAT). The ITAT agreed with the decision of the CIT-A and passed an order in favour of the journalist.

The income tax authorities then took the matter to the Delhi High Court (HC). The HC heard both the parties. The income tax authorities argued that the journalist had not permanently lost the right to contribute to other magazines in future. The compensation received by him was only for termination of the present contract with the German news magazine. He was free to contribute to other magazines and publications in future and earn his income.

The counsel for the journalist argued that compensation was due to loss of his work place and in consideration of his long time association. This was a compensation for loss of an income generating asset, that is, loss of source of income.

The HC referred to similar other cases in the matter. It noted that the same court in the matter of Khanna and Annadhanam vs. CIT had held: "If the receipt represents compensation for the loss of a source of income, it would be capital and it matters little that the tax payer continues to be in receipt of income from other similar operations."

The HC also referred to a couple of Supreme Court (SC) decisions in similar circumstances wherein the SC had held that where a compensation is paid for termination of an arrangement which was in vogue for a fairly long period of time, the compensation has to be considered as a substitute for the source. Therefore, such receipts are not taxable.

Relying on the above decisions, the HC held that the amount received by the journalist from the German magazine is not taxable.

Positive ruling for taxpayers

This is a very important and welcome decision by the Delhi High Court affecting the taxability of compensation received by professionals. The law relating to this matter is settling down with the view that a person should be taxable only for the income which he earns in the course of the profession. An amount received by him as compensation for loss of work or termination of long-term contract should not be taxable. Thus, this case law emphasises that the loss of a source of income is in the nature of a capital receipt and should not be taxable.

A word of caution here. The facts and circumstances of each case have to be analysed before arriving at a view whether the compensation received by a professional is taxable or not. Note that the compensation received for a professional engagement which may be temporary may be viewed by the courts as a revenue receipt and hence be taxable.

DISPUTE RESOLUTION
  • There have often been disputes on classification of severance pay for those hired on contract
     
  • Being a loss of income, recipient classifies it as capital receipt, which is not taxable
     
  • Assessing officer asks receiver to pay tax as they can still earn income from using their professional skills
     
  • A recent landmark verdict from High Court clarifies on the classification and lays ground for resolving such disputes
     
  • The court ruled any amount received as compensation for loss of work or termination of long-term contract shouldn't be taxed


Tapati Ghose is partner and Prakash Hegde is director, Deloitte Haskins & Sells
image
Business Standard
177 22

Severance pay is not taxable

A recent high court judgement classifies such income as capital receipt

The taxation of severance pay has many a times been a point of dispute between the recipients and the Income Tax authorities. While the professional feels that the compensation for loss of income should not be taxed, the taxman takes the view that the severance pay is a gain to the professional as there's no loss of competence to earn further professional income if one employment contract is terminated.

The taxation of such payment depends on whether the assessing officer is classifying it as a capital receipt or revenue receipt. We generally think that any money received is subject to income tax in the hands of the recipient unless specifically exempted by income tax (I-T) laws. In reality, a receipt has to be classified as capital receipt or revenue receipt to determine whether it is taxable under the I-T laws. A revenue receipt is taxable but a capital receipt is not.

To tax or not

The IT laws do not clearly distinguish what kind of receipts are capital receipts and what are revenue receipts. A capital receipt is considered to be an amount which is received for loss of capital, for example, the amount received on loss of a source of income. On the other hand, a revenue receipt is an amount which is received as a gain or profit in a transaction, such as profit in trading by a trader. But there are many instances where difficulty arises in ascertaining whether the amount received is for loss of a source of income or profit in a transaction. Such borderline cases give rise to vexing problems and litigation with the tax authorities.

Generally, any amount received by a professional from his principal who has engaged him to perform professional activities is considered as revenue receipt and is therefore taxable. For example, the fee received by a doctor, chartered accountant, lawyer or journalist from the person to whom he has rendered his services is considered as taxable receipts.

The court case

Recently, the Delhi High Court had an occasion to examine the taxability of a sum of money received by a professional journalist from a foreign publisher as compensation upon termination of contract (in the matter of CIT vs. Sharda Sinha).

The journalist had been working in India exclusively for a German news magazine for almost 23 years. During the time he was working with that magazine, he was paid a flat honorarium in addition to further payments for any published contribution. The news magazine decided to terminate the contract with him. Due to loss of work place and consideration of long time association, the German magazine paid him a compensation of 3,00,000 Deutsche Mark, that is, approximately Rs 54 lakh.

The income tax officer who assessed the journalist's income tax return studied this transaction and took the view that the journalist did not lose his right of authorship in future; he was free to contribute his articles and stories to other magazines or publications; therefore, the receipt is in the nature of a revenue receipt which should be considered as income from profession.

On appeal, the Commissioner of Income Tax (Appeals) or CIT-A, considered the payment to be an ex-gratia payment made by the news magazine in addition to the regular remuneration already paid. CIT-A was of the view that the compensation cannot be treated to constitute future profit remuneration; the payment had fatally injured the journalist's only source of income for the last 23 years; therefore, the compensation received is a capital receipt and is non-taxable.

The income tax authorities appealed against the order of the CIT-A to the Income Tax Appellate Tribunal (ITAT). The ITAT agreed with the decision of the CIT-A and passed an order in favour of the journalist.

The income tax authorities then took the matter to the Delhi High Court (HC). The HC heard both the parties. The income tax authorities argued that the journalist had not permanently lost the right to contribute to other magazines in future. The compensation received by him was only for termination of the present contract with the German news magazine. He was free to contribute to other magazines and publications in future and earn his income.

The counsel for the journalist argued that compensation was due to loss of his work place and in consideration of his long time association. This was a compensation for loss of an income generating asset, that is, loss of source of income.

The HC referred to similar other cases in the matter. It noted that the same court in the matter of Khanna and Annadhanam vs. CIT had held: "If the receipt represents compensation for the loss of a source of income, it would be capital and it matters little that the tax payer continues to be in receipt of income from other similar operations."

The HC also referred to a couple of Supreme Court (SC) decisions in similar circumstances wherein the SC had held that where a compensation is paid for termination of an arrangement which was in vogue for a fairly long period of time, the compensation has to be considered as a substitute for the source. Therefore, such receipts are not taxable.

Relying on the above decisions, the HC held that the amount received by the journalist from the German magazine is not taxable.

Positive ruling for taxpayers

This is a very important and welcome decision by the Delhi High Court affecting the taxability of compensation received by professionals. The law relating to this matter is settling down with the view that a person should be taxable only for the income which he earns in the course of the profession. An amount received by him as compensation for loss of work or termination of long-term contract should not be taxable. Thus, this case law emphasises that the loss of a source of income is in the nature of a capital receipt and should not be taxable.

A word of caution here. The facts and circumstances of each case have to be analysed before arriving at a view whether the compensation received by a professional is taxable or not. Note that the compensation received for a professional engagement which may be temporary may be viewed by the courts as a revenue receipt and hence be taxable.

DISPUTE RESOLUTION

  • There have often been disputes on classification of severance pay for those hired on contract
     
  • Being a loss of income, recipient classifies it as capital receipt, which is not taxable
     
  • Assessing officer asks receiver to pay tax as they can still earn income from using their professional skills
     
  • A recent landmark verdict from High Court clarifies on the classification and lays ground for resolving such disputes
     
  • The court ruled any amount received as compensation for loss of work or termination of long-term contract shouldn't be taxed


Tapati Ghose is partner and Prakash Hegde is director, Deloitte Haskins & Sells

image
Business Standard
177 22