1995-VIL-202-ITAT-

Equivalent Citation: ITD 054, 076,

Income Tax Appellate Tribunal MADRAS

Date: 16.03.1995

KSS. MANI.

Vs

INCOME-TAX OFFICER.

BENCH

Member(s)  : S. ANANDA REDDY., T. V. K. NATARAJA CHANDRAN.

JUDGMENT

Per Sri T.V.K. Natarajachandran, Sr. Vice-President--This appeal by the assessee which is directed against the order of the CIT (Appeals) wherein he upheld the order of the Assessing Officer holding that the sum of Rs. 1 lakh received by the assessee from his employer, is assessable as profits in lieu of salary in terms of section 17(3)(i) and (ii). The assessee has taken grounds to urge that the CIT (Appeals) ought to have considered the restrictive covernant affecting the whole structure of income-making apparatus of the assessee and there was deprivation of what in substance one of its sources of income and therefore the receipt was capital in nature not liable to tax. He ought to have also found that the payment was not related to any business done as an employee or recompense for services past or future so as to be considered as salary and he has also erred in treating the payments as profits in lieu of salary under, section 17(3)(ii).

2. The assessee has also taken a ground relating to levy of interest under section 216 but this ground was given up at the time of hearing.

3. The relevant facts are that the assessee was an employee of M/s. Larsen & Toubro Ltd. As per agreement dated 28-11-1983, he was appointed as Whole-time Director for 5 years from 28-12-1983. But however he resigned his post on 31-10-1986. Thereafter on 30-12-1986 another agreement was entered into by the assessee with the company by which he was to be paid Rs. 2 lakhs in two instalments subject to certain conditions, viz., not to undertake any employment in any business or engage in any business or undertake any work or job in any competitive business of the company or its subsidiaries or associate companies. He has also agreed not to divulge any information whatsoever regarding the working or the affairs of the company to any one else. The Assessing Officer brought the amount of Rs. 1 lakh received during the year relevant for the assessment year 1987-88 to tax treating it as revenue in nature.

4. The assessee appealed to the CIT (Appeals) to contend that the compensation payable for loss of future employment was in the nature of capital receipt not liable to tax. The case of the assessee was that by agreement the assessee was prevented from making the use of experience and knowledge in any employment which would jeopardise the interests of the company. Thus the amount paid was to compensate the assessee for the deprivation of his future earning. However, the CIT (Appeals) concluded that the amount fell within the mischief of 'profits in lieu of salary' contained in section 17(3) of the Income-tax Act, 1961, According to him, the assessee could have continued to be the whole-time director of the company till 28-12-1988 by virtue of the agreement dated 28-11-1983. It is before the expiry of the agreement period the assessee resigned. It was then the company agreed to provide the assessee with compensation. Such compensation receivable from former employer at or in connection with the termination of the employment was to be treated as 'profits in lieu of salary' within the meaning of section 17(3). Accordingly, he upheld the assessment of Rs. 1 lakh in view of the application of sub-clauses (i) and (ii) of section 17(3).

5. At the time of hearing the learned counsel for the assessee filed a paper compilation containing the agreements dated 28-11-1983 and 8-12-1986 and facts of the case. As per the agreement dated 28-11-1983, the assessee was appointed as whole-time director for a period of 5 years effective from 28-12-1983 and the terms and conditions are detailed therein including the remuneration and perquisites and commission payable. However, the assessee resigned on 31-10-1986 and the company has accepted the said resignation effective from that date. As per the agreement dated 8-12-1986 it has been agreed that the assessee shall not for a period of 3 years with effect from 1-12-1986 undertake any employment in any business or engage himself in any business or undertake any work or job which would compete with the business present or future of the company and/or subsidiaries or associate companies or any one or more of them and/or deprives or adversely affect the business interests of the company. Further it has been agreed to by and between the parties as under :--

" 1. Mr. Mani agrees and undertakes that at all times :

(a) he shall observe complete secrecy with regard to all commercial, technical, financial or other confidential knowledge, data and information and trade secrets of the Company and its subsidiary and associate companies and protect, safeguard and preserve the Company's business interests as also its subsidiary and associate companies ;

(b) he shall treat any information and knowledge of secret and confidential nature relating to the Company's affairs and business as also of its subsidiary and associate companies that may have been imparted to him or otherwise received by him during the course of his employment with the Company, as strictly secret and confidential and shall not at any time disclose or impart such confidential information or knowledge to any other person nor use it for commercial or personal gain in any manner whatsoever ;

(c) he shall not accept employment of any nature whether part-time or whole-time and/or act in advisory capacity or otherwise or be associated in any way directly or indirectly with any competitors of the Company and/or its subsidiary and associate companies or with persons carrying on business or businesses similar to the business or businesses of the Company and business or businesses of its subsidiary and associate companies for a period of three years commencing from 1st December, 1986 ; and

(a) he shall not act in any manner which is likely, in the opinion of the Company, jeopardise or adversely affect the Company's business or affairs and business or affairs of its subsidiary and associate companies nor shall he indulge or engage in any activity which may be prejudicial to the interests, image or reputation of the Company and/or its subsidiary and associate companies.

2. In consideration of Mr. Mani undertaking all the covenants set out in clause (1) above, the Company shall pay to Mr. Mani Rs. 2,00,000 (Rupees two lakhs only) as under :

(a) Rs. 1,00,000 (Rupees one lakh only) on the execution of these presents ;

(b) Rs. 1,00,000 (Rupees one lakh only) on the completion of period of three years under these presents, i.e., 30th November, 1989 :

Provided that in the event of breach by Mr. Mani of any of the covenants set out in clause (1) above, any payment already made to Mr. Mani under this clause shall be refunded by him to the Company and the Company will be discharged from its obligations hereunder without prejudice to the Company's other rights and remedies."

Pursuant to the said agreement a sum of Rs. 1,00,000 was paid to the assessee by the said employer which has been brought to tax as profits in lieu of salary. The learned counsel for the assessee relied on the decisions of the courts contained in CIT v. P.K.Das [1958] 34 ITR 729 (Cal.), Karamchand Thapar & Bros. (P.) Ltd v. CIT [1971] 80 ITR 167 (SC), Gillanders Arbuthnot & Co. Ltd v. CIT [1964] 53 ITR 283 (SC) and P. H. Divecha v. CIT [1963] 48 ITR 222 (SC) in support of his proposition that the restrictive covenants contained in the agreement dated 8-12-1986 prevented source of income for the assessee and the profit-making structure was affected and any compensation paid not to carry on competitive business was capital receipt in nature and, therefore, it was not taxable. The learned departmental representative, on the other hand, duly supported the decision of the authorities.

6. We have duly considered the rival submissions, the impugned orders of the authorities and the paper compilation filed. The agreement dated 28-11-1983 appointing the assessee as the whole-time director, inter alia, provided as per clause 8 that this agreement may be terminated at any time by either party by giving to the other party 6 months' notice of such termination and neither party will have any claim against the other for damages or compensation by reason of such termination. In any event the whole-time director shall not be entitled to any compensation in cases mentioned in section 318(3) of the Companies Act, 1956. It is not in dispute that the assessee resigned his post on 31-10-1986 and it has been accepted by the employer-company. It is not brought on record under what circumstances or what prompted the assessee to resign from his post, even though he could have continued to be in service till 28-11-1988. In this background an agreement dated 8-12-1986 has been entered into between the assessee and M/s. Larsen & Toubro Ltd. (" the company " for short). Under this agreement the assessee shall not for a period of 3 years effective from 1-12-1986 undertake any employment in any business or engage himself in any business or undertake any work or job which would compete with the business present or future of the company and its subsidiaries or associates which would adversely affect the business interests of the company vide clause 4 of the agreement. The assessee also undertook several obligations to observe strict secrecy and confidentiality about the information or knowledge gained nor use it for commercial or personal gain in any manner whatsoever vide clause 5(1) of the said agreement. In consideration of the assessee undertaking all the covenants the company shall pay to him Rs. 2 lakhs, namely, Rs. 1 lakh on the execution of the agreement and another one lakh on the completion of the period of 3 years from the date of agreement. It is the first instalment received at the time of execution of the said agreement that is the bone of contention as to its taxability. The assessee claims, relying on several decisions of courts, that it is a compensation for loss of source of profit or employment and, therefore, it is capital receipt in nature and nontaxable. The revenue has held that it is taxable treating it as profits in lieu of salary.

7. It is therefore necessary to consider whether any compensation at all is payable to the assessee or whether the employer is under an obligation to pay any compensation to the assessee. With reference to clause 8 of the agreement dated 28-11-1983 when the agreement was terminated by the assessee by resigning his post on 31-10-1986, neither party will have any claim against the other for damages or compensation by reason of such termination. Section 318 of the Companies Act provides for payment of compensation for loss of office to managing director or a director holding the office of manager or in the wholetime employment of company by way of compensation for loss of office or as consideration for retirement from office or in connection with such loss or retirement. This section is subject to the exceptions contained in sub-section (3). Clause (b) of the said sub-section provides that where the director resigns his office otherwise than on the re-construction of the company or its amalgamation is not eligible or entitled to any compensation for loss of office. In this context, therefore, the payment made by the company assumes significance. It is seen that the assessee had already put in more than 40 years of service with the company when the agreement dated 8-12-1986 was executed. The agreement, as pointed out, contains so many prohibitive covenants in consideration of which the compensation of Rs. 2 lakhs was agreed to be paid. Therefore, the plain terms of the agreement clearly show that the payment made to the assessee was in consideration of all the restrictive covenants undertaken by the assessee or in other words for loss of profits from business or profession in which the assessee could have profitably engaged himself. The various case laws relied upon by the learned counsel for the assessee also support the conclusion that the compensation received by the assessee was nothing but a capital receipt for loss of profit-earning source of income, and not loss of profits as such. in view of these facts and circumstances, it is to be held that the CIT (Appeals) is not justified in holding that the compensation fell within the mischief of section 17(3)(i) or (ii) as profits in lieu of salary ignoring the vital facts and the statutory provisions of the Company Law in this regard. Consequently, we set aside the order of the CIT (Appeals) and direct the Assessing Officer to exclude the compensation which is capital in nature.

8. In the result, the appeal is allowed.

 

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