Have you ever thought that if you, as an employee, receive a lump sum from your employer on account of an out-of-court settlement, will it be taxable as your salary income?
In India, having hundreds of sections on income tax can sometimes make this act complex and bring out some difficulty to grasp, but through this article, let's break down some provisions of this act in simple terms.
As I said earlier in this article, imagine you worked for a company, and after leaving your job, you received a lump sum from your employer as a settlement. Now, the big question is: do you need to pay tax on that money? And if yes, under which head will it be taxable?
In a recent case, Income Tax Officer v. Avirook Sen, appeal no. 6659 (Delhi) of 2015 [Assessment year 2009-10] On April 12, 2024, before the Income Tax Appellate Tribunal in Delhi, a similar situation arose. An individual received a hefty sum of Rs. 2 crore from his former employer, INX Media, after his termination from service. Additionally, he also received Rs. 13,08,444 for the purchase of a new car.
The Income Tax Officer (ITO) believed that the Rs. 2 crore received by Avirook Sen should be treated as compensation, which falls under the category of "income in lieu of salary." Therefore, according to the ITO, it should be taxed accordingly. Similarly, the money received for the car was considered a perk and thus taxable.
Why salary?
As per the Income Tax Act, any income that we get, which is in the form of service that you provide on a contract of employment, which means the relationship that exists is that of employer-employee, then tax is applicable under this head, i.e., income in lieu of salary. This also includes income such as salary, or in case you receive advance salary, perquisites, gratuity, or even any commission; it also covers annual bonuses and pensions.
However, Avirook Sen disagreed with this. He argued that the lump sum he received was not compensation but rather a voluntary settlement reached out of court with his employer. He emphasized that the money was not part of any legal obligation or duty on the part of the employer. Furthermore, he contested that the amount for the car should not be considered taxable income.
The case was about the Income Tax Act's Section 17(3)(i) that refers to "profits in lieu of salary." The ITO grounded his position on previous decisions and explanations. In support of his claim, Avirook Sen pointed out the relevant case law.
Avirook Sen got the support of the Income Tax Appellate Tribunal by the end. They concluded that a lump-sum payment cannot be taxed as compensation under Section 17(3)(i) if it is voluntary and not made in pursuance of any legal obligation. The car money should also not be regarded as income liable to tax, the tribunal ruled.
This case involves a fundamental aspect of income tax law: the differentiation between voluntary payments and those made out of legal obligation. If a payment is said to be voluntary, meaning it has not been enforced by any law, some provisions will exempt it from taxation.
The bone of contention was whether the lump sum paid qualified as compensation. According to the Commissioner (Appeals), if an employer pays such an amount without being required to do so by any rule or agreement, then it does not fall within the scope of what can be regarded as compensation under Section 17(3)(i). Thus, it should not attract tax liability. In conclusion, therefore, while dealing with income taxes, one needs to know what type of money they have received. They may or may not need to pay, depending on whether there was a legal duty or responsibility forcing them to do so. But if they were mandated by law, then yes, indeed, these amounts might be taxable. Such fine distinctions could enable people to understand and operate within the intricacies involved in this sphere more effectively.
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