Settlement Consideration Liable To Be Recognized As “Capital Gains” And Not “Profits In Lieu Of Salary”: Delhi High Court

The Delhi High Court has held that the settlement consideration is liable to be recognized as capital gains and not “profits in lieu of salary.”.

The bench of Justice Yashwant Varma and Justice Ravinder Dudeja has observed that the fundamental mistake which the Tribunal committed was failing to bear in mind the distinction between a “perquisite” and “profits in lieu of salary," both of which are dealt with separately in Section 17 of the Income Tax Act, 1961. “Profits in lieu of salary," which is spoken of in Section 17(3), deals with compensation received by an assessee from his employer or former employer in connection with the termination of his employment or on a modification of terms and conditions of service. However, the Tribunal has fundamentally erred in ignoring the indubitable position of the employment of the assessee having been brought to an end on 24 August 2010 itself and thus before the action came to be even laid or instituted before the Company Law Board (CLB).

The petitioner/assessee is an individual resident who was employed with Tek Travels Private Limited (TTPL) in the capacity of Chief Operating Officer during the period 01 December 2007 to 24 August 2010. In terms of his employment agreement, apart from yearly compensation, the assessee was also entitled to sweat equity in accordance with the stipulations of the said agreement.

It is the case of the assessee that till 31 March 2010, no shares were issued or allotted to him. The issue appears to have been raised with TTPL, which consequently increased its share capital by issuing 6,00,000 fresh equity shares in Financial Year 2010-11, taking its total issued share capital to 16,00,000. The TTPL issued 50,000 sweat equity shares in the name of the assessee, and consequential share certificates were also handed over. Shortly thereafter, TTPL terminated the assessee's employment.

The TTPL took the stand that he was not liable to be recognized as a shareholder and also refused to record his name in the Register of Members. The assessee approached the Company Law Board4 by way of C.P. No. 8/111 of 2011 seeking to invoke the CLB's powers conferred by Section 111(2) of the Companies Act, 1956 for appropriate directions being framed requiring TTPL to register the 50,000 shares in his name.

During the pendency of the petition before the CLB, the assessee and TTPL appear to have agreed to settle all disputes, which led to the signing of a Settlement Agreement on 23 January 2014. In terms of that Settlement Agreement, the assessee received a lump sum consideration of INR 3,03,75,000 towards full and final settlement of all disputes and differences with TTPL. The Settlement Agreement also records the assessee agreeing to unconditionally and irrevocably relinquishing all his rights and entitlements in respect of registration of the 50,000 shares and to consequently hand over the share certificates in original to TTPL. The assessee, in terms of the stipulations contained in the Settlement Agreement, gave up all rights to seek enforcement of any title or interest in the shares.

Based on the settlement, TTPL paid an amount of INR 3.03 crores to the assessee during FY 2013-14. In the Return of Income for Assessment Year 2014-15, which was filed by the assessee, the settlement amount was duly reported and claimed as long-term capital gains, with the cost of acquisition being declared to be “nil.”. The Assessing Officer, however, while framing an order under Section 143(3) of the Income Tax Act, 1961, treated the amount as liable to be taxed under the head of salaries and more particularly under Section 17(3)(iii) of the Income Tax Act.

The AO opined that the settlement amount was not liable to be treated as capital gains since TTPL had deducted tax thereon under Section 192. It further took the view that the surrender of the claim or a “right to sue” emanated essentially from the employer-employee relationship that had existed between the parties. The shares were not registered in the name of the assessee and thus ultimately came to hold that the settlement amount essentially represented “profits in lieu of salary," received in lump sum after cessation of employment.

The assessee approached the Commissioner of Income Tax (Appeals). The CIT(A) in terms of its order deleted the sole addition made by the AO and held that the amount of INR 3.03 crores was chargeable to tax as “capital gains” and not under the head of "salaries.”.

The department preferred the appeal before the tribunal. The tribunal had a had a diametrically opposite view on the appeal, which came to be preferred by the respondents/department. The Tribunal first observed that in terms of the employment agreement, the assessee could have at best been eligible to be offered 15,000 shares as sweat equity. It, accordingly, took the position that the 15,000 eligible shares alone should be treated as taxable under the heading “capital gains,” while the balance of 35,000 shares should be taxed in accordance with the provisions of Section 17(3)(iii).

The petitioner contended that, as per the settlement agreement, the amount of INR 3.03 crore was essentially consideration for the surrender of a “right to sue." The surrender of a mere right to sue cannot possibly be viewed as a transfer of a capital asset. Rather, the entire amount as received by the assessee in pursuance of the Settlement Agreement would constitute capital receipts and thus not be chargeable to tax at all.

The department contended that the settlement consideration would thus clearly fall within the residuary clause comprised in Section 17(3)(iii), since the same clearly amounted to a lump sum amount received after cessation of employment.

The issue raised was whether the Tribunal was justified in bifurcating the settlement consideration between salary and capital gains.

The court has quashed the order of the tribunal and held that the consideration could not have possibly or justifiably been placed in the category of “profits in lieu of salary.”.

Counsel For Appellant: Saurabh Kirpal

Counsel For Respondent: Shlok Chandra

Case Title: Akash Poddar Versus ACIT

Citation: 2024 LiveLaw (Del) 895

Case No.: ITA 270/2023

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