“Delhi High Court Rules Settlement Consideration as Capital Gains, Not Salary Profits”

Last Updated on August 12, 2024 by NewsDesk SLC

The bench of Justice Yashwant Varma and Justice Ravinder Dudeja Observed the tribunal made a fundamental error by distinguishing between a ” perquisite” and “profit in lieu of salary” mentioned in Section 17(3) addresses compensation received from an employer upon termination or modification of employment terms. The tribunal overlooked the fact that the assesses employment ended on 24 August 2010, before any action was initiated before the Company Law Board (CLB). The oversight led to the incorrect classification of the settlement consideration.

The petitioner, an individual resident, was employed as the chief operating officer at Tek Travels Private Limited (TTPL) from December 1, 2007, to August 24, 2010. According to his employment agreement, he was entitled to yearly compensation and sweat equity. However, no shares were issued to him until 31 March 2010. later increased its share capital by issuing 600,000 new equity shares in the financial year 2010-11, the total to 1600000 shares. Petitioner received 50000 sweat equity shares and the corresponding share certificates, shortly after TTPL

TTPL refused to recognize the petitioner as a shareholder and didn’t record his name in the Register of Members. In response, the petitioner filed C.P. No. 8/111 of 2011 with the Company Law Board (CLB, seeking directions under Section 111(2) of the Companies Act, 1956, to compel TTPL to register the 50000 shares in this name.

During the petitioner’s pendency before the company law board (CLB), the assessee and TTPL agreed to settle all disputes, leading to a settlement agreement on January 23, 2014. The assessee received INR 30375000 as a lump sum settlement, relinquishing all rights to the 50000 shares and handing over the share certificates to TTPL. The assessee reported this amount as long-term capital gains in the return of income for the assessment year 2014-15, with a declared cost of acquisition as “nil”. However, the assessing officer classified the amount as taxable under the head of salaries, specifically under Section 17(3)(iii) of the Income Tax Act, 1961.

The AO determined that the settlement amount should not be treated as capital gains because TTPL had deducted tax under Section 192, viewing the settlement as stemming from the employer-employee relationship. Consequently, the AO classified the amount as “profits in lieu of salary.”

 The assessee appealed to the Commissioner of Income Tax (Appeals), who ruled that the INR 3.03 crores should be taxed as capital gains, not as salary. The department then appealed to the tribunal, which had a different view. The tribunal stated that only 15,000 shares should be taxed as capital gains, while the remaining 35,000 shares should be taxed under Section 17(3)(iii).

Petitioner argued that the settlement amount was for surrender of the “right to sue,” which should be considered a capital receipt and not taxable. The department, however, maintained that settlement amount fell under Section 17(3)(iii) as a lump sum received after employment cessation.

 An issue raised by the tribunal was justified in splitting the settlement consideration between salary and capital gains. The court quashed the tribunal’s order, ruling that the settlement consideration could not be classified as ‘profits in lieu of salary’. The decision underscores that the entire settlement amount should be treated as capital gains.

 Case law: Akash Poddar Vs.  ACIT (ITA 270/2023)

Written By: Kirti Sharma