Tax Treatment of Lump Sum Settlement Payments Following Employment Termination, Without Further Obligation from Employer.
Case Study: Rahul’s Tax Troubles After Termination:
Introduction:
Mr. Rahul, a dedicated employee at INX Media, faced unexpected challenges after being terminated from his position. His subsequent receipt of a lump sum amount and a new car led to legal complexities with the Income Tax Department.
- Rahul worked diligently at INX Media for several years before his sudden termination.
- In the aftermath of his termination, Rahul received a lump sum amount of Rs. 2,00,00,000 as part of an out-of-court settlement with INX Media.
- Additionally, Rahul was granted a perk in the form of a new car, valued at Rs. 13,08,444.
- The Income Tax Department issued a notice to Rahul, adding the lump sum amount and the value of the car to his total income for the assessment year 2009-10, under the head “income from salary.”
- The department asserted that these amounts constituted profits in lieu of salary, as per Section 17(3)(i) of the Income Tax Act, 1961.
- Whether the lump sum amount and the value of the car qualify as “profits in lieu of salary” under Section 17(3)(i) of the Income Tax Act, 1961.
- Whether the out-of-court settlement should be treated as income from salary or as a one-time settlement payment.
- Whether the receipt of the new car should be considered a taxable perquisite.
- Whether Rahul can challenge the Income Tax Department’s decision and appeal for a favorable outcome.
| Department’s Arguments | Assessee’s Arguments |
| The facts of the case CIT v. Deepak Verma, [2010] pertains to the assessment year 2001-02 i.e. before the insertion of Section 17(3)(iii) in the Act and therefore AO was right in treating the aforesaid receipt of assessee as profits in lieu of salary. | Respondent-assessee received the aforesaid amount of Rs. 2 crore as lump sum amount as a settlement out of court with the employer (INX Media) of the assessee and voluntary settled the case as the reputation of the assessee was diminished due to extreme harassment and ill treatment caused by the employer. He also argued that the additional amount of Rs. 13,08,444/-received from the employer (INX media) for the purchase of new car could not have been treated as taxable income as prequisite. He has relied on Deepak Verma |
- If payment is made as ex gratia or voluntary by an employer out of his own sweet will and is not conditioned by any legal duty or legal obligation, either on sympathetic grounds or otherwise, such payment is not to be treated as profit in lieu of salary under sub clause (i) of section 17(3).
- In other words and to be more precise, payment of ex gratia compensation received by the employee u/s 17(3) if voluntary in nature without being any obligation on part of employer to pay any further amount to assessee in terms of service rules, it would not amount to compensation in terms of section 17(3)(i). [Arunbhai R. Naik v ITO]
In conclusion, it is evident that the ex-gratia compensation received by Mr. Rahul was voluntary and not mandated by any service rule or obligation on the part of the employer. Therefore, it does not qualify as compensation under Section 17(3)(i) of the Act. Moving forward, it is imperative for individuals facing similar tax challenges to assert their rights and seek legal recourse when necessary. By understanding and applying relevant tax laws effectively, individuals can navigate complex situations with confidence and ensure fair treatment under the law.
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