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Your Compensation is Taxable

February 2, 2018 29033 Views
Meenakshi Subramaniam
Former IRS Officer

A king, who had a huge treasury had six men, to guard it. There was one man at front, another at back, two on both sides, one man, a little further to alert on front side and another man to alert in same way, at back. Now, the king who was getting miserly, decided to remove the man who sent alerts, at back. 'What about my compensation ?" the poor man cried. The king replied: " Isn't it enough that your king has a fat treasury ?" Needles to say, a band of thieves in a surprise attack from the back, removed the whole treasury.

Budget 2018's biggest shocker has been the bizarre, cruel imposition of income tax on compensation. That is, people who suffer business or profession termination would have to pay income tax on the compensation, they get ! Can there be anything more pitiless and ruthless ?

The object of taxing compensation is stated to be widening and deepening the tax base.



The Budget's clause reads as under:

Taxability of compensation in connection to business or employment

Under the existing provisions of the Act, certain types of compensation receipts are taxable as business income under section 28.

However, the existing provisions of clause (ii) of section 28 is restrictive in its scope as far as taxation of compensation is concerned; a large segment of compensation receipts in connection with business and employment is out of the purview of taxation leading to base erosion and revenue loss.

Therefore, it is proposed to amend section 28 of the Act to provide that any compensation received or receivable, whether revenue or capital, in connection with the termination or the modification of the terms and conditions of any contract relating to its business shall be taxable as business income. It is further proposed that any compensation received or receivable, whether in the nature of revenue or capital, in connection with the termination or the modification of the terms and conditions of any contract relating to its employment shall be taxable under section 56 of the Act.

These amendments will take effect from 1st April, 2019 and will, accordingly, apply in relation to assessment year 2019-20 and subsequent assessment years.



Compensation is a final payment. It is the only means of sustenance. Compensation gives the strength to look for a new business or profession. If this too is taxed, how can a person survive ? The impact of imposing income tax on compensation can be seen, as below:

*The new provision makes a mockery of distinction between capital and revenue receipts. In a callous manner, the income tax department says it would tax compensation, whether it's capital or revenue receipt.

*The novel clauses say that compensation receivable would also be taxed. It means a person who hopes to get compensation in future might as well forget it.

*There are certain tests, which courts use to determine whether compensation is tax-exempt. But, all these have been reduced to nothingness.

For example, in CIT v IPL Chemical Ltd. (Petition 471 of 2014), the Madras High Court held that if termination of business agency results in loss of profit, it is revenue receipt. But, if the termination results in loss of source of income, it's capital receipt.

In Blue Star Ltd.v CIT Case (217 ITR 514), the court upheld that if cancellation of contract affects trading structure, then compensation is capital receipt. Or if loss of source of income occurs, the compensation is also capital receipt.

But, now such tests can't take place, because the tax department has decided to bring capital and revenue compensation receipts, under the tax dragnet.

*The new tax provision upholds cases like Gillander Arbuthnot v CIT (63 ITR 148), where the Supreme Court said the business agency was terminated, but termination is normal in course of business.



In CIT v Capt. H.C.Dhanda (76 ITR 404), the professional contract of the assessee was terminated by Maharaja Holkar and compensation sought to be taxed. The income tax department alleged compensation was a cloak for disguising the whole transaction. The Madhya Pradesh High Court favoured the assessee, saying that the compensation was not taxable.



Compensation is not income receipt. It's a solatium. How can it be taxed ? As the government is giving priority to jobs, it should not hit the persons, whose business or professional work has suffered termination. After all, they have only, got consolation in form of compensation.


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