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Customer Care No.

91-1145562222

Taxability of compensation
for injury, termination or
waiver of rights and source
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General
1.Injury, termination or severance or waiver of rights or source
has many facets. It may be a right of employment; of business
rights or of a right in a property/capital asset; or it may be of any
other arrangement, present or future. Again it may be voluntary
or involuntary or compulsory; or direct or consequential. On
injury, termination or severance of any of the form,
compensation is paid to the severing person. Taxability of such
receipts is being examined in this article.
Receipt and Income
2."What comes in" is broadly taken as 'income'. This meaning is
generally adopted in upholding the constitutional validity of
taxation of an item as income. It is, however, clear that it does
not include fixed capital or the realising of fixed capital by turning
it into some other form of capital or money.
A receipt can be charged to tax, if it assumes the character of
income earned by a person. Normally, under the Income-tax Act,
the income is a 'periodical return in money or money's worth
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91-11- or expected regularity from definite
coming inCare
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regularity

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The expression 'income' may also be defined as the gain derived from land, capital or labour or
any two or more of them. It is the receipt of revenue nature that is income and is charged to
tax, in contrast to what is capital receipt, except certain receipts which are not incomes in
general sense but deemed as income on statutory invasion by their inclusion in the definition.
It then takes the form of a legal concept or statutory income.
The gap between the ordinary meaning of income and the legal concept of income is very
widely increasing, because of the numerous deeming provisions in the taxing statute. Tax on
capital gains itself is an example of taxing what is not an income. Deeming provisions even in
respect of salary income treat terminal benefits as income, subject, no doubt, to measured
relief and various other provisions like anti-compete fee under section28of the Act; income
from lotteries under section 56, are again capital receipts, which are treated as revenue
receipts, contrary to accepted understanding of revenue.
Income charged to Tax
3.To charge the income to tax under the Income-tax Act, it has to fall and be classified under
five heads as enumerated in section14of the Income-tax Act, 1961. Once it is determined that
a receipt is not income either in general meaning or statutorily extended meaning, it is not
chargeable
income-tax;
conversely, if it is income , its taxability is determined
by the
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The receipt which is income and does not specifically fall in any specific head is charged to tax under the
residuary head "income from other sources". Therefore, the first process is to determine the nature of receipt
and whether the receipt is income and then attribute a head to it under section 14 of the Act. Where a
particular receipt, though falls under a particular head, but is not chargeable because of its exemption
provided thereunder or otherwise, it cannot then be brought to tax under the residuary head. The heads of
income as provided by section 14 are (i) income from salary, (ii) income from house property, (iii) income
from business or profession, (iv) income from capital gains, and (v) income from other sources. A receipt for
services rendered as an employee is chargeable as income from salary. A receipt from exploitation of house
property is charged to tax as income from house property, unless the house is used by the owner for carrying
on his business. A receipt by carrying on the business activity or a profession is charged to tax as income from
business or profession. A receipt of gains for transfer of a capital asset is charged to tax as income from
capital gains. The other receipts, which do not specifically fall in any of the aforesaid heads, are charged to tax
as income from other sources.
Nature of compensation receipt
4.Compensation is generally of two types - revenue or capital. It may be a receipt emanating from the
property or labour. When it is a return for use of money or services, capital or labour, it is income. It may be in
the form of lease rent/licence fee in cases of immovable property - land and building, hire charges in cases of
moveable property, like plant and machinery and equipment, interest in case of money lent or royalty in cases
of know-how intellectual property or sale of merchandise.

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On the contrary, when it is for the exchange of capital or property or a source, it is capital
receipt,i.e., receipt for termination of a service agreement, or for loss of office or employment
or termination of an agreement or cessation of business, is a capital receipt. Right from the
decision of the Privy Council in 1936and then of the Supreme Court in 1959and 1963judicial
consensus has been albeit the payment had been entirely voluntary and the receipt may have
no legal right to any compensation at all. If the agreement is terminated and compensation or
consideration is paid for loss of office or employment or for abandonment the contractual
rights which the recipient of the compensation was entitled to like where the director, who
was practically forced to retireor the manager of the company whose contract of service is
terminated, gives up his rights under the agreement with the company the compensation was
considered as capital receipt.
In case of a premature termination of the agreement the decisive factor is whether the agency
agreement was capital or whether it merely represented a contract entered into in the normal
course of business? Where the companies had many agencies but they were capital assets and
constituted the profit-making apparatus, the compensation paid upon termination of one of the
agencies was held to be a capital receipt. Conversely, where the company had a large business
and acquired distributing and other agencies in normal course of business, the compensation
received on termination of one of the such agencies was held to be on revenue account; it
being not a capital asset.
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