Compensation for loss of employment was not taxable as salary substitute on premature termination of a fixed-term contract.

A lump-sum paid on premature termination of a fixed-term employment contract was treated as compensation for breach and loss of employment, not as remuneration for past services or a salary substitute. Because the payment was made solely as solatium for deprivation of employment, it fell outside profits in lieu of salary under Explanation 2 to section 7(1). The sum was therefore not taxable under section 7 of the Indian Income-tax Act, 1922.

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Issues: Whether the sum of Rs. 7 lakhs received on termination of employment was liable to tax as profits in lieu of salary under section 7(1) of the Indian Income-tax Act, 1922, or was exempt as compensation solely for loss of employment.

Analysis: The payment had to be tested on the true substance of the employment arrangement, the termination letter, and the settlement embodied in the two documents. The term of employment was for a definite period of 25 years, and premature cessation of service was treated by the parties as a breach of the agreement. The stipulated sum was not shown to be remuneration for past services or an exercise of any contractual option allowing the employer to end the service on payment of a fixed sum. Instead, the agreed amount represented the measure of compensation for wrongful termination. The legal position under Explanation 2 to section 7(1) was that a payment received from an employer would be profits in lieu of salary unless it was made solely as compensation for loss of employment. On the facts, the payment was a solatium for deprivation of employment and not a taxable salary substitute.

Conclusion: The sum of Rs. 7 lakhs was not taxable under section 7 of the Indian Income-tax Act, 1922, and was compensation solely for loss of employment.

Ratio Decidendi: Where a lump sum is paid on premature termination of a fixed-term employment contract as compensation for breach and loss of employment, and not under a contractual option reserved to the employer as remuneration, it falls outside profits in lieu of salary under Explanation 2 to section 7(1).

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