Compensation for loss of employment may escape salary treatment where the original employer-employee relationship has ended.

A payment made on termination of the legal employer-employee relationship is treated as salary under Explanation 2 to section 7(1) of the Income-tax Act, 1922 only if it is remuneration for past services; where it is solely compensation for loss of employment, it is not taxable as salary. The decisive inquiry is whether the original employment relationship had ended, and immediate engagement by another concern does not by itself alter the character of the payment. On the stated facts, the correspondence supported a genuine compensation arrangement, so the amount was treated as capital receipt for loss of employment rather than salary income.

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Issues: Whether the sum of Rs. 1 lakh received on termination of employment was a capital receipt as compensation for loss of employment, or taxable income as salary or remuneration for past services.

Analysis: Section 7(1) of the Income-tax Act, 1922, read with Explanation 2, treated a payment received from an employer or former employer as salary unless it was made solely as compensation for loss of employment and not by way of remuneration for past services. The decisive question was whether the legal relationship of employer and employee had come to an end. The fact that the assessee continued to perform similar work for another company without interruption did not ate loss of employment, because the relevant inquiry was whether the original employer had terminated the jural relationship. The court also accepted the genuineness of the arrangement recorded in the correspondence and held that the payment could not be treated as a mere voluntary gratuity for past services.

Conclusion: The sum of Rs. 1 lakh was received solely as compensation for loss of employment and was not taxable as salary income.

Ratio Decidendi: A payment made on termination of the legal employer-employee relationship is exempt from salary treatment under Explanation 2 to Section 7(1) if it is solely compensation for loss of employment, and the employee's immediate engagement by another concern does not by itself destroy that character.

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