Income-tax---

----Salary---Profits in lieu of salary---Encashment of unavailed leave-received after retirement before 1-4-1978---Assessable as profit in lieu of salary-- Indian Income Tax Act, 1961, Ss. 17 & 89.

In view of the provisions contained in section 17(1)(v-a) of the Income Tax Act, 1961, introduced by the Taxation Laws Amendment Act, 1984, the encashment of leave salary is taxable from April 1, 1978, onwards. According to the unamended provision of section 17, profit in lieu of salary is liable to be taxed. Encashment of leave salary is profit in lieu of salary and, therefore, taxable under section 17(3) of the Act prior to the amendment.

Krishna Murthy M. v. CIT (1985) 152 ITR 163 (AP); Patil Vijaykumar v. Union of India. (1985) 151 ITR 48 (Kar.) and All India Defence Accounts Association, In re: Shailendra Kumar v. Union of India (1989) 175 ITR 494 (All.) fol.

N.V. Balasubramaniam for the Commissioner.

P.P.S. Janarthana Raja for the Assessee.

JUDGMENT

THANIKKACHALAM, J.---At the instance of the Revenue for the assessment year 1974-75, the Tribunal referred the following question for the opinion of this Court, under section 256(1) of the Income Tax Act, 1961 (hereinafter referred to as "the Act"):

"Whether, on the facts and in the circumstances of the case, the sum of Rs.22,730 received on account of encashment of unavailed leave by the assessee at the time of retirement was not taxable under the Income Tax Act, 1961 ?"

The assessee is an individual, who was earning salary from his employment from the Madras Fertilizers Ltd. During the previous year ended March 31, 1974, corresponding to the assessment year 1974-75, the assessee retired. On retirement, he received a sum of Rs.22,730 by encashment of the unutilised leave standing to his credit. The assessee filed a return showing an income of Rs.62,572 including the sum of Rs.22,730 and claiming the spread over of this amount under section 89(1) of the Act. The assessment was originally completed under section 143(1)(a) disallowing the claim. The assessee then applied under section 143(2)(a) objecting to the assessment of the sum of.Rs.22,730. But the Income-tax Officer repeated the assessment in the view that section 89(1) had no application to encashment of leave salary. The assessee appealed to the Appellate Assistant Commissioner contending that encashing the leave is purely a voluntary act and so he should not be taxed. But the Appellate Assistant Commissioner was of the view that leave was accumulated in the course of service for which salary was paid and any benefit derived was salary. He, therefore, confirmed the assessment of the amount received by encashment of leave as part of salary.

Aggrieved, the assessee filed a second appeal before the Appellate Tribunal and contended that the Appellate Assistant Commissioner erred in confirming the order of the Income-tax Officer. The assessee also contended that section 89(1) of the Act was applicable. The Appellate Tribunal understood the first ground of appeal to be one against the assessment of the amount received by encashment of leave as salary and the other ground as an alternative prayer for relief under section 89(1) of the Act, because the Appellate Assistant Commissioner had dealt with the contention that the assessee should not be taxed in respect of that amount and that contention had been rejected. The Appellate Tribunal, for the reasons stated in the order, ultimately came to the conclusion that the encashment of leave salary is not income and, therefore, not taxable under section 17(3) of the Act prior to the amendment. The Tribunal further held that the alternative relief of the assessee for relief under section 89(1) of the Act was not tenable. Accordingly, the Tribunal ultimately came to the conclusion that the encashment of leave salary is not taxable under the Act.

Learned standing counsel for the Department submitted that many of the conclusions arrived at by the Tribunal in its order are against the provisions contained in the Act. It was further submitted that the-assessee has not made a plea to the effect that the leave encashment is not taxable under the Act. What was contended by the assessee before the authorities below was that inasmuch as the encashment of leave salary was earned over a period of years, it cannot be assessed in one single assessment year. Therefore, according to the assessee, the amount should be spread over for a number of years and assessment should be made accordingly. According to standing counsel, the encashment of leave salary would come under section 17(3)(ii) of the Act and, therefore, is liable to be taxed as profit in lieu of salary. Learned standing counsel also submitted that many of the reasons given by the Tribunal for coming to the conclusion that encashment of leave salary is not taxable were repelled by the Andhra Pradesh High Court in its decisions in M. Krishna Murthy v. CIT (1985) 152 ITR 163. Learned standing counsel further submitted that the assessee's contention that the assessee is entitled to relief under section 89(1) of the Act was not accepted by the Tribunal. Therefore, in the reference filed by the Department, it is not open to the assessee to claim benefit under section 89(1) of the Act. The learned standing counsel also took us through the object of introducing the Finance Act, 1982, and the Bill introduced by the Government in Parliament for inserting the amendments to sections 10, (10-AA) and 17(3)(ii) of the Act in order to show that the intention of the Legislature was to tax the encashment of leave salary from April 1, 1978, onwards.

On the other hand, learned counsel appearing for the assessee, while supporting the order passed by the Tribunal, submitted that the decisions relied upon by the learned standing counsel are concerned with persons, who are in employment and those decisions are having no bearing with regard to the retired employee. According to learned counsel, the assessee in the present case is a retired employee from the Fertilizer Corporation of India, Durgapur. Learned counsel for the assessee submitted that in view of the provisions contained in section 17(3)(ii), any amount received by an employee in respect of any period of leave not availed of by him, is taxable from April 1, 1978, onwards, and therefore, prior to that period, encashment of leave salary is not taxable. Learned counsel further submitted that there is a doubt with regard to the applicability of section 17(1)(v-a) and section 17(3)(ii) of the Act and the benefit of doubt should go in favour of the assessee. Learned counsel for the assessee further relied upon the reasons given by the Tribunal for considering encashment of leave salary as not an income as defined under the Act. It is also the submission of the assessee that when under section 17(1)(v-a) of the Act, any amount received by an employee in respect of any period of leave not availed of by him, is a specific clause under which the said encashment of leave salary is taxable from April 1, 1978. In such a circumstance, the residuary clause in section 17(1)(v-a) is not applicable for taxing the encashment of leave salary. Alternatively, it was submitted that the encashment of leave salary was earned over a period of years and the receipt of the said amount in one year cannot be taxable in that year, but it should be spread over for the years in which the amounts were received proportionately. It was, therefore, submitted that the Tribunal was correct in holding that encashment of leave salary cannot be characterised as income chargeable to tax.

We have heard the rival submissions. The assessee claimed that encashment of leave salary of Rs.22,730 in the assessment year 1974-75 is not taxable as profit in lieu of salary as contemplated under section 17(3) of the Act prior to the amendment. The assessee in the assessment year under consideration retired from service. Alternatively, the assessee claimed that if at all that the encashment of leave salary is taxable, it should be spread over for a period of years and it should be taxed proportionately in each year.

In order to come to the conclusion that the encashment of leave salary is not an income, taxable under the Act, the Tribunal gave the following reasons:

(1) The encashment is clearly not a pensionary benefit even though the cash is given only by the employer and the money comes to the assessee from the employer because the consideration for this payment is not satisfactory past service with the employer.

(2) Though encashment of leave is permitted on or after retirement, strictly it is not a retirement benefit. In other words, payment of encashment of leave cannot clearly be payment for service.

(3) The characteristics of such an amount received has nothing to do with the employment at all. The employee could have received the price from any other person to whom this was sold.

(4) The leave which he, therefore, accumulates over a period of years is something which has nothing to do with the factum of his work and the compensation which he receives for the same on his retirement has also nothing to do with the work.

(5) The fact also would go to show that it has nothing to do with the employee's service or his rate of salary while in service.

(6) The accumulated leave is an asset, which the former employee can keep for himself and not even encash.

(7) The nexus between the receipt and the employment where the employee has a right merely to take leave or not is too much to regard a receipt after retirement as proceeding from his employment so as to be classed as salary.

(8) It has an existence only when he receives it on his claiming it in exchange for the "sacrifice" he made while in service and not for rendering service.

(9) Thus the. anticipation of encashment is only a possibility and not a certainty. Secondly, there is one time receipt only; hence, non recurring.

(10) Proviso to section 10(3) also would not apply, since it is not a receipt from capital gains.

For all these reasons, the Tribunal held that the encashment of leave salary is not an income, and, therefore, not taxable under the Act. In so far as the claim under section 89(1) of the Act is concerned, the Tribunal held that it does not arise in the present case.

All these contentions were raised before the Andhra Pradesh High Court in the decision in M.Krishna Murthy v. CIT (1985) 152 ITR 163. While deciding the question arising of similar nature by the Andhra Pradesh High Court, the assessee also produced orders passed by the Income-tax Appellate Tribunal of the Madras Bench as well as the Hyderabad Bench.

While considering these orders, the Andhra Pradesh High Court pointed out that (at page 179):

"The reasoning of the orders, we are afraid, is based on an erroneous appreciation of the provisions of the Act, and so is diametrically opposite. Therefore, we are not persuaded to accede to the said submission. "

While considering the issue arising on the merits, the Andhra Pradesh High Court held as under headnote:

"The amount received as encashment of leave by an employee who continues in employment is not exempt from tax. Leave as such is not a capital asset. If at all there is any income yielding asset, it is not the leave as such, but the right conferred to surrender it and obtain cash in lieu thereof. There is no surrender or transfer of that right by the employee. He is only exploiting that right to earn some more money to supplement his regular salary. Moreover, even receipts considered to be of a capital nature under general law are assessable under the Income Tax Act, e.g., capital gains. This receipt is in the nature of addition to the remuneration of the employee and not a casual and non-recurring receipt, which is exempt from tax under section 10(3). It is a 'profit in lieu of salary' within the meaning of section 17(3)(ii). There is nothing in the language of section 17(3)(ii) warranting the interpretation that the payment made by the employer should be out of commercial profits. The. Legislature has designedly used both the words due to or received. They are disjunctive and bring within the net of taxation amounts that fall due though not received as well as amounts that are received without the same being due. There is no warrant for ignoring the disjunctive ' or' occurring between the words 'former employer' and 'from provident fund or other fund'. The usage of the preposition ' or' in between the said words makes it explicit that any amount due or received not only from an employer or former employer, but also any payment from a provident fund or other fund, subject to the qualifications made thereunder, would constitute' profit in lieu of salary . Secondly, the pronoun ' it' must necessarily be referable to the preceding nouns 'provident fund or other fund', and not to 'any payment' inasmuch as it is only a fund that may consist of contributions and not any payments. The essential ingredients that are to be satisfied for the purpose of application of the provisions enacted in section 17(3)(ii) are: (1) that the payment must be relatable to employment; (2) that it must not be based on personal or extra-employment considerations; and (3) that it must not be a payment falling under any clause of section 10 specified in the parenthetical clause of section 17(3)(ii). Leave encashment satisfies all these ingredients, being in the nature of recompense or reward for the services rendered by the employee. The legislative history of the provisions also makes this clear. The amount is not exempt under the provisions of section 10. Under the clause (10-AA) of section 10, which was introduced by the Finance Act, 1982, with retrospective effect from April 1, 1978, the receipt by way of leave encashment paid to the employee at the time of retirement on superannuation is specifically exempted from inclusion in the recipients total income. This is indicative of the fact that the Legislature did not intend to exempt likewise the receipt of leave encashment amount paid to the employee while in service. "

The Karnataka High Court had an occasion to consider a question of similar nature in the decision in Patil Vijaykumar v. Union of India (1985) 151 ITR 48, wherein the Karnataka High Court held as under (headnote):

"There are two forms of interpretation clauses. In one., when the word defined is declared to 'mean' something, the definition is explanatory and prima facie restrictive. In the other, where the word defined is declared to 'include' something, the definition is extensive. A definition or interpretation clause which extends the meaning of a term does not take away its ordinary meaning. The words 'salary' and profits in lieu of salary' have, therefore, to be understood as comprehensive of not only such things as they signify according to their nature and import but also those things which the interpretation clause declares that they shall include. These words cannot be understood to mean only such things which the definition of the interpretation clause declares they shall include. The terms and conditions of employment are regulated by rules and regulations relating `to the employment. The grant of leave to an employee is also regulated by the relevant rules and regulations. An employee has to earn admissible leave in the first instance and only when he has leave to his credit, can he apply for leave. An employee is also allowed to surrender earned leave and receive payment of the salary and allowances to which he is entitled for the period of leave not availed. This is also regulated by a set of rules in force in this behalf. The receipt of leave salary and allowances for the leave surrendered and the receipt of salary and allowances for the said period he works are relatable to the terms and conditions of employment. The leave salary and allowances are not paid to an employee outside the terms of employment or as damages because of repudiation of the contract of employment. In fact, this payment flows from the terms and conditions of employment by virtue of the post the employee holds. Section 10(10-AA) inserted by the Finance Act, 1982, exempts from tax only the encashment of leave an assessee receives at the, time of retirement. The intention of Parliament is not to exempt encashment of leave by all employees. In the case of employees who continue in employment, the payment of leave salary and allowances to an employee who surrenders his leave is related to or' flows from the relationship of the employer and the employee and from the terms and conditions of employment and falls within the meaning of 'profits in lieu of salary' in clause (ii) of subsection (3) of section 17 of the Act and is assessable as such.

When the meaning of words is clear and unambiguous, the Court has to give effect to it whatever be the consequences, as the Court has no jurisdiction to mitigate harsh consequences of the statute, if any.

A similar view was taken by the Allahabad High Court in the decision in All India Defence Accounts Association, In re: Shailendra Kumar v. Union of India (1989) 175 ITR 494, while considering whether encashment of leave salary is taxable under section 17(3) of the Act, prior to the amendment. Learned counsel appearing for the assessee submitted that in view of the provisions contained in section 17(1)(v-a), the encashment of leave salary is taxable from April 1, 1978, onwards and prior to that date, the encashment of leave salary is not taxable. It was further submitted that profit in lieu of salary is taxable under section 17(3)(ii) of the Act. According to learned counsel when the encashment of leave salary is taxable under the provisions contained in section 17(1)(v-a), the provisions contained in section 17(3)(ii) would be only residuary in nature. The contention put forward by learned counsel cannot be accepted because the assessment year under consideration would fall prior to the amendment. The law as it stood prior to the amendment has to be followed in the present case. According to the unamended provisions of section 17(3) of the Act, profit in lieu of salary is liable to be taxed. As we have seen in the above said three decisions all the Courts uniformly came to the conclusion that encashment of leave salary is profit in lieu of salary and, therefore, taxable under section 17(3) of the Act prior to the amendment. Learned standing counsel also took us through the objects for introducing the amendment and the Bill introduced by the Government in Parliament relating to the provisions contained in section 10(10-AA)(ii) and section 17(3)(ii) of the Act. The intention of the Legislature prior to the amendment is to tax the encashment of leave salary since it happened to be profit in lieu of salary. Therefore, we hold the Tribunal was not correct in coming to the conclusion that encashment of leave salary is not income chargeable under the Act.

Learned counsel appearing for the assessee submitted that in case this Court comes to the conclusion that the encashment of leave salary is profit in lieu of salary, then the assessee would be permitted to ask for relief under section 89(1) of the Act. According to learned counsel, before the authorities below, the assessee claimed such a relief. It remains to be seen that in the present case, we hold that encashment of leave salary is profit in lieu of salary, and in case the assessee is entitled to ask for relief under section 89(1) of the Act, is open to the assessee to do so, and if such a request is made, the Tribunal is directed to consider the same on the merits, in accordance with law, after giving proper opportunity of being heard to the assessee. In that view of the matter, we answer the question referred to us in the negative and in favour of the Department. No costs. Counsel's fee Rs.1,000 (rupees one thousand).

M.B.A./1253/FC Reference answered.