March 4, 2002	Monday	Zilhaj 19, 1422

A LARGE number of employees in Pakistan have lost their jobs in the name of rightsizing or downsizing by private and public organizations and many more are going to be victims of this process in the coming days.

The ordeal of all such persons has been aggravated, as payments received by them under the so-called voluntary retirement schemes (which are, in fact, forced separation agreements) have been declared taxable by higher courts in two recent judgments.

Earlier, there were many favourable judgments passed by the Lahore High Court holding that instructions issued by the Central Board of Revenue (CBR) regarding taxation of such payments were illegal, and that tax deducted on such payments should be refunded. The court directed that the assessing officers should decide the issue of taxability of such receipts in each individual case after applying their independent minds. In one judgment (Order dated 3-12-1999 in Writ No. 2086/99), the court even declared that these receipts were capital in nature, thus not chargeable to tax. This was challenged through an inter-court appeal.

A cursory look at two recent judgments shows that proper assistance was not extended to the courts by the counsel for the petitioners, as they failed to raise most vital legal questions vis-a-vis the controversy involved, as well as the relevant case law for its resolution. None of the counsel who appeared in these cases brought the following to the notice of the courts: 1. Section 16(2)(c)(i) of the Income Tax Ordinance, 1979 (hereinafter: “the said provision” and “the Ordinance” respectively) is not applicable to lump sum payments received on compulsory “cessation” of employment on the dictates of the employer, when no negligence or incapability/incapacity could be attributed to the employee. The word “termination” as used in the said provision does not cover forced “cessation” of employment. The expression, “termination of employment” in the said provision, covers termination of service agreement in the natural course of events, and would not apply to voluntary or/and forced separation schemes, known as “golden handshake schemes”. 2.Binding precedents have not been brought to the knowledge of the courts and cases relied by the petitioners’ counsel were totally irrelevant. The conclusions reached by the honourable Supreme Court of AJK in CIT v Altaf Ahmad Mir (2001) 84 TAX 43 (S.C. AJK) and the Lahore High Court in its latest judgment dated 31-10-2001 (disposing various writ petitions) under the said provision, are based on the assumption that the expression “termination” used therein covers all kinds of situations resulting into “loss of employment”. This assumption, which was not challenged by the counsel, needs a thorough appraisal in the light of established principles of interpretation of statutes and binding precedents. Unfortunately, no arguments supported by reasons, logic, principles of interpretation of statutes and case law challenging this presumption were presented before the courts.

It is pertinent to mention that the said provision (section 16(2)(c)(i) of the Ordinance) which defines “profits in lieu of salary” is exactly the same as section 17(3)(i) of the Indian Income Tax Act, 1961 with the exception that in the Indian provision the words “or former employer” also find specific mention. The position under the repealed Act of 1922 wherein the somewhat relevant provision (Explanation-2 to section 7(1) as amended by Finance Act 1955 in Indian and 1965 in Pakistan) contained even the words “former employer”, which are missing in the said provision of the Ordinance. It is worthwhile to mention that the word “termination” was not used in the Act of 1922 till 1965 in Pakistan.

The 1955 change in Explanation-2 to section 7(1) of the 1922 Act in India deleting the words “unless the payment is made solely as compensation for loss of employment and not by way of remuneration for past services”, cannot be construed to mean that the well established principle of non-taxability of capital receipts (unless otherwise provided by the statute in explicit words) was altered to include compensatory payments as “profit in lieu of salary”.

The expression “profit in lieu of salary” implies that there is a clear interlinking between payment and rendering of services, covering the span of employment. In Pakistan an amendment in Explanation-2 to section 7 of the 1922 Act was made vide section 6 of Act No. V of 1965 inserting the words “including compensation due to or received by him at, or in connection with the termination of his employment or the modification of the terms or conditions of his employment”. The Indians inserted these words in the 1961 Act in section 17(3) (iii), and it appears that the same were copied by our so-called legislators in the CBR in 1965. The same words reappeared in section 16(2)(c)(i) of the 1979 Income Tax Ordinance of Pakistan.

“Profits in lieu of salary” accrues on the termination or modification of terms and conditions of employment to reward past services rendered by the employee and does not cover situations where service agreements are terminated prematurely by the employee (voluntary resignation) or the employer (offering golden handshake). The latter situation is not covered in the said provision as the expression “termination” is to be viewed in the context of law governing master-servant relationship.

There exists a wealth of legal literature and judicial pronouncements confirming “compensation for loss of source of income is not income at all”. This well-recognised proposition vis-a-vis taxation of receipts on account of golden handshake scheme, which are surely in the nature of compensation for loss of employment, was not argued before the Lahore High Court. Resultantly, this most vital aspect of the case remained unadjudicated. These payments are not for past services but represent compensation for loss of employment that cannot be equated with the expression “termination” of services in the said provision.

The learned authors of Sundram’s Law of Income Tax, Volume 1, 1982 edition, while commenting on parallel and pari materia Indian provision and after discussing the issue in great detail based on various judicial authorities, concluded at page 79 that compensation for loss of employment is distinguishable from compensation on termination of service. Renowned authors of Kanga & Palkhiwala’s Law and Practice of Income Tax and Iyengar’s Law of Income Tax expressed the same opinion in their treatise on Income Tax Law.

Section 16 of the Ordinance deals with income chargeable under the head “Salary” and it presupposes a relationship of employer and employee governed by express or implied terms and conditions of employment. The relationship between the employer and employee has to be interpreted in the context of the law of master and servant. It is a well-established and undisputed position that u