A voluntary ex-gratia payment is not taxable as profits in lieu of salary.

Issue

Is a voluntary, one-time ex-gratia payment received by an employee from an employer upon the closure of a business unit taxable as “profits in lieu of salary” under Section 17(3) of the Income-tax Act, 1961?

Facts

An assessee, who was a salaried employee, received a full and final settlement amount from his employer following the closure of the business unit where he was employed.
A component of this settlement was specifically designated as an “ex-gratia” payment. The assessee claimed this amount as exempt from tax, arguing that it was a voluntary payment and was not a part of his formal employment contract.
The Assessing Officer (AO) disallowed this exemption and sought to tax the amount. The AO’s reasoning was that the payment did not fall into the specific exempt categories that were mentioned in an old CBDT Circular (No. 573, dated 21-8-1990).

Decision

The Tribunal/Court ruled in favour of the assessee.

It held that the evidence showed the ex-gratia payment was purely voluntary in nature. There was no pre-existing legal or contractual obligation on the part of the employer to pay this additional amount to the assessee.
Because of its voluntary nature, the payment did not fit the definition of “compensation” and therefore could not be classified as “profits in lieu of salary” under Section 17(3) of the Act.
Since the amount was not salary or profits in lieu of salary, it was not taxable under the head ‘Salaries’, and the addition made by the AO was directed to be deleted.

Key Takeways

Voluntary vs. Obligatory is the Key Test: The crucial factor in determining the taxability of such payments is whether the employer was under any obligation—be it legal, contractual, or through a consistent practice—to make the payment. A purely voluntary payment made out of goodwill and with no obligation is generally not considered income from employment.
The Scope of Section 17(3): The term “profits in lieu of salary” primarily covers payments that have a direct connection to the cessation or modification of employment, such as compensation for loss of employment or payments that are due to an employee under the terms of their employment. A payment made without any such underlying obligation may fall outside this definition.
CBDT Circulars are Not Exhaustive: CBDT circulars are often issued to provide guidance or clarify the department’s view on certain situations, but they are not always exhaustive of the law. A payment can be non-taxable based on the primary provisions of the Act itself, even if it is not explicitly mentioned as being exempt in a particular circular.
The Meaning of “Ex-gratia”: The term “ex-gratia” itself means “by favour” or a payment made where no legal liability exists. The court gave weight to the voluntary nature that is implied by this very term when analyzing the character of the payment.

IN THE ITAT CHENNAI BENCH ‘B SMC’

Kalyanasundaram Ranjithkumar

Income-tax Officer

S.S. Viswanethra ravi, Judicial Member

IT Appeal No.1622 (Chny) of 2025
[Assessment year 2019-20]

SEPTEMBER 4, 2025

Girish Kumar, Adv. for the Appellant. Ms. V. Aswathy, JCIT for the Respondent.

ORDER

1. This appeal filed by the assessee is directed against the order dated 06.11.2023 passed by the ld. Commissioner of Income Tax (Appeals), National Faceless Appeal Centre (NFAC), Delhi for the assessment year 2019-20.

2. This appeal is filed with a delay of 489 days. The assessee filed petition for condonation of delay stating the reasons in support of an affidavit. Upon hearing both the parties and on examination of the said affidavit, I find the reasons stated by the assessee are bonafide, which really prevented in filing the appeal in time. Thus, the delay is condoned and admitted the appeal for adjudication.

3. The assessee raised 10 grounds of appeal amongst which, the only issue emanates for our consideration as to whether the ld. CIT(A) is justified in confirming the addition made by the Assessing Officer being the ex-gratia received from assessee’s employer.

4. Brief facts relating to the case are that the assessee is an individual and filed revised return of income on 01.09.2020 declaring total income of ?.7,45,580/- and claimed ?.35,47,920/- as exempt income under section 10 of the Income Tax Act, 1961 [“Act” in short] as ex-gratia not forming part of the employment contract. However, the Assessing Officer disallowed the said exemption claimed by the assessee on the ground that the ex-gratia received by the assessee is not covered by the instances stated in CBDT circular No. 573 dated 21.08.1990. The ld. CIT(A) confirmed the disallowance made by the Assessing Officer.

5. The ld. AR Shri Girish Kumar, Advocate, besides relying upon various case law, referred to the order of Pune Bench in the case of Ashok Raghunathrao Kulkarni v. ITO 680 (Pune – Trib.)/ITA No. 117/PUN/2024 dated 12.08.2024 and submits that the issue is squarely covered in favour of the assessee and prayed to follow the same.

6. The ld. DR Ms. V. Aswathy, JCIT supported the order passed by the ld. CIT(A).

7. Having heard both the parties and perused the material available on record. The assessee is a salaried employee in Pfizer Healthcare India Pvt. Ltd. and received full and final settlement during the financial year 2018-19 on account of closure of unit. The assessee has claimed exemption of ?.35,47,920/- as exempt income under section 10 of the Act as ex-gratia not forming part of employment contract. However, by referring to the CBDT circular No. 573 dated 21.08.1990, the Assessing Officer disallowed the exemption of ex-gratia amount claimed by the assessee. Similar issue on identical fact was subject matter in appeal before the Pune Bench of the Tribunal in the case of Ashok Raghunathrao Kulkarni (supra) wherein, by following various case law, the Tribunal has observed as under:

23. We have heard the rival arguments made by both the sides, perused the orders of the Assessing Officer and Ld. CIT(A) / NFAC and the paper book filed by both the sides. We have also considered the various decisions cited before us. We find the Assessing Officer in the instant case rejected the claim of relief u/s 89 of the Act of Rs.18,74,899/- on income of Rs.57,12,674/- treating the same as income u/s 17(3) of the Act. We find the CIT(A) / NFAC upheld the action of the Assessing Officer, reasons of which are already reproduced in the preceding paragraphs. The CIT(A) / NFAC also rejected the alternate claim of the assessee that such amount being a capital receipt cannot be brought to tax. It is the submission of the Ld. Counsel for the assessee that in case of various other employees who have received similar compensation, the same has been accepted as capital receipt by the respective AOs in re-assessment proceedings and no addition has been made. Further, various Co-ordinate Benches of the Tribunal in similarly placed employees have also treated such compensation received on termination of service as capital in nature and not falling u/s 17(3) of the Act.

24. We find the Assessing Officer in the case of Sharad D. Magar, who also resigned voluntarily from service of Pfizer Healthcare India Pvt. Ltd., Aurangabad has accepted the compensation received at Rs.30,49,176/- as capital in nature by observing as under:

“Brief facts of the case:

The assessee, Shri Sharad Daulatrao Magar, having PAN: ASHPM1986C, an salaried individual, had filed ITR-1 u/s. 139(1) for AY 2019-20 on 29.07.2019 declaring total income of Rs.32,03,150/-. Further, Rs.35,54,140/- was shown as Gross Salary. The assessee was employee of M/s Pfizer Healthcare India Pvt. Ltd, Aurangabad during FY2018-19. The company launched VRS beneficial to the employees on planned closure of its unit. The assessee voluntarily resigned from service w.e.f 08.02.2019 and received compensation and out of that compensation he claimed Rs.30,49,176/- being salary claimed in Advance as exempt u/s 89 from taxation in his ITR u/s 139(1) of the Act.

………..

14. The submissions made by the assessee have been examined. As the assessee has submitted corroborative and binding judicial pronouncements in support of his claim that the amount of Rs.30,49,176/- received by him from his employer at the time of cessation of his employment due to closure of the manufacturing unit was a capital receipt, not subject to tax. The assessee has also placed reliance on various case laws, in support of his above claim, and court has held as under “The amounts received were due to loss of employment & not recurring in nature & are not paid in lieu of any salary hence it does not come under the preview of sec. 17(3)(i) as amount of compensation. The said amounts have not been paid against any services of the assessee. Hence the same is not compensation as contemplated under the provisions of sec. 17(3)(i).” As the various courts have allowed the claim that the amount received at the time of cessation of his employment due to closure of the manufacturing unit as capital receipt during assessment proceedings in the cases referred by the assessee, the AO’s has duly accepted the above claims of the respective assessee, which are very similar cases as that of the assessee’s instant case. Hence, the reopened assessment proceedings in the case of the assessee, is hereby proposed to be completed by accepting the income returned by the assessee in response to 148.”

25. In the remaining cases also, the respective AOs have treated such compensation as capital in nature. We, therefore, find merit in the arguments of the Ld. Counsel for the assessee that when the concerned AOs after reopening of the assessment have treated such compensation as capital in nature and the Revenue has not challenged the same and which has attained finality since no 263 proceedings have been initiated, therefore, the assessee’s case being identical to the facts of the other employees of Pfizer Healthcare India Pvt. Ltd., the CIT(A) / NFAC is not justified in sustaining the addition made by the Assessing Officer.

26. We further find the Hon’ble Calcutta High Court in the case of CIT v. Ajit Kumar Bose (supra) has observed as under:

“4. The amount in question was received by the assessee from his employer. It was received by him in connection with the termination of his service. But the question still remains whether it was compensation. Since it was received by the assessee in connection with the termination of his employment, the term “compensation” would be referable to that event. In other words, it is to be seen whether the amount was paid as compensation for the termination or in lieu of the termination of the employment.

5. The letter issued by the employer dated July 3, 1969, stated that the amount was being paid ex gratia. There is nothing to indicate that the assessee was entitled to continue in the employment of the company up to any particular age. Under the conditions of service, his services were liable to be terminated on giving three months’ notice without assigning any reason. Under the circumstances, it cannot be said that the assessee was entitled to remain in service for any period longer after the requisite notice has been given or that the employer was under any obligation to pay anything to the assessee in connection with the termination of his employment other than the salary for the period of notice. Under the circumstances, in its true nature and character, the payment was ex gratia, that is to say, totally voluntary; it was not compensation which implies some sort of an obligation to pay.

6. In this view, it cannot be said that the amount in question was profits in lieu of salary within the meaning of Clause (3) of Section 17. It was not taxable as such. The finding of the Tribunal that the amount was a capital receipt or that it was payment of a casual and non-recurring nature was in the circumstances not necessary. We, hence, do not express any opinion on it.

7. The question of law referred to us in this case, namely:

“Whether, on the facts and in the circumstances of the case, the amount of Rs. 24,933 received by the assessee could be treated as income under the charging section or under the section dealing with the computation of income of the assessee ?”

8. is answered in the negative, in favour of the assessee and against the Department.”

27. We find the Delhi Bench of the Tribunal in the case of ITO v. Avirook Sen (supra) at para 12 of the order has observed as under:

“12. As the payment of ex-gratia compensation was voluntary in nature without there being any obligation on the part of employer to pay further amount to assessee in terms of any service rule. it would not amount to compensation in terms of section 17(3)(i) of the Act. The impugned addition was rightly deleted by the Ld. CIT(A). The aforesaid point is accordingly determined against the revenue department. The appeal is accordingly not sustainable as we don’t find any error of law or fact in the impugned order passed by Ld. CIT(A). The department appeal is liable to be dismissed.”

28. The various other decisions relied on by the Ld. Counsel for the assessee placed in the paper book support his case to the proposition that the payment of ex-gratia compensation received by the assessee was voluntary in nature without there being any obligation on the part of the employer to pay further amounts to the assessee in terms of any service rule and therefore, would not amount to compensation in terms of section 17(3) of the Act. We, therefore, set aside the order of the CIT(A) / NFAC and direct the Assessing Officer to delete the addition. The grounds raised by the assessee are accordingly allowed.

8. It is noted that various courts have held that the payment of ex- gratia received by assessee was voluntary in nature without there being any obligation on the part of the employer to pay further amounts to the assessee in terms of any service rule and would not amount to compensation in terms of section 17(3) of the Act. Accordingly, I set aside the order of the ld. CIT(A) and delete the addition made by the Assessing Officer. Thus, the ground raised by the assessee is allowed.

9. In the result, the appeal filed by the assessee is allowed.