Ram Pershad v. C.I.T. (1972)

Salary is not defined by the size or the shape of the payment. It is defined by the relationship out of which the payment comes: there must be an employer and an employee. Get the relationship wrong and the whole computation is wrong — the standard deduction, the treatment of perquisites, the deduction of tax at source and the employment tax deduction all hang on it.

The hard case is the person at the top of a company, who both directs the company and is paid by it. Ram Pershad is the authority on that case, and its method — read the articles and the terms of employment — is the method to apply to any disputed relationship.

The assessee and his wife owned a large number of shares in a private limited company engaged in the business of running hotels.

By virtue of Article 109 of the company's articles of association, the assessee became its first Managing Director, on terms embodied in an agreement dated 20 November 1955 between himself and the company. Under that agreement he was to receive Rs 2,000 per month, a fixed Rs 500 per month as car allowance, 10 per cent of the gross profits of the company, and free board and lodging in the hotel for himself and his wife.

For the assessment year 1956-57 he was assessed on Rs 53,913 payable to him as his 10 per cent of the gross profits. He had given up that sum soon after the accounts were finalised but before they were passed by the general meeting of the shareholders, because the company would not be making net profits if the stipulated commission were paid to him.

He contended that the amount was not includible in his total income because it had never accrued to him; and that even if it had accrued, it was not taxable as salary but fell to be dealt with under the business head, in which case he claimed a deduction of the same sum.

The Income-tax Officer, the Appellate Assistant Commissioner, the Tribunal and the High Court all held that the commission was taxable as salary and that the income had accrued during the previous year. The assessee appealed by special leave.

The commission was salary. The managing director was a servant of the company, because the articles and the agreement placed him under the control of the board.

On how that question is to be decided: "whether or not a Managing Director is a servant of the company apart from his being a Director can only be determined by the article of association and the terms of his employment".

On the kind of control required: it "need not necessarily be one which tells him what to do from day to day."

The label on the office decides nothing. A managing director is a director, and a director as such is not a servant. But he may hold, alongside that office, a contract of employment. Whether he does is a question about the documents.

So read the documents — both of them. The articles, which create the office and define its powers, and the agreement, which fixes the terms on which he serves. Together they show whether he is subject to the direction of the board or is his own master.

Control is the test, but control at the right level. The Court's refinement is the part students most often miss. Supervision of daily work is the paradigm of employment, not its definition. A senior employee is trusted to decide how to do the work; what makes him an employee is that he is subject to the directions of the company's governing body, which may direct him and may call him to account. A managing director who serves subject to the board's control is an employee however wide his discretion in practice.

Once the relationship is employment, the form of the remuneration follows it. A commission measured by gross profits is not thereby a share of profits or a business receipt; it is remuneration for service, computed by reference to profits. Its measure does not change its character.

It opens any question on the meaning of salary, on the chargeability of a director's or managing director's remuneration, and on the distinction between a contract of service and a contract for services.

The steps: state that the salary head presupposes an employer–employee relationship; say that the existence of that relationship is determined from the articles and the terms of employment; apply the control test at the level Ram Pershad sets it, namely subjection to the direction of the board rather than day-to-day instruction; and only then compute under the salary head, with its deductions.

Pair it with C.I.T. v. L.W. Russel, which works the same requirement from the other end. There an employer's contribution to a superannuation scheme was held not to be a taxable perquisite, because the employee's rights under the scheme were contingent, so the sum was neither paid to him nor due to him; and the Court said the provision "presupposes the existence of the relationship of employer and employee". Ram Pershad establishes when the relationship exists; Russel establishes that even within an existing relationship a payment is taxed only when it has actually become the employee's.

It disposes of the submission that wide managerial powers, or a shareholding, or remuneration measured by profits, are inconsistent with employment.

It does not decide that every director is an employee. A director paid fees for attending board meetings, with no contract of service behind the office, is not — and the way to show it is the way the case itself requires: read the articles and the terms.