Whether “Tips” Could Be Treated as Income Under the Head Salary?

The Assessing Officer treated the receipt of the tips as income under the head “salary” in the hands of the various employees and held that the assesses were liable to deduct tax at source from such payments under Section 192 of the Income Tax Act, 1961. The assessees were treated by the Assessing Officers as assesses-in-default under Section 201(1) of the Act. The Assessing Officers in various assessment orders worked out the different amounts of tax to be paid by all the aforesaid assesses under Section 201(1), as also interest under Section 201(1A) of the said Act for assessment years 2003-2004, 2004- 2005 and 2005-2006.

The CIT (Appeals) vide his common order dated 28.11.2008 allowed the various appeals of the assesses holding that the assesses could not be treated as assesses in-default under Section 201(1) of the Act for non-deduction of tax on tips collected by them and distributed to their employees. Appeals filed by the Revenue to the Income Tax Appellate Tribunal (ITAT) came to be dismissed by the Tribunal by relying upon its own order for assessment year 1986- 1987 in the case of ITC and the case of Nehru Palace Hotels Limited. Against the said orders of the Tribunal, appeals were preferred by the Revenue to the High Court.

The High Court vide the impugned judgement dated 11.5.2011 framed the questions of law as follows:

(a) Whether on the facts and in the circumstances of the case, the Ld. ITAT erred in law and on merits holding that the assessee was not an “assessee in default” for short/non deduction of tax at source on account of banquet and restaurant tips collected and paid by it to its employees? (b) Whether on the facts and in the circumstances of the case, the Ld. ITAT erred in law and on merits in holding that the payment of banquet and restaurant tips to the employees of the assessee in the capacity an employer were not profits in lieu of salary within the meaning of Section 17 (3) (ii) of the Income Tax Act, 1961?

The High Court held, after considering Sections 15, 17 and 192 of the Income Tax Act, that tips would amount fall under Section 15(b) read with Section 17(1)(iv) and 17(3)(ii). Even so, the High Court held that when tips are received by employees directly in cash, the employer has no role to play and would therefore be outside the purview of Section 192 of the Act. However, the moment a tip is included and paid by way of a credit card by a customer, since such tip goes into the account of the employer after which it is distributed to the employees, the receipt of such money from the employer would according to the High Court amount to “salary” within the extended definition contained in Section 17 of the Act. For arriving at this interpretation, the High Court relied upon the decision of Supreme Court in Karamchari Union, Agra v. Union of India [2000 (3) SCC 335], while distinguishing the judgements of Supreme Court in Rambagh Palace Hotel v. Rajasthan Hotel Workers’ Union [1976 (4) SCC 817] and Quality Inn Southern Star v. ESI Corpn., [2008 (2) SCC 549]. After distinguishing the said judgement, the High Court arrived at the following conclusion:

From the above discussion, we may conclude that the receipt of the tips constitute income at the hands of the recipients and in chargeable to the income tax under the head “salary” under Section 15 of the Act. That being so, it was obligatory upon the assessees to deduct taxes at source from such payments under Section 192 of the Act.

Since the assessees were, therefore, declared to be assesses-in-default under Section 201 of the Act, the High Court found that despite the fact that the assesses did not deduct the said amounts based on a bonafide belief and no dishonest intention could be attributed to any of them, yet the High Court held that levy of interest under Section 201(1A) would follow, as the payment of simple interest under the said provision is mandatory, and not being penal in nature, no question of bonafide belief would arise to absolve the assesses from any interest liability under the said provision.

Against the judgement of the High Court special leave petition was filed. The Supreme Court accepted the appeals filed by the assessees and the appeals filed by the Revenue were dismissed. The judgement of the High Court was set aside with no order as to costs.

The operative part of the judgement read as under :

At this stage it is important to analayse Section 192 of the Income Tax Act. First and foremost, under sub- section (1) thereof, “any person responsible” for paying any income chargeable under the head “salaries” is alone brought into the dragnet of deduction of tax at source. The person responsible for paying an employee an amount which is to be regarded as the employee’s income is only the employer. In the facts of the present case, it is clear that the person who is responsible for paying the employee is not the employer at all, but a third person – namely, the customer. Also, if an employee receives income chargeable under a head other than the head “salaries”, then Section 192 does not get attracted at all. In Emil Webber v. CIT [JT 1993 (2) SC 555], the Ballarpur Paper and Straw Board Mills wanted to set up a caustic soda/chlorine manufacturing plant at Ballarpur. For this purpose, it entered into two agreements with Krebs, a French concern, which in turn entered into an agreement with a Swiss concern for making available services of certain personnel. The assessee, Emil Webber, was a person engaged by the Swiss concern. The assessee came to India and worked in connection with the setting up of the said plant. The question that was posed before this Court was whether the tax component paid by Ballarpur of the assessee’s taxable income could be included within the income of the assessee. This Court, in answering the said question, specifically stated in paragraph 8, that the question arose as to under which head of income should the said income be placed. This Court held that inasmuch as the assessee is not an employee of Ballarpur, which made the payment, it cannot be brought within the purview of Section 17 of the Act. Thus, such income must necessarily be placed under Section 56(1) of the Act as income from other sources’.

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Following the aforesaid decision, it is clear that as income from tips would be chargeable in the hands of the employees as income from other sources, such tips being received from customers and not from the employer, Section 192 would not get attracted at all on the facts of the present case.

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It can be seen, on an analysis of Section 15, that for the said Section to apply, there should be a vested right in an employee to claim any salary from an employer or former employer, whether due or not if paid; or paid or allowed, though not due. In CIT v. L.W. Russel [53 ITR 91 (SC), this Court dealt with the provisions of Section 7(1) of the 1922 Act, which preceded Sections 15 and 17 of the present Act. Holding that it is necessary for the employee to have a vested right to receive an amount from his employer before he could be brought to tax under the head “salaries”.

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On the facts of the present case, it is clear that there is no vested right in the employee to claim any amount of tip from his employer. Tips being purely voluntary amounts that may or may not be paid by customers for services rendered to them would not, therefore, fall within Section 15(b) at all. Also, it is clear that salary must be paid or allowed to an employee in the previous year “by or on behalf of” an employer. Even assuming that the expression “allowed” is an expression of width, the salary must be paid by or on behalf of an employer. It must first be noticed that the expression “employer” is different from the expression “person”. An “employer” is a person who employs another person under a contract of employment, express or implied, to perform work for the employer. Therefore, Section 15(b) necessarily has reference to the contract of employment between employer and employee, and salary paid or allowed must therefore have reference to such contract of employment. On the facts of the present case, it is clear that the amount of tip paid by the employer to the employees has no reference to the contract of employment at all. Tips are received by the employer in a fiduciary capacity as trustee for payments that are received from customers which they disburse to their employees for service rendered to the customer. There is, therefore, no reference to the contract of employment when these amounts are paid by the employer to the employee. Shri Kaul, however, argued that there is an indirect reference to the contract of employment inasmuch as but for such contract, tips to employees could not possibly have been paid at all. We are afraid that this argument must be rejected for the simple reason that the payments received by the employees have no reference whatsoever to the contract of employment and are received from the customer, the employer only being a conduit in a fiduciary capacity in between the two. Indeed, if Shri Kaul’s arguments were to be accepted, even the position accepted by the revenue and consequently the High Court that tips given in cash, which admittedly are not covered by Section 192, would also then be covered inasmuch as such tips also would not have been given but for the contract of employment between employer and employee. Clearly, therefore, such argument does not avail Revenue.

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We agree with the statement of law that there is no ground for saying that these tips ever became the property of the employers. Even if the box were kept in the actual custody of the employer he would have no title to the money as he would hold such money in a fiduciary capacity for and on behalf of his employees. In the said circumstances, it is clear that such payments would be outside the purview of Section 15(b) of the Act.

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However, the sheet anchor of Shri Kaul’s submission is Section 17(3)(ii) in which Shri Kaul stressed that any payment received by an assessee from an employer would be regarded as profits in lieu of salary. According to Shri Kaul it is undisputable that payments were received by the employees from their employer and that, without more, Section 17 would therefore be attracted to the facts of the case. This argument again cannot be countenanced for the simple reason that Section 17(3) itself uses two different expressions-“employer” in sub-clause (ii) and “person” in sub-clause (iii). Obviously “person” is wider than “employer”. Even the word

“person” which appears in the said sub-clause has reference either to a future employer or a past employer. Therefore, it is clear that under the scheme of Section 17, payment must be by an employer, whether such employer is a futur e employer or a past employer of the employee in question. When sub-clause (ii) uses the expression “employer”, it uses the said expression in the same sense as is used in Section 15, as the opening line of Section 17 itself states that “for the purposes of Section 15” salary includes profits in lieu of salary. We have already held that the word “employer” in Section 15 necessarily brings in a contract of employment, express or implied, and for this reason also we are afraid we are not able to accept Shri Kaul’s argument.

We find, therefore, that the contract of employment in the present cases, not being the proximate cause for the receipt of tips by the employee from a customer, the same would be outside the dragnet of Sections 15 and 17 of the Income Tax Act.

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Authorities relied upon : 2008 (2) SCC 549, 1976 (4) SCC 817, 1960A.C. 376, (1955) 2W.L.R. 96, 1951 (2) K.B. 277, 53 ITR 91 (SC), 1947 (1) KB 526.