Interest on Compensation Is Non-Taxable, Rules Bombay HC
One aspect of tax terrorism deals with what is taxed. Can you tax compensation received for accident or for land acquisition?  Can you tax interest on that compensation, for the number of years you spend getting the compensation in your account? These questions came up recently before the Bombay High Court in the case of Rupesh Rashmikant Shah Vs Union of India (WRIT PETITION (Original Side) No. 2902 OF 2016). The Court did well to split hairs on the letter of the law; but in the process, exposed what is wrong with our taxes and laws.
The Bombay High Court Case in Brief
In the year 1978, an accident with speeding vehicle left 8-year old Rupesh Shah, the petitioner, bedridden for life. The Motor Vehicles Accident Tribunal awarded compensation in the year 1990 to be paid in three months. The decision awarded interest at 6% from the date of filing of the claim petition till realisation. The Tribunal also directed that if compensation is not paid in three months the rate of interest payable will be 12%. 
Mr Shah, now a major, filed his first appeal which was decided in the year 2014.
The High Court awarded a compensation of Rs39.92 lakh to be paid with an interest of 9%. He then had to file an execution petition after the decision of the High Court and the amount of Rs1.4 crore (Rs39.92 lakh compensation and Rs1.14 crore interest) was deposited by the insurance company after deducting tax at source (TDS) of 10% on the interest amount.
When Mr Shah filed  his income-tax (I-T) return, he was assessed for tax on the interest component of his compensation, i.e., on Rs1.14 crore. He challenged this assessment.
The Bombay High Court read the law in great detail and concluded two central points. First, that interest from the date of filing the claim petition (around 1978) till date of its enhancement by the High Court (2014) was not taxable. However, the interest that the insurance company had to pay after 2014 was eligible to tax as income from other sources. Second, that if any income is not taxable, tax cannot be deducted at source.
What does it mean?
To explain simply, the judgement says that till such time as the computation (i.e., the basis and amount) of compensation is not final, the interest is part of the compensation. By the decision of the final court’s determination of the compensation, it becomes final and may be called the final award. 
For Motor Vehicles Act, this final award, is the compensation. The interest from the date of filing of claims petition till the date of the final award is part of this final award. 
But just because a court determines the compensation that does not mean the victim actually receives it. Like Mr Shah, the victim, is required to file an execution petition that petition runs its course and then the money is deposited in the court.
Then the executing court passes an order releasing the money. The victim takes the order to the bank, then the bank asks for a bank guarantee or surety or indemnity or all of these. Then the money is paid to the victim. 
Readers will note that this process itself takes years. During this time too, the victim must receive interest. But, as per the order of the Hon’ble High Court, this interest is taxable under the head of ‘income from other sources’.
What about compensation for land acquisition?
The question is relevant for land acquisition because of the delays. Just as in motor vehicles, after the final award is made by the court, claimants need to file an execution petition and wait for the payment of compensation. In the case of land acquisition cases, it takes decades before payment is made AFTER the compensation is determined finally.
Thankfully, as per the Land Acquisition Act, compensation means the final award AND the interest on that final award till it is paid. Thus, compensation for land acquisition means final award AND interest. Thus, for the amount received as compensation for land acquisition, income tax is not payable. Further, since it does not amount to income, there should be no tax deduction at source.
Do note that capital gains tax is applicable on compensation awarded for land acquisition. However, since the compensation awarded is paltry and since only simple interest is awarded, and final award is decided after decades, the value of compensation is always less than the capital gains index. And that conveys the enormous tragedy of land acquisition and why there is always a resistance to acquisition.
So how to tax compensation?
Simple, compensation and interest on compensation should not be taxed. Not for motor vehicles, not for land acquisition, nor for anything. 
Just because some court says this amount is due to you does not mean that the victim gets the compensation. The law simply assumes that there is no cost to executing the order of the court. In reality, the costs are enormous both in terms of time and money. Indian law has also conveniently ignored opportunity costs. That interest accrues itself is a blight on enforcement of law. Interest on compensation is actually another compensation for hardship for delay in getting the compensation paid to you. Penalising the victim for delays of justice system is cruel.
In Sum
While the reading of the law by the Bombay High Court may be correct, it shows the unnecessary complications in the calculation of taxes. It opens another avenue for lawyers (like me) and accountants to make money. There is no need to allow such complexity in the tax system.
In principle, compensation is given to reduce the hardship. Imposing hardship (i.e., tax) in getting that compensation undermines the spirit of the law. This colonial legacy should be done away with immediately. Let us hope the finance minister is listening.
Reference: WRIT PETITION (Original Side) No. 2902 of the 2016 decision dated July 23 2019 by Shri Akil Kureshi and S. J. Kathawalla JJ.


2 years ago
I am awarded appropriate compensation, compensation, legal costs by Rera Adj. Officer from builder for his unlawful practices against my complaint. Please confirm such amount will attract Income tax. Thanks
5 years ago
A very critical matter in the dispensing of justice. All this requires is understanding on the part of our leaders. Hope this matter catches their attention.
5 years ago
Pl refer to circular no 36/2016 by Ministry of finance compensation for land acquisition is exempt from capital gains
5 years ago
Very well explained.
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