PROSPERR.IO

When a property owner receives enhanced compensation after a land acquisition case, or an accident victim gets a court award with interest, a critical tax question emerges: Is that interest taxable? If yes, under which head? The answer has evolved through legislative amendments and contradictory court rulings, creating genuine confusion for taxpayers in 2026.

This examination looks at how Indian tax law treats interest on compensation, why courts disagree, and what taxpayers need to know.

The Core Issue: Interest as Compensation or Income?

Interest awarded on compensation arises in several scenarios:

• Land acquisition cases under the Land Acquisition Act
• Motor accident claims
• Delayed salary or bonus payments
• Enhanced compensation awarded by courts

The fundamental question: Is this interest compensatory (making up for delayed payment), or is it genuine income that should be taxed?

Before 2009, the position was clear. In CIT vs. Ghanshyam (HUF) [2009] 315 ITR 1, the Supreme Court held that interest under Section 28 of the Land Acquisition Act was an accretion to compensation value. It formed part of enhanced compensation and was taxable as capital gains under Section 45(5).

Logical reasoning: If you're receiving compensation for losing an asset, interest on that compensation is part of overall compensation, not separate income.

Then the 2009 legislative changes upended everything.

The 2009 Legislative Overhaul

Finance (No. 2) Act, 2009 introduced a comprehensive set of amendments effective from April 1, 2010:

Section 56(2)(viii) was inserted: "Income by way of interest received on compensation or on enhanced compensation referred to in clause (b) of section 145A shall be chargeable to tax."

Section 145A(b) was substituted: "Interest received by an assessee on compensation or on enhanced compensation, as the case may be, shall be deemed to be the income of the year in which it is received."

Section 57(iv) was inserted: Provided a deduction of 50% of such interest income. No other deduction allowed.

The legislative intent seemed clear: treat interest on compensation as income from other sources, tax it in the year of receipt, and allow a flat 50% deduction. But did this override the Supreme Court's Ghanshyam ruling? Courts began disagreeing.

The Judicial Split: Different High Courts, Different Views

Gujarat High Court Position:

In Movaliya Bhikhubhai Balabhai vs. ITO (2016) 388 ITR 343, the Gujarat High Court held that interest under Section 28 of the Land Acquisition Act continues to be part of compensation even after the 2009 amendments.

The court reasoned that the amendments were not in response to the Ghanshyam decision but to mitigate hardship caused by another Supreme Court case (Rama Bai) regarding the year of taxation. Therefore, the nature of interest as "compensation" remained unchanged—it's capital gains, not income from other sources.

Implication: No TDS under Section 194A should be deducted on such interest.

Punjab & Haryana High Court Position:

In Mahender Pal Narang vs. ITO, the Punjab & Haryana High Court took the opposite view. The court held that post-2009 amendments, interest on compensation under Section 28 must be taxed as income from other sources as per the specific provisions of Section 56(2)(viii) and Section 145B.

The court emphasized that the legislature has the power to modify judicial interpretations through statute. The clear language of Section 56(2)(viii) brings such interest under income from other sources.

Implication: TDS under Section 194A applies; tax it as income from other sources.

Bombay High Court Position (Motor Accident Cases):

In Rupesh Rashmikant Shah vs. UOI (2019) 417 ITR 169, the Bombay High Court examined interest awarded in motor accident claims. The court held that interest awarded from the date of claim petition till the award is compensatory in nature and forms part of the compensation itself. It is not exigible to tax.

The reasoning: Section 56(2)(viii) doesn't make a receipt taxable if it's not income in the first place. Section 145B merely prescribes the year of taxation, not whether it's taxable. If the underlying receipt is compensatory and not income, the charging provision doesn't apply.

Implication: Interest on motor accident compensation is not taxable.

Understanding the Statutory Framework

Types of Compensation and Tax Treatment 

The framework seems comprehensive, but the judicial interpretation varies based on the underlying nature of the "interest." 

Land Acquisition Under Section 28: Section 28 of the Land Acquisition Act, 1894 provides for 9% interest from possession date till payment. Courts differ on whether this is compensation (Gujarat HC) or income from other sources (P&H HC). Current practical position: Most tax authorities assess as income from other sources. Litigation continues.

Motor Accident Claims: Interest awarded by MACT for delayed compensation. Bombay HC held this is not taxable as it's compensatory. Practical position: If interest doesn't exceed ₹50,000, no TDS. Above that, expect litigation.

Enhanced Compensation: When original compensation is enhanced by court, interest paid on enhanced amount. Treatment same as land acquisition, conflicting views exist.Delayed Salary/Bonus: Interest on delayed salary is taxable as "Salary" under Section 17, not under Section 56(2)(viii). Different provision, clearer treatment. 

The 50% Deduction Under Section 57(iv)

If interest on compensation is indeed taxable as income from other sources, Section 57(iv) provides relief:

Deduction allowed: 50% of the interest received No other deduction: Cannot claim actual expenses against this income

Example: Interest received on enhanced compensation: ₹10 lakh

Taxable income = ₹10 lakh - ₹5 lakh (50% deduction) = ₹5 lakh Tax @ 30% (assuming 30% slab) = ₹1.5 lakh

Without the 50% deduction, tax would be ₹3 lakh. The deduction halves the tax burden.

TDS Provisions: Section 194A

Section 194A(3)(ix) deals with TDS on interest on compensation:

• No TDS if interest doesn't exceed ₹50,000 in a financial year
• Above ₹50,000, TDS at applicable rates (usually 10%)
• Controversy: Should TDS apply if the underlying receipt is not taxable?

Courts have held that TDS provisions are machinery provisions, not charging provisions. If there's no tax liability, TDS shouldn't apply. But in practice, payers often deduct TDS to be safe, leaving the recipient to claim refund.

What Taxpayers Should Do

Given the conflicting judicial positions, here's practical guidance:

If you receive interest on land acquisition compensation:

1. Check the amount—if below ₹50,000, likely no TDS
2. If TDS is deducted, you have two options:

• Pay tax as income from other sources (safer, less litigation)
• Challenge it based on Gujarat HC ruling (more litigation risk)

3. If paying tax, claim 50% deduction under Section 57(iv)

4. Consult a tax professional before choosing your stance

If you receive interest on motor accident compensation:

1. Rely on Bombay HC ruling (Rupesh Shah case)
2. If TDS is deducted, file return claiming it's not taxable
3. Attach court ruling as supporting document
4. Be prepared for potential scrutiny

If you receive interest on delayed salary/bonus:

1. This is taxable as salary under Section 17
2. Not covered by Section 56(2)(viii)
3. Claim standard deduction if applicable
4. Report under "Salary" head in ITR

The Road Ahead

The conflicting judicial positions create genuine difficulty for taxpayers. Several questions remain unresolved:

Does the 2009 amendment override Ghanshyam? The amendment doesn't explicitly say. Some courts say yes (P&H HC), others say no (Gujarat HC).

Can interest be "not income" despite Section 56(2)(viii)? Bombay HC says yes—if compensatory, the charging provision doesn't apply.

Will the Supreme Court clarify? Given the High Court split, an appeal seems likely. Until then, taxpayers navigate based on their jurisdiction's High Court view.

What about the new Income Tax Act 2025? The new Act largely retains these provisions with renumbering. The controversy continues.

Conclusion

Interest on compensation occupies a peculiar space in Indian tax law—explicitly covered by statute yet subject to conflicting judicial interpretations about its fundamental nature.

For taxpayers receiving such interest, the approach depends on amount involved, appetite for litigation, and jurisdiction. Smaller amounts might be easier to just pay tax on with the 50% deduction. Larger amounts might justify fighting based on favorable court rulings.

What's certain: the controversy won't settle without Supreme Court intervention. Until then, careful documentation, professional advice, and clear understanding of the judicial landscape are essential for anyone dealing with compensation interest.
 

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Frequently Asked Questions

Q1: A property was acquired in 2018, and enhanced compensation with interest was received in 2025. In which year should the interest be taxed?

Under Section 145B(1), interest on compensation is deemed to be income of the year in which it is received. So if you received the interest in 2025, it's taxable in FY 2024-25 (Assessment Year 2025-26), regardless of when the property was acquired or when the compensation was determined. This is on a "receipt basis," not accrual basis. The 2009 amendment specifically addressed this to avoid hardship of taxing decades of accumulated interest in one year based on accrual. Report it in your ITR for the year you actually received the money.

Q2: If TDS was deducted on interest received on compensation, but the taxpayer believes it's not taxable based on court rulings, how to get a refund?

File your income tax return showing the TDS credit (as per Form 26AS) but not offering the interest as taxable income. In the return, you can add a note in "Schedule VIA" or attach an explanation stating your position and citing relevant court ruling (Gujarat HC or Bombay HC as applicable). Claim refund of the TDS amount. However, this likely triggers scrutiny assessment where you'll need to defend your position with legal arguments and case law. Many taxpayers choose to pay the tax to avoid litigation, especially if the amount is not very large. It's a judgment call based on amount involved and your appetite for litigation.

Q3: What is the difference between compensation and interest on compensation for tax purposes?

Compensation itself (for land acquisition, motor accident, etc.) is the principal amount paid for the loss suffered. This is often not taxable or taxed as capital gains depending on the asset type. Interest on compensation is the additional amount paid for delay in settling the compensation. Courts disagree on whether this interest is merely part of the compensation (and should follow the same tax treatment) or is separate income. Section 56(2)(viii) specifically taxes interest as income from other sources, but courts like Gujarat HC and Bombay HC have held that if interest is compensatory in nature (integral to compensation), it doesn't become income just because Section 56 mentions it.

Q4: Can the 50% deduction under Section 57(iv) be claimed if the interest is contested as not taxable?

No. The 50% deduction under Section 57(iv) is available only if you're treating the interest as taxable income from other sources under Section 56(2)(viii). If your position is that the interest is not taxable at all (based on judicial rulings), you don't offer it as income, and therefore the question of claiming deduction doesn't arise. You can't have it both ways—either it's fully not taxable (in which case you fight on that ground), or it's taxable as income from other sources (in which case you get the 50% deduction). The deduction is a consolation if you accept the taxability.

Q5: How does the taxation differ if the same person receives interest on land acquisition compensation and also interest on a motor accident claim in the same year?

Technically, they should be treated differently based on current judicial positions. Interest on land acquisition has conflicting HC rulings (Gujarat says capital gains, P&H says income from other sources). Interest on motor accident claim has Bombay HC ruling saying it's not taxable as it's compensatory. In practice, if filing return:

• For land acquisition interest: safest to show under income from other sources with 50% deduction (unless you want to litigate)
• For motor accident interest: claim it's not taxable, cite Bombay HC ruling However, tax authorities may take a uniform view and try taxing both under Section 56(2)(viii). This area is genuinely uncertain, and consultation with a tax professional based on your specific case facts is essential.