Taxability of Compensation & Interest awarded by Motor Accidents Claims

As per Income Tax Act, 1961, the definition of income do not specifically define compensation received as income. The question is whether the provisions of the Income Tax Act 1961, and more specifically, whether the compensation awarded by the Motor Accident Claims Tribunal to the victim can be classified as a  taxable income under the Income Tax law?

The answer to this question in the opinion of various High Courts is in the negative. Compensation cannot be categorized or even described as income as it has already been stated that the intention of the legislature in awarding compensation to the victims of Motor Accident cases is to restitute them and rehabilitate them. Thus it is well settled law that compensation received as per order of Motor Accident Claims Tribunal is not taxable as per Income Tax Act.

The compensation received under the Motor Vehicles Act is either on account of loss of earning capacity on account of death or injury or on account of pain and suffering and such receipt is not by way of earning or profit

The issue of taxation in case of compensation for motor accident depends on the question whether the receipt is Capital or Revenue receipt in the hand of recipient. If the person who has been given any compensation for motor accident or any accident, is permanently disabled because of accident, such receipt is considered as Capital receipt which is not taxable. Whereas, if the disablement is temporary, payment of claim in that case is taxable.

According to the Motor Vehicles Act, 1988, any person who has suffered injury, permanent disability or death caused by a motor accident, the victim or their next of kin is entitled to claim a compensation from the Motor Accidents Claim Tribunal or MACT. In case of delays in settling the claims, as often is the case, the tribunal also awards interest on the compensation amount provided for the duration of the delay.

The income tax law is not clear on the definition of income when it comes to such compensations. Money compensated for land acquisition is considered as an income source, but that is because, in this case a clear transfer of asset (land) has taken place. However, with motor accident claim, no such asset is transferred.

In most cases the amount of compensation is determined as a multiple of the annual income of the victim. And under income tax laws, any capital gain as a substitute of regular income is a capital receipt. Capital receipts do come under the purview of taxable income. However, capital receipt to relieve a personal loss do not fall under taxable income specifically. Thus, it is clear that any compensation for motor vehicle accident is not a taxable source of income.

The legislature is indeed supreme and it can make laws to fill up gaps in earlier legislations and to plug revenue leakage if necessary with retrospective effect. However, a statute is still bound by its governing principle or rule.

It is observed by various courts when there is conflict between the Social Welfare Legislation and Taxation Legislation, then the Social Welfare Legislation should prevail, since, it sub-serves larger public interest.  The Motor Vehicle Act is one such legislation which has been passed with a benevolent intention for compensating the accident victims who have suffered bodily disablement or loss of life and the Income Tax Act which is primarily intended for Tax collection by the State cannot put spokes in the effective and efficacious enforcement of the Motor Vehicles Act

Limitation

No application for compensation shall be entertained unless it is made within six months of the occurrence of the accident.

TDS on Interest Payment on Compensation ?

Many Insurance companies deduct TDS on the interest amount despite many high court rulings stating TDS should not be deduction as it do not form part of income and is capital receipt. Many High court has ruled that the interest paid along with the compensation as a result of the order of the Tribunal or of the superior Court is not liable for TDS.

Compensation awarded by Motor Accident Claims Tribunal – Interest awarded on compensation in motor accident cases cannot be considered as taxable income under the Income Tax Act, 1961- Interest on compensation awarded up to date of order of Tribunal or Court is held to be not taxable – Provision for deduction at source is not charging section

Petitioner when he was 8 years old while crossing the was road knocked down by a speeding vehicle. He was in coma for six months. Compensation was determined after 36 years after the accident. Motor Accident Tribunal awarded compensation within three months and the rate of interest payable was 12 per cent per annum on the unpaid amount. The insurance company before depositing the tax deducted the tax at source at 10 per cent on interest component. The petitioner filed the return and claimed the refund on the ground that the tax was wrongly deducted. The petitioner moved the petition challenging the vires of sections 194A(3)(ix), and (ixa) as also section 145A(b) and 56(2)(viii) of the Act. When the petition was pending the AO has passed the order. The petition was amended accordingly. Allowing the petition the Court held that awarding interest for delayed computation of compensation is therefore an integral part of this exercise. Interest awarded in motor accident claims cases is, thus, compensatory in nature and forms part of the compensation itself hence not taxable. Court also held that clause (viii) of sub-section (2) of section 56 by itself would not make the receipt of interest on compensation chargeable to tax as income from other sources, if such receipt is not income. Clause (b) of section 145A of the Act does not make interest on compensation or enhanced compensation taxable if it is otherwise not exigible to tax. It merely provides for the point of time when it would be subject to tax if otherwise taxable. The provision for deduction of tax at source is not a charging provision. It only provides for deduction of tax at source on payment of a sum, which, in the hands of the payee, is income. If the payee has no liability to tax on such income, the liability to deduct tax at source in the hands of the payer cannot be fastened. The provision for deducting tax at source cannot govern the taxability of the amount which is being paid. Accordingly the question of deduction of tax at source would arise only if the payment is in the nature of income of the payee. (Related Assessment year : 2016-17) – [Rupesh Rashmikant Shah. v. UOI (2019) 417 ITR 169 (Bom)]

Compensation awarded under Motor Vehicles Act or Employees’ Compensation Act in lieu of death of a person or bodily injury suffered in a vehicular accident, is a damage and not an income and cannot be treated as taxable income – Not liable to deduct tax at source on compensation and interest accrued thereon
Allowing the petition the Court held that, compensation awarded under Motor Vehicles Act or Employees’ Compensation Act in lieu of death of a person or bodily injury suffered in a vehicular accident, is a damage and not an income and cannot be treated as taxable income. Accordingly interest awarded by the Motor Accident Claims Tribunal on a compensation is also a part of compensation upon which tax is not chargeable hence the action of Insurance company deduct tax at source on the awarded compensation and interest accrued thereon is illegal and is contrary to the law of land. Accordingly respondent directed to refund the tax deducted at source. – [National Insurance Company Ltd. v. Savitri Devi (2018) 259 Taxman 579 (HP)]

The Division Bench of the Himachal Pradesh High Court in the case of Court on its own Motion v. The H.P. State Cooperative Bank Ltd. & Ors. held that the compensation awarded under the Motor Vehicles Act is not a taxable income. It was observed as under:

“13. While going through the said provisions of law, one comes to the inescapable conclusion that the mandate of the said provisions does not apply to the accident claim cases and the compensation awarded under the Motor Vehicles Act cannot be said to be taxable income. The compensation is awarded in lieu of death of a person or bodily injury suffered in a vehicular accident, which is damage and not income.”

Deduction of tax at source – Compensation awarded under Motor Vehicles Act, 1988 is awarded in lieu of death of a person or bodily injury suffered in a vehicular accident and it could not be taxed as income – Circular of Board of Board to deduct tax at source was quashed

The Registrar of the High Court had put up a note that Bank Authorities were making tax deductions on interest accrued on the term deposits, i.e., fixed deposits made by the Registry in terms of the orders passed by the Court in Motor Accident Claims cases. The matter was referred to the Finance/ Purchase Committee for examination. The Committee was of the view that since the dispute involved was intricate and public interest was involved, it was recommended that the matter required consideration on judicial side. The recommendation of the Committee was treated as Public interest Litigation and suo motu proceedings were drawn. The department filed the reply and pleaded that in terms of Circular No. 8/2011, dated 14.10.2011, issued by the income-tax authorities, income-tax was to be deducted on the interest periodically accruing on the deposits made on the court orders to protect the interest of the litigants. The Court held that the circular, dated 14.10.2011, issued by the income-tax authorities, is not in tune with the mandate of sections 2(42) and 2(31), read with section 6. The said circular also is not in accordance with the mandate of section 194A hence the Compensation awarded under Motor Vehicles Act is awarded in lieu of death of a person or bodily injury suffered in a vehicular accident and it could not be taxed as income. Circular No. 8/2011, dated 14.10.2011, issued by Income-tax Authorities, whereby deduction of income-tax has been ordered on award amount and interest accrued on deposits made under orders of Court in Motor Accident Claims cases run contrary to mandate of granting compensation, thus, was quashed.In case any such deduction has been made by department, they are directed to refund the same, with interest at the rate of 12% from the date of deduction till payment. – [Court on its own motion v. H.P. State Cooperative Bank Ltd. (2015) 276 CTR 264 : 228 Taxman 151 : 117 DTR 231 (HP)]

Interest on delayed compensation paid under motor accident claim -Assessee was not under any legal obligation to deduct TDS while making payment under section 194A

Assessee insurance company paid compensation and interest thereon under Motor Vehicle Act, 1988 to the claimants. The Assessing Officer held that as the assessees had failed to deduct tax at source on amount of interest and therefore, they are liable to amount of TDS under section 201(1) along with interest under section 201(A). Held: Interest paid on delayed payment of compensation under Motor Vehicle Act, 1988 did not come within the ambit of section 2(23A) and as such, assessee was not under any legal obligation to deduct TDS while making payment under section 194A. – [CIT v. Oriental Insurance Co. Ltd. (2013) 052 (I) ITCL 106 : (2012) 211 TAXMAN 369 (All)]

Compensation received due to an accident can be taxable if there is no disablement and shall be tax free if there is permanent or temporary disablement (tax free amount will be proportionate to temporary disablement

In Vinod Kumar v ITO (1990) 32 ITD 254, ITAT Chandigarh in Para 13 has held that –

“assessee in all fairness and in a bona fide manner based upon in actual happenings in life made disclosure of the amount of Rs. 34,143 received from the insurance company for temporary disablement proved by necessary documents. This amount was, on the facts of the case, capital receipt and not taxable and includible in the total income of the assessee. The Income-tax Officer, therefore, reached a correct conclusion that the amount was not includible in the total income of the assessee. His order could not be said to be erroneous as well as prejudicial to the interest of revenue within the ambit of section 263 of the Act. We, therefore, cancel the order of the Commissioner under appeal before us.” – [Vinod Kumar v ITO (1990) 32 ITD 254 (ITAT Chandigarh)]

Interest awarded by the Court for loss suffered on account of deprivation of the property amounts to compensation and is not taxable and therefore, not assessable as income

Interest awarded as compensation is not a revenue receipt. In CIT v. Chiranji Lal Multani Mal Rai Bahadur (P) Ltd., Punjab and Haryana High Court, it was held interest is received on the basis of a contract or under a statute the same is taxable, but if interest is awarded by the court for loss suffered on account of deprivation of property, it amounts to compensation, though called interest, and would not be taxable. Thus, the High Court held that interest awarded by the Court using its discretion, under the facts and circumstances of the case cannot be a revenue receipt. It did not agree with the argument of the revenue department that interest had been awarded as per statute viz., Section 34 of the Civil Procedure Code, 1908 reasoning that the Delhi High Court had awarded interest under its discretion as compensation for loss suffered on deprivation of property. – [CIT v. Chiranji Lal Multani Mal Rai Bahadur (P) Ltd. (1988) (12) TMI 62(P&H)]

However, from the above discussion it is clear that neither motor accident compensation, nor the interest on such claims are taxable, as the definition of taxable income depends on the nature of the receipt and in this case neither can be deemed as income. The confusion and litigation arises due to the unclear set of rules regarding such claims. There is no specific exemption for such compensation or interest, like those for workmen’s compensation, LIC maturity proceeds, and compensations for disasters. Until such time as a specific provision is made in the law for exemption of motor accidents compensation, victims will continue to suffer under these circumstances.