Taxability of Compensation and interest on compensation received from Govt or Insurance companies

Generally compensation is paid by insurance company or Govt on account of any damage to property or human being on an accident or similar incidents.

Example of compensation paid by Govt:

  • On compulsory acquisition of land for development of infrastructure or other project
  • On death or disablement due to natural calamity like cyclone etc
  • On death or disablement due to some building or flyover collapse
  • On death or disablement due to railway accident or other accident or incidents.

(Please note that award given by Govt to some people on account of achievement in sports etc does not fall within the meaning of compensation as there is a difference between award and compensation. Award is given on some achievement whereas compensation is paid on account of certain loss or damages).

Compensation & Interest

Example of compensation paid by Insurance companies:

  • On death of a person on account of Life insurance policy taken by the deceased person earlier.
  • Reimbursement of medical expenses on account of medical insurance policies
  • Compensation in case of motor accident claims either on death or disablement (permanent or temporary) of injured person
  • Claim for damage of property insured in case of general insurance like car insurance, home insurance, fire insurance, marine insurance etc.

Beside it, many a times there is a sufficient time lag between the date of occurrence of accident and actual date of receipt of compensation (In some case this time gap may be for years). To discourage such cases appropriate interest is also allowed by the courts and competent authority in addition to the actual amount of claim.

In this article we will talk about the taxability of this claim amount as well as interest received on such claims awarded by competent authority.

We have segregate the whole discussion in following 6 parts:

  • Taxability in case of compulsory acquisition of land (Compensation by Govt)
  • Taxability of compensation received from Govt on death or disablement due to natural calamity, collapse of building or flyover, railway accident or other accident or incidents (Compensation by Govt)
  • Taxability of compensation on death of a person on account of Life insurance policy taken by the deceased person earlier. (Compensation by Insurance Company)
  • Taxability of Reimbursement of medical expenses on account of medical insurance policies (Compensation by Insurance Company)
  • Taxability of Compensation in case of motor accident claims either on death or disablement (permanent or temporary) of injured person (Compensation by Insurance Company)
  • Taxability in case of Claim for damage of property insured in case of general insurance like car insurance, home insurance, fire insurance, marine insurance etc. (Compensation by Insurance Company)

1) Taxability in case of compulsory acquisition of land (Compensation by Govt)

Generally land or property is compulsory acquired by the Govt for infrastructure development work like construction of flyover, construction of roads, widening of roads etc.

Any income (i.e compensation amount – actual cost of such asset) arising on such compulsory acquisition is taxable under the head capital gain. [Section 45(5)].

However any income arising on compulsory acquisition of agriculture land in India is not taxable rather exempted u/s 10(37) since agriculture land is not included in definition of capital asset u/s 2(14).

Any income arising on account of compulsory acquisition (other than Agricultural land ) is taxable in the year in which the original / enhanced compensation amount is received. However a clause has been inserted via Finance Act 2014 which states that in case of amount received in case of an interim order the amount will be taxable in the year in which final order is made.

Many a time interest is allowed on amount of such compensation or enhanced compensation. Such interest would be taxable as Income from other sources (u/s 56) and 50% of such interest amount is allowed as deduction u/s 57.

For Example- if a person has been awarded an interest of Rs 3 lacs on the amount compensation / enhanced compensation then only Rs 1.50 Lacs is effectively taxable under the head Income from other sources.

2) Taxability of compensation received from Govt on death or disablement due to natural calamity, collapse of building or flyover, railway accident or other accident or incidents (Compensation by Govt)

Due to natural calamities like earthquake, flood etc as well as other accident many people lose their life and it also causes temporary or permanent disablement.

Due to such event the affected person as well as their dependent family members suffers loss of future income and personal loss.

In order to provide financial support to affected families, Govt announces compensation of certain amount to them.

Now question arises whether such compensation is taxable in hands of recipient. The answer is negative (i.e No).

The reason being it’s a capital receipt and it’s not covered under any of the charging section under five heads of Income.

One may argue that if nothing is taxable under a particular head of Income (like capital gain, salary, Business or profession or House property) then it will automatically fall under the residual head i.e “Income from Other Sources” i.e u/s 56 of Income Tax Act 1961.

However any receipt can only be treated as Income only when it’s an income at first instance. Compensation is received 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.

Hence any compensation received from Govt on death or disablement due to natural calamity, collapse of building or flyover, railway accident or other accident or incidents is not taxable in hands of recipient.

Beside it section 10(10BC) specifies that any compensation paid on account of disaster by Govt or local authority is fully exempt from tax.

In this case if any interest is paid on the amount of compensation (for delay in processing of claim of compensation) then the same contains the nature of original compensation and hence is also exempt from tax.

3) Taxability of compensation on death of a person on account of Life insurance policy taken by the deceased person earlier. (Compensation by Insurance Company)

Life Insurance is one of the key investment product all over the world. In life insurance there are basically two types of policies:

  • Term policy
  • Endowment policy

In case of term insurance the amount is paid by Insurance Company only on death of the person. In case the insured person survive during insurance is valid the whole premium amount is forfeited.

In case of endowment policies certain amount is paid on maturity of policy (even if insured person is alive) and in case of death the insured amount is paid upon death.

Any amount received by legal heir from insurance company on death of insured person is fully exempted u/s 10(10D)

However in case of endowment policy payment (other than in case of death) the taxability is explained below:

S.N Criteria of the period of issue of insurance policy Criteria of premium If criteria for payment is met If criteria for payment is Not met
1 The insurance policy issued on or after 1st April 2003 but on or before 31st March 2012 The premium payable, exceeds 20% of the actual capital sum assured, for any of the years (during the term of the policy). Fully exempt Profit portion is taxable (i.e Maturity amount – Investment amount)
2 The insurance policy issued on or after 1st April 2012 The premium payable, exceeds 10% of the actual capital sum assured, for any of the years (during the term of the policy).

In this case there is no interest being paid (instead bonus is paid which forms part of policy proceeds). Bonus is already included in insurance proceeds and treatment of bonus would be in line with insurance proceeds.

4) Taxability of Reimbursement of medical expenses on account of medical insurance policies (Compensation by Insurance Company)

Health Insurance is one of the key product one should include in his portfolio as it protects the person against unforeseen requirement of funds during medical crisis.

In many countries like US medical insurance is mandatory.

In the case of medical insurance there are two types of payment:

  • Cashless policy
  • Reimbursement mode

In cashless the whole bill is directly settled by the medical insurance company to hospitals and insured person need not to pay anything.

In case of reimbursement mode, firstly bill is settled by insured person and then claim is put with insurance company and after verification approved amount is credit to the account of insured person.

The insurance company does not provide any amount in excess of expenditure incurred towards hospitalisation and medical treatment.

As such a transaction does not amount to income or profit for the insured person, and hence not taxable

Beside it on paying medical insurance deduction is available u/s 80D upto Rs 1 lac.

It may be noted that medical reimbursement provided by employer to employee is fully taxable since it is covered within the definition of salary u/s 17. However proviso to sec 17(2) provides that in specified cases (like hospital maintained by employer, medical treatment at approved hospitals etc) medical reimbursement is fully exempt from tax.

Recently via press release dated 25.06.2021, Ministry of Finance has clarified that in case of medical reimbursement by anybody (like relatives, well wishers etc including employer) for COVID treatment received during FY 2019-20 onwards will be fully exempt.

5) Taxability of Compensation in case of motor accident claims either on death or disablement (permanent or temporary) of injured person (Compensation by Insurance Company)

In case of any claim received by a person on account of death or disability on account of motor accident under Motor Vehicles Act, 1988 then the same is not taxable since it’s a capital receipt.

Compensation is received 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.

Now question arises whether interest payable by insurance companies on account of delay in processing of claims is taxable or not.

In various case laws i.e Rupesh Rashmikant Shah. v. UOI (2019) 417 ITR 169 (Bom), National Insurance Company Ltd. v. Savitri Devi (2018) 259 Taxman 579 (HP), CIT v. Oriental Insurance Co. Ltd. (2013) 052 (I) ITCL 106 : (2012) 211 TAXMAN 369 (All) etc it has been decided by court that even if TDS is deducted by the insurance company on the amount of interest then even interest is not a part of income of the recipient and deducting tax at source cannot govern the taxability of the amount which is being paid.

Hence interest received on the amount of compensation (on account of delay in payment of claim amount) is not taxable in hands of recipient.

6) Taxability in case of Claim for damage of property insured in case of general insurance like car insurance, home insurance, fire insurance, marine insurance etc. (Compensation by Insurance Company)

As per section 45(1A) any profit arising on receipt of claim from Insurance company on account of damage or destruction of capital asset would be treated as Capital Gain of the year in which such claim is received.

However any profit on receipt of claim from Insurance company on account of damage or destruction of stock would be treated as Profit and Gains from Business or profession.

Here profit means (Claim amount received – Cost of asset damaged or destroyed) and not whole claim amount received from insurance company.

For example- If a company has lost a machinery due to some fire at plant and WDV of machinery was Rs 10 lacs and compensation received is Rs 12 lacs then Rs 2 lacs will be treated as capital gain. On the other hand if claim amount was only Rs 6 Lacs then Rs 4 lacs will be treated as loss under the head “Capital Gain”.

In case of stock if loss of stock of Rs 10 lacs occurred in FY 2018-19 and claim of Rs 6 lacs is given by Insurance company in FY 2019-20, then in FY 2018-19 whole loss of Rs 10 lacs would be allowed as a trading loss and in FY 2019-20 whole compensation of Rs 6 lacs would be treated as income from Business.

In summary the treatment of compensation from Govt or Insurance company depends on nature of compensation and circumstances in which they  are paid.

Hope readers will find the above information useful.

Author Bio

Qualification: CA in Job / Business
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Location: Mumbai, Maharashtra, India
Member Since: 04 Feb 2018 | Total Posts: 60
I am a working professional having more than 13 years of experience in field of Income Tax, TDS, VAT, Sales tax, GST and accounting. Can be contacted at [email protected] View Full Profile

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