Interest received on ‘Compensation or on Enhanced Compensation’ – Whether ‘Income’ or Not?
The statutory provisions for the income in the nature of ‘Interest received on compensation or on enhanced compensation’ were brought to Income Tax by the Finance Act’ 2009. When these provisions were introduced, the Memorandum explaining the provisions of the Finance Bill 2009 had this to say:
‘’Rationalization of provisions for taxation of interest received on delayed compensation or enhanced compensation
The existing provisions of Income-tax Act provide that income chargeable under the head “Profits and gains of business or profession” or “Income from other sources”, shall be computed in accordance with either cash or mercantile system of accounting regularly employed by the assessee. Further, the Hon’ble Supreme Court, in the case of Rama BaiVs. CIT (181 ITR 400) has held that arrears of interest computed on delayed or enhanced compensation shall be taxable on accrual basis. This has caused undue hardship to taxpayers.
With a view to mitigate the hardship, it is proposed to amend section 145A to provide that the interest received by an assessee on compensation or enhanced compensation shall be deemed to be his income for the year in which it is received, irrespective of the method of accounting followed by the assessee. Further, it is proposed to insert clause (viii) in sub-section (2)of section 56 to provide that income by way of interest received on compensation or on enhanced compensation referred to in sub-section(2) of section 145A shall be assessed as “income from other sources” in the year in which it is received. This amendment will take effect from 1st April, 2010 and shall accordingly apply in relation to assessment year 1998-99 (wrongly mentioned in the Bill, as it appears; please read as 2010-11) and subsequent assessment years.’’
ANALYSIS OF SECTION 145A
The amendment by way of insertion of Clause (b) in Section 145A deals with the point of time when an income is to be taxable. It does not bring to tax an income which was, until the point of time when amendment was made, not taxable earlier. Section 145A, it is important to bear in mind, deals with the method of accounting on cash or mercantile basis which again has its focus on the POINT OF TIME(Emphasis given) when an income is taxable rather than taxability of income itself. When an income is not taxable, section 145A has no relevance. It is in this backdrop that we can take a look at Section 145A which is as follows:
Section 145A: Method of accounting in certain cases—
Notwithstanding anything to the contrary contained in section 145,—
(a)…………………………..(not relevant for our purposes)
(b) 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 145A starts with a non-obstante clause which restricts the scope of Section 145 dealing with the method of accounting. It is not a CHARGING PROVISION. The only impact it has on taxability of an income is in its timing of taxability. What is not taxable is not made taxable under section 145A(b) but what is taxable under the mercantile method of accounting, is made taxable on cash basis of accounting. Nothing else needs to read into this provision, and the memorandum explaining the provision of Finance Bill 2009, as reproduced earlier, makes that amply clear.
ANALYSIS OF SECTION 56(viii)
As for the provisions of Section 56(2)(viii), it is only an ENABLING PROVISION, as unambiguously made clear in the above memorandum as well, to bring interest income to tax in the year of receipt rather than in the year of accrual.
Section 56(2)(viii) provides that……
’’INCOMES (Emphasis given), shall be chargeable to income tax under the head ‘income from other sources’, namely ….(viii) income by way of interest received on compensation or enhanced compensation referred to in clause (b) of Section 145A”.
The starting point of this exercise is ‘income’, and it is only when the receipt is in the nature of an income, that the classification of income under a particular category arises. In other words, when interest received by the assessee is in the nature of income, such interest can be taxed under section 56 (2)(viii). Section 56(1) makes this aspect even more clear when it states that “Income of every kind, which is not to be excluded from the total income under this Act, shall be chargeable to income tax under the head “income from other sources”, if it is not chargeable to income tax under any of the heads specified in Section 14, items A to E”, and then, in the subsequent provision, i.e. Section 56(2), proceeds to set out an illustrative, rather than exhaustive list of, such “incomes”. Clearly, unless a receipt is not an income, there is no occasion for the provisions of Section 56(1) or 56(2) coming into play. Section 56 does not decide what an income is. What it holds is that if there is an income, which is not taxable under any of the heads under Section 14, i.e item A to E, it is taxable under the head ‘income from other sources’. The receipt being in the nature of income is a condition precedent for Section 56 coming into play, and not vice versa. To suggest that since an item is listed under section 56(2), even without there being anything to show that it is of income nature, it can be brought to tax is like putting a cart before the horse.
WHAT SECTION 4 AND SECTION 14 SAYS
Section 4 is the charging section in Income Tax which reads as under:
Charge of income-tax.
4. (1) Where any Central Act enacts that income-tax shall be charged for any assessment year at any rate or rates, income-tax at that rate or those rates shall be charged for that year in accordance with, and subject to the provisions (including provisions for the levy of additional income-tax) of, this Act in respect of the total income of the previous year of every person:
Provided that where by virtue of any provision of this Act income-tax is to be charged in respect of the income of a period other than the previous year, income-tax shall be charged accordingly.
(2) In respect of income chargeable under sub-section (1), income-tax shall be deducted at the source or paid in advance, where it is so deductible or payable under any provision of this Act.
Section 14 speaks about classification of Incomes under five different heads. It reads as under:
Heads of income.
14. Save as otherwise provided by this Act, all income shall, for the purposes of charge of income-tax and computation of total income, be CLASSIFIED under the following heads of income:—
C.—Income from house property.
D.—Profits and gains of business or profession.
F.—Income from other sources.
INTEREST GRANTED UNDER STATUTORY PROVISIONS, GRANTED BY COURTS
There could be situations where interest on compensation or on enhanced compensation is either granted under the statutory provisions (like in the case of compulsory land acquisition) or granted by Courts (viz. in case of motor vehicle accident). Tax treatment will be different in both the given cases. Whereas the former is taxable, the latter being a capital receipt, outside the scope of ‘Income’ and hence not taxable.
i) Granted under Statutory Provisions
Honourable Apex Court in the case of CIT VrsGhanshyam HUF(2009) 315 ITR 1 has held that Interest awarded u/s 28 of Land Acquisition Act, 1894 is nothing but an accretion to the value of compensation and hence it is part and parcel of compensation. Thus taxability of such interest is of Capital nature and should be included to Consideration received for the purpose of computation of Capital Gain u/s 45 of Income Tax Act, 1961.
ii) Granted by Courts
Hon’ble Punjab & Haryana High Court, in the case of CIT Vs B Rai [(2004) 264 ITR 617 (P&H)], draws a line of demarcation between the interest granted under the statutory provisions and interest granted under discretion of the court, and holds that the latter is outside the scope of ‘income’ which can be brought to tax under the Income Tax Act, 1961. As their Lordships stated, in so many words, “where interest………is to be paid is in the discretion of the court, as in the present case, the said interest would not amount to ‘income’ for the purposes of income tax”.
In the case of CIT Vs Oriental Insurance Co Ltd [(2012) 211 Taxman 369 (All)], Hon’ble Allahabad High Court has, inter alia, held that “To our opinion, the award of compensation under motor accidents claims cannot be regarded as income. The award is in the form of compensation to the legal heirs for the loss of life of their bread earner. Hence the interest on such an award cannot be termed as income to the legal heirs or to the victim himself”. Essentially, this conclusion supports the school of thought that when principal transaction, i.e. accident compensation for the delayed payment of which the interest is awarded, itself is outside the ambit of taxation, similar fate must follow for the subsidiary transaction, i.e. interest for delay in payment of compensation, as well.
Hon’ble Supreme Court has, in the case of Padmaraje R. Kadambande vs. CIT [(1992) 195 ITR 877 (SC)], observed that, “….we hold that the amounts received by the assessee during the financial years in question have to be regarded as capital receipts and, therefore, are not income within meaning of s. 2(24) of the Income Tax Act.” [Emphasis supplied].
This clearly implies, as is the settled law, that a capital receipt, unless specifically taxable under section 45 under the head Capital Gain, in principle, is outside the scope of ‘income’ chargeable to tax and a receipt cannot be taxed as income unless it is in the nature of a revenue receipt or is specifically brought within ambit of ‘income’ by way of specific provisions of the Income Tax Act.
Section 2(24) defines ‘Income’. It’s an inclusive definition. Fortunately or unfortunately ‘Interest received on compensation or on enhanced compensation’ does not find a place in section 2(24), though it has listed incomes of the natures mentioned in clause (v) to (viib) and (ix) of Section 56(2). On a plain reading of Section 56(2)(viii) and Section 145A, it appears that such receipts are taxable.In my humble opinion, such receipts are outside the purview of these sections in view of the reasons discussed herein above.
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