Interest Received on Delayed Compulsory Agricultural Land Acquisition Compensation be Classified as 'Capital Gain': Kerala HC [Read Order]

In a recent ruling, the Kerala High Court has ruled that the interest received on delayed compensation for compulsory agricultural land acquisition will be treated as Capital Gain as it is an accrual to the principal compensation amount. Thus, the court thereby rejected the possibility of treatment of interest on compensation as Income from other sources under Section 56(2)(viii) of the Income Tax Act, 1961.

The bench of Justice A K Jayasankaran Nambiar and Easwaran S. held that “interest amounts received by an assessee in respect of delayed payment of compensation under the LAA will be treated as accruals to the principal compensation amount and be classified as “Capital Gains’ for the purposes of the I.T. Act.”

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The Division Bench considers two appeals, filed by Anvar Ali Poolakkodan and Abdul Azeez Poolakkodan involving the classification of interest received on delayed or enhanced compensation for the compulsory acquisition of agricultural land under the correct head of income.

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In both cases, the assessees had received compensation from the State for agricultural land acquired under the Land Acquisition Act, 1894 (LAA). Upon seeking enhancement of the awarded compensation through reference courts, they were granted not only an enhanced compensation but also statutory interest under Section 28 of the LAA. The assessees declared both amounts under the head "Capital Gains" and claimed exemption under Section 10(37) income tax legislation.

However, the Income Tax Appellate Tribunal (ITAT) held that while compensation and enhanced compensation qualified as ‘Capital Gains’, the interest received was liable to be taxed as ‘Income from Other Sources’ under Section 56(2)(viii) of the Income Tax Act, thus denying exemption under Section 10(37) of the Income Tax Act.

The court, rejecting the tribunal's reasoning, observed the nature and purpose of statutory interest paid under Sections 28 and 34 of the LAA. It noted that interest on delayed compensation is not a mere interest income, but a compensatory payment for the State’s failure to pay the compensation when it fell due. Therefore, such interest partakes the character of the compensation itself.

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The Court further observed that the statutory obligation to pay compensation for compulsory acquisition is rooted in Article 300A of the Constitution, which safeguards a citizen's right to property.

In addition, the court quoted the observation of the apex court in Dharnidhar Mishra (D) & Anr. v. State of Bihar & Ors, where it was pointed out that although the right to property ceased to be a fundamental right by the Constitution (44th Amendment) Act, 1978, it continues to be a human right in a welfare state, and a constitutional right under Article 300A of the Constitution. Accordingly, the State cannot dispossess a citizen of his property except in accordance with the procedure established by law.

With regards to the applicability of Section 56(2)(viii)  Income Tax law, the Court clarified that although the section deals with interest on compensation or enhanced compensation, it need not be presumed to apply automatically to cases involving compulsory acquisition of agricultural land. The key issue is whether the interest in question retains a distinct character or is an accretion to the compensation amount.

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The Court also pointed out that the definition of “interest” under Section 2(28A) of the Income Tax Act does not encompass interest paid as compensation under the LAA. Since the interest in these cases does not fall within the purview of Section 2(28A), Section 56 is not attracted. In its conclusion, the bench observed that “The applicability of Section 56 (2)(viii) will depend upon whether or not, in the particular factual situation, the interest amount can be  treated as different in nature from the principal compensation amount.”

Accordingly, the judgment was ruled in favour of the assessee.

To Read the full text of the Order CLICK HERE

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