Interest on Land Acquisition Compensation: Can It Be Taxed Separately?
ITAT Says Interest Under Section 28 of the Land Acquisition Act Forms Part of Compensation Where the Underlying Land Is Not a Capital Asset
Land acquisition compensation can sometimes come in two parts.
First, there is the compensation for the land.
Then there may be substantial interest awarded under Section 28 of the Land Acquisition Act, 1894.
For a landowner, the question is obvious:
If the compensation is not taxable, can the interest nevertheless be taxed separately as “Income from Other Sources”?
The New Delhi ITAT has recently considered this issue in Akhilesh Bansal and has held that, on the facts of the case, the answer is no.
The Tribunal held that where the underlying land was rural agricultural land outside the definition of “capital asset” under Section 2(14)(iii), the enhanced compensation itself was not taxable under the capital-gains provisions.
More importantly, the Tribunal held that interest awarded under Section 28 of the Land Acquisition Act forms an integral part of the compensation.
Therefore, where the compensation itself is not taxable, such interest cannot be separately brought to tax merely by changing its description to “Income from Other Sources”.
The Numbers Were Substantial
The assessee had received:
Enhanced compensation: approximately ₹2.16 crore
Interest under Section 28: approximately ₹2.24 crore
The interest was therefore even higher than the enhanced compensation itself.
The Revenue sought to examine the taxability of these receipts separately.
The issue ultimately turned on a more fundamental question:
What was the character of the land that had been acquired?
Was the Land a “Capital Asset”?
Section 2(14) defines the expression “capital asset”.
However, the definition specifically excludes certain categories of agricultural land.
One such exclusion covers rural agricultural land which falls outside the prescribed distance from municipal limits and other specified areas, subject to the statutory conditions.
In the present case, the agricultural land was situated beyond the prescribed 8-kilometre distance from municipal limits.
Therefore, the Tribunal held that the land did not fall within the definition of a capital asset under Section 2(14)(iii).
And that finding had significant consequences.
If the Land Is Not a Capital Asset, What Happens to Capital Gains?
The charging provision for capital gains is Section 45.
Broadly, capital gains arise from the transfer of a capital asset.
If the underlying property itself is not a capital asset, the capital-gains machinery cannot simply be applied to the transaction as though it were one.
Therefore, the Tribunal held that Section 45(5), which contains specific provisions relating to compulsory acquisition and enhanced compensation, could not be invoked in respect of the agricultural land in question.
The nature of the land therefore became the foundation of the tax treatment.
This is an important lesson:
Before calculating the tax on compensation, first determine whether the asset that generated the compensation was itself a capital asset.
But What About the Interest?
This was the more interesting part of the case.
The Revenue sought to treat the interest awarded under Section 28 of the Land Acquisition Act as a separate taxable receipt.
The argument effectively treated:
Compensation = one receipt
and
Interest = another receipt
But the Tribunal did not accept this approach.
It relied upon the principles laid down by the Supreme Court in CIT v. Ghanshyam (HUF).
The nature of interest under Section 28 of the Land Acquisition Act has been judicially distinguished from ordinary interest.
It is closely connected with the enhanced compensation payable to the landowner.
Consequently, the Tribunal treated the Section 28 interest as an integral part of the compensation.
Why Section 28 Interest Is Different
This distinction is extremely important.
The word “interest” can sometimes create the impression that every amount described as interest is automatically taxable as interest income.
Tax law, however, looks at the nature and source of the receipt, not merely its label.
Interest under Section 28 of the Land Acquisition Act arises in the context of determination of compensation for compulsory acquisition.
It has a direct connection with the compensation awarded to the landowner.
Therefore, the Tribunal followed the judicial principle that such interest forms part of the compensation rather than being treated as an entirely independent source of income.
A Simple Illustration
Suppose rural agricultural land is compulsorily acquired.
The land qualifies as agricultural land excluded from the definition of capital asset.
The landowner subsequently receives:
Compensation: ₹1 crore
Enhanced compensation: ₹50 lakh
Section 28 interest: ₹60 lakh
If the underlying land itself is outside the capital-gains provisions, the Revenue cannot simply say:
“The land compensation is not taxable, but the ₹60 lakh interest is taxable as other income.”
If the interest is integrally connected with the compensation and forms part of that compensation, its tax character must be examined accordingly.
The label “interest” does not by itself determine the tax treatment.
The Supreme Court’s Ghanshyam Principle
The Tribunal relied upon CIT v. Ghanshyam (HUF), where the Supreme Court examined the character of interest awarded under Section 28 of the Land Acquisition Act.
The decision is important because it recognises the special character of such interest in the context of enhanced compensation.
The Tribunal also considered Satender Kumar v. ITO in reaching its conclusion.
The broader judicial principle is that the nature of a receipt must be determined by examining the statutory framework under which it arises.
The Importance of Section 45(5)
Section 45(5) contains special provisions dealing with capital gains arising from compulsory acquisition.
But these provisions operate in the context of a capital asset.
Therefore, the first question remains:
Is the acquired land a capital asset within Section 2(14)?
If the answer is no, Section 45(5) cannot be mechanically applied simply because the Government compulsorily acquired the property.
This makes the location and character of agricultural land particularly important.
Eight Kilometres Can Make a Big Difference
For owners of agricultural land, the geographical location of the land can have significant tax consequences.
Agricultural land situated beyond the prescribed distance from specified municipal limits may fall outside the definition of capital asset, subject to the conditions of Section 2(14)(iii).
Consequently, compulsory acquisition of such land may not result in taxable capital gains.
But this should never be determined merely by looking at the address.
The statutory test relating to municipal limits, population and prescribed distance needs to be carefully examined for the relevant year.
Don’t Ignore the Land Records
The case also provides an important practical lesson for landowners receiving acquisition compensation.
Before deciding the tax treatment, preserve:
• Revenue records;
• 7/12 extracts and other land records, where applicable;
• Location details;
• Municipal-limit notifications;
• Distance evidence;
• Acquisition notices;
• Original compensation award;
• Enhanced compensation order;
• Computation of compensation;
• Details of Section 28 interest; and
• Bank statements evidencing receipt.
The question of whether land is rural agricultural land can sometimes become the decisive issue.
Proper documentation is therefore essential.
Compensation and Interest Should Be Examined Together
A common mistake is to look at the compensation and interest separately because they appear as separate figures in the award.
Tax analysis should begin differently.
First ask:
What is the underlying asset?
Then:
Is it a capital asset?
Then:
What is the nature of the compensation?
And finally:
What is the legal character of the interest awarded under the Land Acquisition Act?
Only after answering these questions should the taxability be determined.
The Revenue Cannot Tax by Changing the Label
This case also reinforces a broader tax principle.
A receipt does not become taxable merely because it has been given a different description.
If the compensation is not taxable because the underlying land is not a capital asset, the Revenue cannot necessarily create taxability by taking the interest component out of the compensation and calling it “other income”.
The statutory character of the receipt has to be respected.
A Word of Caution
The ruling should not be interpreted as saying that all land acquisition interest is automatically exempt from tax.
That would be far too broad.
The tax treatment depends upon:
• Whether the land is a capital asset;
• Whether it qualifies as rural agricultural land;
• Its location;
• The applicable statutory provisions;
• The nature of the compensation;
• The statutory provision under which interest is awarded; and
• The facts of the particular case.
The distinction between Section 28 interest and interest under other provisions of the Land Acquisition Act can also be significant.
Therefore, the exact award and nature of the receipt should always be examined.
The Bigger Lesson
The case demonstrates an important sequence for taxation of compulsory acquisition compensation:
First determine the character of the land.
Then determine whether it is a capital asset.
Then examine the capital-gains provisions.
Then determine the character of compensation and statutory interest.
Skipping the first step can result in an entirely different tax conclusion.
For a landowner, the question is therefore not merely:
“How much compensation did I receive?”
It is:
“What was acquired, where was it situated, and under which statutory provision was each component of the compensation awarded?”
The Message Is Simple
The Akhilesh Bansal ruling provides significant relief on the facts considered by the New Delhi ITAT.
Where the underlying land was rural agricultural land outside the definition of a capital asset, the enhanced compensation was not taxable under the capital-gains provisions.
And where the interest was awarded under Section 28 of the Land Acquisition Act, the Tribunal held that it formed an integral part of the compensation.
Therefore, it could not be separately taxed as “Income from Other Sources” merely because it was described as interest.
For landowners, the lesson is clear:
Do not determine the taxability of land acquisition receipts merely by looking at the words “compensation” and “interest” on the award.
Examine the land, its location, the acquisition, the statutory provision and the character of each receipt.
Because in taxation, the name on the cheque may tell you what you received-but the statute decides what it really is.
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Case at a Glance
Case: Akhilesh Bansal
Forum: ITAT New Delhi
Issue: Taxability of enhanced land acquisition compensation and interest under Section 28 of the Land Acquisition Act
Enhanced compensation: Approximately ₹2.16 crore
Section 28 interest: Approximately ₹2.24 crore
Nature of land: Rural agricultural land
Location: Beyond the prescribed 8-km distance from municipal limits
Key provisions: Sections 2(14)(iii), 45(5), 10(1) and relevant provisions concerning compensation
Key precedents: CIT v. Ghanshyam (HUF) (SC); Satender Kumar v. ITO
Key finding: Section 28 interest forms an integral part of compensation; where the underlying rural agricultural land is not a capital asset, the compensation and such integral interest cannot be separately brought to tax merely by treating the interest as “Income from Other Sources”.
Disclaimer: This article is intended for general information and awareness purposes and should not be construed as professional advice. The taxability of compensation and interest arising from compulsory acquisition depends upon the nature and location of the land, the statutory provision under which the amount is awarded and the facts applicable to the particular case.
The copy of the order is as under:
