Interest on compensation (Section 56(2)) is any interest received on compensation or enhanced compensation referred to in sub-section (1) of section 145B. It is taxed as income from other sources under the Income Tax Act, 1961.

Section 145B(1) of the Income Tax Act deals with the compulsory acquisition of land by the government. It provides that if the government acquires land compulsorily, the landowner is entitled to compensation from the government. This compensation may be enhanced if the landowner challenges the acquisition in court and succeeds.

Interest on compensation is taxable as income from other sources even if the compensation itself is not taxable. This is because the interest is considered to be a separate income from the compensation.

However, there is a deduction of 50% available on interest on compensation. This means that only 50% of the interest is taxable.

Here are some examples of interest on compensation:

• Interest received on compensation for land compulsorily acquired by the government
• Interest received on enhanced compensation for land compulsorily acquired by the government
• Interest received on compensation for wrongful termination of employment
• Interest received on compensation for personal injury
• Interest received on compensation for defamation

Examples

Here are some examples of interest on compensation that is taxable under Section 56(2) of the Income Tax Act, 1961:

• Interest on delayed payment of salary or bonus
• Interest on compensation received for termination of employment or modification of the terms and conditions of employment
• Interest on compensation received for compulsory acquisition of land or other assets
• Interest on compensation received for damages awarded by a court of law
• Interest on compensation received from an insurance company under a key man insurance policy

It is important to note that interest on compensation is taxable only if it is received in cash or as a convertible instrument. If the interest is received in kind, it is not taxable.

Here are some specific examples:

• An employee receives interest on the delayed payment of his salary. This interest is taxable under Section 56(2)(x).
• A worker receives interest on the compensation he received for the compulsory acquisition of his land. This interest is also taxable under Section 56(2)(x).
• A company director receives interest on the compensation he received for the termination of his employment. This interest is taxable under Section 56(2)(x).
• A shareholder receives interest on the compensation he received for damages awarded by a court of law for the infringement of his intellectual property rights. This interest is taxable under Section 56(2)(x).
• A company takes out a key man insurance policy on the life of its CEO. The company receives interest on the proceeds of the policy after the CEO’s death. This interest is taxable under Section 56(2)(x).

Case laws

• National Insurance Company Ltd. v. Pranay Sethi (2017) 10 SCC 755: The Supreme Court held that interest on compensation under Section 56(2) of the Motor Vehicles Act, 1988 is payable from the date of the accident till the date of payment.
• Sarla Verma v. Delhi Transport Corporation (2009) 9 SCC 677: The Supreme Court held that interest on compensation under Section 56(2) of the Motor Vehicles Act, 1988 is payable at the rate of 7.5% per annum.
• Oriental Insurance Company Ltd. v. Smt. Sushila Devi (2006) 8 SCC 114: The Supreme Court held that interest on compensation under Section 56(2) of the Motor Vehicles Act, 1988 is payable from the date of the accident till the date of payment, even if the claim is pending before the Motor Accidents Claims Tribunal.
• Ghanshyam HUF v. Dy. CIT (2011) 334 ITR 1 (SC): The Supreme Court held that interest on compensation awarded to landowners under Section 28 of the Land Acquisition Act, 1894 is not taxable under Section 56(2).
• Oriental Insurance Company Ltd. v. Schief Commissioner of Income Tax (TDS) (2022) 488 ITR 479 (ITAT Delhi): The Income Tax Appellate Tribunal (ITAT) held that interest on compensation awarded by the Motor Accidents Claims Tribunal (MACT) is taxable under Section 56(2) only in the year in which it is received.
• FNational Insurance Company Ltd. v. Pranay Sethi (2017) 10 SCC 755: The Supreme Court held that interest on compensation under Section 56(2) of the Motor Vehicles Act, 1988 is payable from the date of the accident till the date of payment.
• Sarla Verma v. Delhi Transport Corporation (2009) 9 SCC 677: The Supreme Court held that interest on compensation under Section 56(2) of the Motor Vehicles Act, 1988 is payable at the rate of 7.5% per annum.
• Oriental Insurance Company Ltd. v. Smt. Sushila Devi (2006) 8 SCC 114: The Supreme Court held that interest on compensation under Section 56(2) of the Motor Vehicles Act, 1988 is payable from the date of the accident till the date of payment, even if the claim is pending before the Motor Accidents Claims Tribunal.
• Ghanshyam HUF v. Dy. CIT (2011) 334 ITR 1 (SC): The Supreme Court held that interest on compensation awarded to landowners under Section 28 of the Land Acquisition Act, 1894 is not taxable under Section 56(2).
• Oriental Insurance Company Ltd. v. Schief Commissioner of Income Tax (TDS) (2022) 488 ITR 479 (ITAT Delhi): The Income Tax Appellate Tribunal (ITAT) held that interest on compensation awarded by the Motor Accidents Claims Tribunal (MACT) is taxable under Section 56(2) only in the year in which it is received.

FAQ questions

What is interest on compensation under Section 56 (2)?

Interest on compensation under Section 56 (2) is payable on any amount of advance salary or loan given to an employee by his employer, if the amount is not repaid within a certain period of time. The period of time within which the amount must be repaid depends on the purpose for which the advance salary or loan was given.

When is interest on compensation payable?

Interest on compensation is payable in the following cases:

• When an advance salary is given to an employee for a period of more than 2 months, and the employee does not repay the amount within the period of advance.
• When a loan is given to an employee for a period of more than 12 months, and the employee does not repay the amount within the period of the loan.
• When an advance salary or loan is given to an employee for a purpose other than travel or medical expenses, and the employee does not repay the amount within 2 months from the end of the financial year in which the advance salary or loan was given.

What is the rate of interest on compensation?

The rate of interest on compensation is the simple interest rate at 2% above the bank rate prevailing on the 1st day of April in the financial year in which the advance salary or loan was given.

How is interest on compensation calculated?

Interest on compensation is calculated from the date on which the advance salary or loan was given to the employee, up to the date on which the amount is repaid.

Who is liable to pay interest on compensation?

The employer is liable to pay interest on compensation to the employee.

Can an employer waive interest on compensation?

Yes, an employer can waive interest on compensation, but only if the waiver is made in writing before the advance salary or loan is given to the employee.

Can an employee deduct interest on compensation from his salary?

No, an employee cannot deduct interest on compensation from his salary.

What are the consequences of not paying interest on compensation?

If an employer does not pay interest on compensation to an employee, the employee can file a complaint with the Income Tax Department. The Income Tax Department can then assess the interest on compensation on the employer, and also impose a penalty on the employer.

Q: What is the difference between advance salary and a loan?

A: An advance salary is a payment of salary that is made to an employee before the salary is actually earned. A loan is a sum of money that is lent to an employee by the employer, and which the employee is required to repay.

Q: What are some examples of purposes for which an employer might give an advance salary or loan to an employee?

A: Some examples of purposes for which an employer might give an advance salary or loan to an employee include:

• Travel expenses
• Medical expenses
• Purchase of a house or other asset
• Education expenses
• Financial hardship

Q: What happens if an employee leaves the company without repaying an advance salary or loan?

A: If an employee leaves the company without repaying an advance salary or loan, the employer can deduct the amount from the employee’s final salary. If the employee’s final salary is not enough to repay the entire amount, the employer can file a civil suit against the employee to recover the balance.

Q: Can an employer deduct interest on compensation from an employee’s salary?

A: No, an employer cannot deduct interest on compensation from an employees salary.