Interest received on enhanced income is to be taxed in the year in which such interest was received – SC

Capital gain is the profit one earns on the sale of an asset like stocks, bonds or real estate. It results in capital gain when the selling price of an asset exceeds its purchase price. It is the difference between the selling price (higher) and cost price (lower) of the asset. Capital loss arises when the cost price is higher than the selling price. The sale of capital assets may lead to capital gains and these gains may attract tax under the Income Tax Act. Section 45 of Income Tax Act, 1961 provides that any profits or gains arising from the transfer of a capital asset effected in the previous year will be chargeable to income-tax under the head ‘Capital Gains’. Such capital gains will be deemed to be the income of the previous year in which the transfer took place.

Compulsory acquisition is the power of government to acquire private rights in land without the willing consent of its owner or occupant in order to benefit society. Compensation against such acquisition is provided to the assessee by the government. On occurrence of such transaction, capital gain is to be computed as per the provisions of Income Tax Act. 

Let us refer to the case of CIT v. Govindbhai Mamaiya (2014), where the issue under consideration was whether interest on compulsory acquisition has to be taxed in year of receipt or is the same to be spread over years on accrual basis?

Facts of the Case:

• The respondents were three brothers. Their father died leaving the land to the three brothers and two other persons who relinquished their rights in favour of the three brothers.
• A part of this bequeathed land was acquired by the State Government and compensation was paid for it.
• On appeal, the compensation amount was enhanced and additional compensation along with interest was awarded
• The respondents filed their return of income for each assessment years claiming the status of ‘individual’.
• Two questions arose for consideration before the Assessing Officer (AO).
• One was as to whether these three brothers could file separate returns claiming the status of the ‘individual’ or they were to be treated as ‘Association of Persons’ (AOP).
• Second question was regarding the taxability of the interest on enhanced compensation and this interest which was received in a particular year was to be assessed in the year of receipt or it could be spread over the period of time.
• The AO had passed the assessment order by treating their status as that of an AOP.

• The AO had also refused to spread the interest income over the years and treated it as taxable in the year of receipt.
• Ultimately, the High Court decided that these persons were to be given the status of ‘individual’ and assessed accordingly and not as AOP and that the interest income was to be spread over from the year of dispossession of land applying the principles of accrual of income.
• In this backdrop, the Revenue has approached the Supreme Court (SC) challenging the decision of the High Court.

Observations of SC on whether the assessee’s were to be assessed as ‘individuals’ or as an ‘AOP’?

• In Meera & Co. v. CIT [1997], SC laid down the basic test to determine a ‘AOP’ as an association formed by volition of the parties for the purpose of generation of income.
• In the case of CIT v. Indira Balkrishna, SC held that “association of persons” meant an association in which two or more persons joined in a common purpose or common action.
• The association must be one the object of which was to produce income, profits or gains.
• The meaning of “an association of persons” was also examined by this Court in the case of G. Murugesan & Brothers v. CIT, (1973).
• It was held in that case that an association of persons could be formed only when two or more individuals voluntarily combined together for certain purposes.
• Volition on the part of the members of the association was an essential ingredient.
• It was further held that even a minor could join “an association of persons” if his lawful guardian gave his consent.

• In the present case, the admitted facts were that the property in question which was acquired by the Government, came to the respondents on inheritance from their father i.e. by the operation of law.
• Furthermore, even the income which was earned in the form of interest was not because of any business venture of the three assessee’s but it was the result of the act of the Government in compulsorily acquiring the said land.
• In these circumstances, the case was squarely covered by the ratio of the judgment laid down in Meera & Company (supra), as it was not a case where any Association of Persons was formed by volition of the parties for the purpose of generation of income.
• This basic test to determine the status of AOP was absent in the present case.

Observations of SC on whether the interest has to be taxed in year of receipt or to be spread over years on accrual basis?

• In Commissioner of Income Tax, Faridabad vs. Ghanshyam (HUF), SC reported in favour of the Revenue.
• In that case, SC drew distinction between the interest earned under Section 28 of the Land Acquisition Act and the interest which is under Section 34 of the said Act.
• SC clarified that whereas compensation given to the assessee of the land acquired would be ‘income’, the enhanced compensation/consideration became income by virtue of Section 45(5)(b) of the Income Tax Act.
• The question was whether it will cover interest and if so, what would be the year of taxability.
• It was held that interest earned under section 28 of the Land Acquisition Act, which was on enhanced compensation, was treated as an accretion to the value and therefore, part of the enhanced compensation/consideration, making it eligible to tax under section 45.
• In that case, SC also held the said interest would be taxed in the year in which it is received.

In conclusion, in assessee’s case, it was not a case where any AOP was formed by volition of parties for purpose of generation of income, these persons were to be given status of ‘individual’ and assessed accordingly and not as AOP. Also, interest received under section 28 of the Land Acquisition Act, 1894, on the enhanced income was to be taxed in the year in which such interest on the enhanced compensation was received and was not to be spread over the period in question.

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