Enhanced compensation and land acquisition interest are analysed by reference to capital gains and accounting method for taxability.

Enhanced compensation received on acquisition is examined under the capital gains provisions, with the article noting that section 45 applies only where the statutory conditions for transfer and accrued gains are met; on the facts discussed, sections 45(5)(b) and 155(7A) were said not to apply, so the enhanced compensation was not taxable for the relevant assessment year. Interest income is then distinguished by source: interest under section 28 of the Land Acquisition Act is treated as compensation, while interest under section 34 depends on the assessee's method of accounting. Where the cash system is followed, tax is attracted on receipt, and the interest received during the year is taxable accordingly.

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Issues: (i) Whether enhanced compensation received on acquisition of land was chargeable to capital gains tax for the assessment year in question. (ii) Whether interest received on the enhanced compensation was taxable on the basis of the assessee's method of accounting. (iii) Whether interest under section 28 of the Land Acquisition Act, 1894 differed in tax treatment from interest under section 34 of that Act.

Issue (i): Whether enhanced compensation received on acquisition of land was chargeable to capital gains tax for the assessment year in question.

Analysis: Chargeability under section 45 of the Income-tax Act, 1961 depends on a transfer of a capital asset and the arising of profits or gains from that transfer. The land had been acquired in an earlier year, and the later receipt was only enhanced compensation. Section 45(5)(b) and section 155(7A) could not be applied to the assessment year involved, as section 45(5) was inserted prospectively from 1 April 1988 and section 155(7A) did not cover the assessee's situation for the relevant year.

Conclusion: Enhanced compensation was not taxable as capital gains for the assessment year 1985-86.

Issue (ii): Whether interest received on the enhanced compensation was taxable on the basis of the assessee's method of accounting.

Analysis: For interest under section 34 of the Land Acquisition Act, 1894, the decisive question was the method of accounting regularly followed by the assessee. Under section 145 of the Income-tax Act, 1961, income is brought to tax according to the adopted system of accounting. No material showed that the assessee had been offering the interest income on accrual basis in earlier years; therefore, the assessee was treated as having followed the cash system for this source of income. On that basis, the interest received during the relevant assessment year was taxable on receipt.

Conclusion: Interest under section 34 was taxable in the year of receipt.

Issue (iii): Whether interest under section 28 of the Land Acquisition Act, 1894 differed in tax treatment from interest under section 34 of that Act.

Analysis: Interest under section 28 partakes of the character of compensation and follows the same tax treatment as enhanced compensation. Interest under section 34 is distinct and depends upon the assessee's method of accounting for taxation in the year of receipt.

Conclusion: Interest under section 28 was to be treated as compensation, while interest under section 34 was taxable according to the accounting method followed.

Final Conclusion: The reference was answered by holding that enhanced compensation was not liable to capital gains tax for the relevant assessment year, but interest on the compensation was taxable to the extent it was received under the applicable accounting method.

Ratio Decidendi: Enhanced compensation received after acquisition is not taxable under capital gains provisions unless the statutory mechanism specifically applicable to that period governs the assessment, while interest under the land acquisition law is taxable according to the character of the interest and the assessee's regularly followed method of accounting.

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