The Hindu Business Line : All interests are not equal

SECTION 2 (28 A) of the Income-Tax Act, 1961 defines interest both in an exhaustive and inclusive manner. `Interest' means interest payable in any manner in respect of any monies borrowed or debt incurred (including the deposit, claim or other similar right or obligation) and includes any service fee or other charge in respect of the monies borrowed or debt incurred or in respect of any credit facility which has not being utilised.

A perusal of the definition can indicate no exemption to the rule that all interest is taxable, by whatever name called. Courts have, however, interpreted the term in a way as to limit the meaning to the strict definition and nothing beyond. This is illustrated by the latest ruling of the Punjab and Haryana High Court in CIT vs B. Rai (264 ITR 617).

Rai was a district and sessions judge and claimed a higher pay scale than what was being allowed to him. He went to the High Court with a writ petition and the court was pleased to sanction his request. While passing the order granting higher pay scale the court also ordered payment of interest at 12 per cent per annum from the date of accrual of the amount till the date of actual payment.

The amount of interest thus payable worked out to Rs 1,17,975. In the return filed by Rai, it was claimed that this interest was not in the nature of income. This claim was accepted by the Income-Tax Appellate Tribunal (ITAT). It held that the interest was awarded by the court for loss of arrears of salary, which was property and the element of interest was determined by way of estimating the compensation to be granted for such loss of capital and as such the receipt was a capital receipt in the hands of the assessee.

The Revenue took the matter in reference before the High Court arguing that the interest awarded by the court on the arrears of salary consequent upon grant of higher scale of pay was not within the definition of property and, therefore, the interest was not a payment ordered in the discretion of the court on account of delayed payment of salary to be deposited.

The court considered this contention as incorrect. It pointed out that when interest is paid to an assessee under a statute, such as Section 34 of the Code of Civil Procedure, the same has to be calculated as income for the purpose of income-tax. However, where interest is to be paid in the discretion of the court, the said payment would not amount to income for the purpose of income-tax. Rai was not paid interest under the statute consequent upon grant of arrears of salary on account of higher pay scale. He was, in fact, paid interest in the discretion of the court vested under article 226 of the Constitution. The grant of interest was in absolute discretion of the court and so would be the rate of interest. The court ruled that the interest of Rs 1,17,975 received on arrears of salary after grant of higher is not taxable as income.

Is there any test to be applied in cases of this type to decide what is taxable and what is not? There is a difference between `interest proper' and `damages by way of interest'. If the quality of the claim of interest is compensation, for the reason that the claimant had been deprived of the use of the money and has not had his money at the due date, it would be income in his hands.

It may be regarded either as representing the profit he might have made if he had had use of the money in time, or the loss he had suffered because he had not had the use. If, on the other hand, the claim is for loss of property/ goods or some other injury to capital and the element of interest comes in by way of estimating the compensation to be granted for such capital loss or capital injury, then the receipt would be capital. The mesne profits received for wrongful occupation of property and compensation paid under the Zamindary Abolition Act, are cases in point.

Mesne profits themselves mean compensation in the nature of damages, which the court may mould according to the justice of the case, and will not be taxable. Interest thereon, being an integral part of the mesne profits, will not also be revenue receipt and not taxable as income. The fact that such compensation is estimated with reference to the profits which the person in wrongful possession of such property actually received or would have ordinarily received for the purpose of computation or determination of the compensation will not in any way render them as `income' or a revenue receipt. Courts can differ depending on the facts and interpretation of a case. But this judgment of the Punjab and Haryana High Court appears unexceptionable. Interest on arrears of salary, interest from arbitration claims and similar amounts awarded at the discretion of the court will not be taxable as income.

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