Tax Treatment of Interest on Enhanced Compensation

There are certain cases where a person might receive interest on the enhanced compensation received. Such an interest will be treated differently for tax purposes. There are deductions which are available using which the taxpayer can save tax on the interest. It is important to know the provisions so that the taxpayer does not end up paying more taxes or does not claim excess deduction on it.  

In this article we will look into the treatment and taxability of interest on enhanced compensation.  

What is Enhanced Compensation?

Compensation is a monetary consideration received by a person against transfer of goods or provision of services. Enhanced compensation is an additional consideration or an increase in the initial compensation received or agreed upon. 

Interest on Enhanced Compensation and its Taxability

An interest is a charge or penalty for a delay caused in the payment of the compensation. 

Interest on enhanced compensation will be classified under the head Income from Other Source even though it is received against a compensation which is taxed under other heads of income. Such an interest is treated as an income and is taxed in the hands of the taxpayer in the year of receipt i.e., on a cash basis.

For Example: Interest on Enhanced Compensation received by Mr. G during the previous year 2024-25 was Rs. 5,00,000. Out of this Rs. 1,60,000 relates to the previous year 2021-22 and Rs. 2,00,000 relates to previous year 2023-24. What will be the tax implication of the same for Assessment year 2025-26?

The entire interest of Rs. 5,00,000 received by Mr. G will be taxed in 2024-25, as interest is liable to tax in the year of receipt.

Deductions Allowed for Interest on Enhanced Compensation

However, the entire interest received on enhanced compensation will not be subject to tax. The taxpayer has a benefit to claim 50% of the interest received as a deduction under section. In other words, only 50% of the interest received will be taxed.

In the same example of Mr. G, we determined that Rs. 5,00,000 interest on enhanced compensation will be treated as his income for the year and will be tax. But Mr. G will be able to claim 50% of it as a deduction.

Therefore, the taxable interest amount will be as follows:

Therefore, Mr. G will only be liable to tax on Rs. 2,50,000 of the interest on enhanced compensation.

Conclusion

In conclusion, make sure that interest on enhanced compensation is disclosed under the head Income from Other Sources in the year of receipt after claiming a deduction of 50% on it. However, note that this deduction is not applicable under the new tax regime.