Income-tax on Compulsory Acquisition of Land – A Complete Guide
Compulsory acquisition of land is a subject that brings together law, tax, public policy and personal finance. For most landowners, the acquisition of their property by the Government is not a routine event. It is often sudden, involves large sums of money, and raises immediate questions about financial planning and tax obligations. The most common question is simple: Is the compensation received on compulsory acquisition taxable?
The answer is not the same in every situation. It depends on several factors, such as the law under which the land is acquired, the type and classification of the land, the manner in which compensation is structured, and the eligibility of the landowner for specific exemptions provided under the Income-tax Act.
What Is Compulsory Acquisition?
Compulsory acquisition refers to the process through which the Government, or an authority empowered by the Government, takes private land for a public purpose. Public purpose typically includes projects such as national highways, metro rail systems, airports, railways, water reservoirs, industrial corridors, power infrastructure, and urban development projects.
The defining feature of compulsory acquisition is that the owner does not voluntarily sell the land. Instead, the acquisition happens under a statutory framework, and the owner receives compensation determined through legal procedures. For taxation purposes, this compensation is treated as consideration for transfer of a capital asset, but various special rules govern how and when the tax is levied.
Why the Law Used for Acquisition Matters for Income Tax
There is a common misunderstanding that all compulsory acquisitions are treated the same under the Income-tax Act. In reality, the tax treatment depends significantly on which law was used to acquire the land. Three broad categories exist:
1. Acquisitions made under the Right to Fair Compensation and Transparency in Land Acquisition, Rehabilitation and Resettlement Act, 2013 (commonly known as the RFCTLARR Act).
2. Acquisitions made under State-specific acquisition laws, which several States continue to use for industrial or infrastructure development.
3. Negotiated or consent acquisitions, where landowners execute sale deeds or agreements directly with Government agencies, even though the project is a public purpose project.
Each category has different tax implications, particularly because the RFCTLARR Act contains a specific exemption from income tax, whereas most State laws and consent acquisitions do not.
The RFCTLARR Act and the Income-tax Exemption
Section 96 of the RFCTLARR Act provides one of the most significant tax exemptions available to landowners. It states that no income tax shall be levied on any award or agreement made under the Act.
This means that if the land is compulsorily acquired under the RFCTLARR Act, the entire compensation becomes exempt from income tax. This exemption applies not only to the base compensation, but also to every component of the award, including:
– Solatium
– Multiplying factor or market value enhancement
– Additional market value
– Rehabilitation and resettlement (R&R) benefits
– Enhanced compensation received through court orders
The Central Board of Direct Taxes (CBDT), through Circular No. 36/2016, confirmed that all compensation received under the RFCTLARR Act is exempt from income tax. This exemption also overrides the provisions of the Income-tax Act, ensuring complete relief to landowners where RFCTLARR applies.
However, this exemption is available only when the acquisition is legally carried out under the RFCTLARR Act. If the award or acquisition notification does not cite the RFCTLARR Act, or if the compensation is paid through a negotiated sale deed, the exemption cannot be claimed merely because the compensation formula resembles that of RFCTLARR.
When RFCTLARR Does Not Apply
Not all acquisitions in India are carried out under the RFCTLARR Act. Several States use their own acquisition statutes for special projects. In other situations, landowners voluntarily execute sale deeds after negotiations with Government agencies, even though the underlying project is a public purpose project.
In such cases, the RFCTLARR exemption under Section 96 does not apply. Instead, the taxability is determined under the Income-tax Act based on the type of land and the nature of the compensation.
Tax Treatment Under the Income-tax Act When RFCTLARR Exemption Is Not Available
The Income-tax Act contains its own provisions for compulsory acquisition. These rules apply when the RFCTLARR exemption does not cover the transaction.
Rural Agricultural Land
Rural agricultural land is not treated as a capital asset under Section 2(14). As a result, any capital gain arising from its transfer, including compulsory acquisition, is completely exempt from tax.
The exemption applies regardless of whether the compensation is received through an award or a sale deed, and regardless of which acquisition law is used. This is one of the most favourable categories for landowners.
Urban Agricultural Land
Urban agricultural land is treated as a capital asset. However, Section 10(37) of the Income-tax Act provides an exemption for compulsory acquisition of such land, subject to the following conditions:
- The land must be used for agricultural purposes during the two years immediately preceding the acquisition.
- The owner must be an individual or an HUF.
- The acquisition must be compulsory.
- The compensation must be received on or after 1 April 2004.
When these conditions are satisfied, the capital gain arising from compulsory acquisition becomes fully exempt. This exemption applies even when the acquisition is not under the RFCTLARR Act.
Non-Agricultural Land
When the land compulsorily acquired is non-agricultural in nature (for example, residential plots, commercial land, industrial land or vacant sites), the compensation is taxable as capital gains unless a specific exemption is available.
The taxable capital gain is calculated based on the indexed cost of acquisition and the compensation amount received. If the land was held for more than 24 months, the gain is treated as a long-term capital gain and qualifies for indexation benefits.
Landowners may also reduce or eliminate tax liability by reinvesting the capital gain or the net consideration under the provisions of Sections 54, 54F or 54EC, depending on the nature of the asset and the reinvestment made.
Special Rules for Compulsory Acquisition under Section 45(5)
Section 45(5) contains special rules for computing capital gains arising from compulsory acquisition:
- Capital gain is taxed in the year in which compensation is received, even if the possession or acquisition occurred earlier.
- Any enhanced compensation awarded by a court, tribunal or authority is also taxed in the year of receipt.
- If the enhanced compensation is later reduced, provisions are available for rectification and refund.
These rules ensure that taxpayers are not burdened with tax liability before receiving compensation.
Taxability of Interest and Additional Amounts
Different types of interest are payable depending on the acquisition law. Their tax treatment varies:
- Interest under Section 28 of the old Land Acquisition Act is considered part of the compensation and is taxable as capital gains (unless RFCTLARR applies).
- Interest under Section 34 of the old Act is treated as income from other sources.
- The 12 per cent additional amount under the RFCTLARR Act is not interest; it forms part of compensation and is exempt when RFCTLARR applies.
Understanding the nature of interest is critical for correct tax reporting.
TDS Under Section 194LA
Section 194LA requires the Government or acquiring authority to deduct TDS at 10 per cent when paying compensation for compulsory acquisition of land or building.
However, TDS is not applicable in the following situations:
- When the acquired property is agricultural land.
- When compensation is awarded under the RFCTLARR Act.
- When the total compensation payable during the financial year does not exceed the prescribed threshold.
If TDS is deducted erroneously, the landowner must claim refund through the Income-tax Return.
Reinvestment Options to Reduce or Avoid Capital Gains Tax
Landowners whose compensation is taxable may consider the following reinvestment options to reduce or eliminate tax liability:
- Section 54F: Investment in a residential house when a long-term capital asset (other than a house) is transferred.
- Section 54EC: Investment in NHAI or REC bonds within six months of receipt of compensation, subject to a monetary limit.
- Section 54: Available when a residential house is transferred and the proceeds are reinvested in another house.
- Section 54B: Available when agricultural land is transferred and new agricultural land is purchased.
These provisions require careful timing and documentation, but they offer significant tax savings.
Documentation Required for Correct Tax Treatment
For correct reporting and to defend the claim during assessment or scrutiny, landowners should maintain:
- Copy of acquisition notification or award
- Compensation statement and break-up
- Sale deed (if negotiated settlement)
- Land classification records, such as Patta, Chitta or Adangal
- Proof of agricultural operations (if claiming Section 10(37))
- Orders relating to enhanced compensation
- Proof of reinvestment for claiming exemptions
Compulsory acquisition of land can have different income-tax outcomes depending on the acquisition law, the nature of the land, and the reinvestment decisions of the landowner. If the acquisition is carried out under the RFCTLARR Act, the entire compensation becomes tax-free due to Section 96 of that Act and the corresponding CBDT circular.
If RFCTLARR does not apply, rural agricultural land remains fully exempt, urban agricultural land may qualify for exemption under Section 10(37), and non-agricultural land may be taxable as capital gains unless reinvestment exemptions are utilised.
Being aware of these rules helps landowners plan their finances effectively and avoid unexpected tax liabilities.
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