“compensatory interest”
The decision most relied on for compensatory interest is Prakash Cotton Mills Pvt. Ltd. v. CIT (201 ITR 684), cited in 133 judgments on BharatTax.
Leading authorities on compensatory interest
Compensatory interest or damages paid for a breach of contract, arising in the normal course of business, are allowable as a deduction under section 37(1) as wholly and exclusively incurred for business purposes. This principle extends to indirect taxes paid in the course of business, which are admissible as business expenditure.
Interest paid on delayed payment of statutory dues, such as sales tax, service tax, TDS, and GST, is compensatory in nature rather than penal. Consequently, such interest is an allowable deduction in computing business profits.
Interest received under Section 28 of the Land Acquisition Act, 1894, forms an integral part of enhanced compensation and is not taxable as "Income from Other Sources" under Section 56(2)(viii) of the Income-tax Act, 1961. The Finance Act, 2009 amendments do not alter the compensatory nature of such interest.
Interest paid under section 201(1A) for delay in remitting tax deducted at source is not an allowable business expenditure and cannot be regarded as a compensatory payment. This interest takes its character from the nature of the tax levy, being a direct tax itself.
Interest levied under Section 201(1A) for delayed remittance of Tax Deducted at Source (TDS) is compensatory in nature, not penal. It is a distinct provision for delayed remittance, similar to interest paid by Revenue on refunds.
Payments that are compensatory in nature, such as interest paid for the delayed payment of statutory dues like cess, are an allowable business deduction under section 37(1) of the Income-tax Act. Such payments are not considered a penalty for an infringement of law.
Interest on arrears of tax is compensatory in nature, not penal, and is therefore an allowable deduction under the Income-tax Act. This decision reversed a previous Full Bench ruling.
Interest under Section 234A cannot be charged when tax has been paid, even if the return of income is filed belatedly, as such interest is compensatory and not penal in nature and only applies if there is a loss caused to the revenue.
