Imagine owning a piece of land for years — perhaps ancestral property or a small plot near a highway — and suddenly receiving a government notice that it will be acquired for a public project. While the government’s move may serve a broader purpose, it can also leave landowners wondering: Will I be taxed on the compensation I receive?
To address this, the Income Tax Act, 1961 clearly defines how compensation for compulsory acquisition is treated. The governing rule lies in Section 45(5), which deals with capital gains arising from compulsory acquisition of land or buildings. The law ensures that taxpayers receive fair tax relief & aren’t burdened unfairly when their property is taken for public use.
What Is Compulsory Acquisition?
Compulsory acquisition means when the government legally takes ownership of private land for public purposes — such as infrastructure, roads, or defense projects — even if the owner doesn’t wish to sell. The Right to Fair Compensation and Transparency in Land Acquisition, Rehabilitation and Resettlement Act, 2013, regulates how compensation is determined.
But when it comes to taxation, the Income Tax Act steps in to define when & how these amounts are taxed. Unlike normal property sales, a compulsory acquisition isn’t a voluntary transaction. Hence, the Act provides special provisions to ensure fair & consistent tax treatment.
Relevant Income Tax Section – Section 45(5)
Under Section 45(5) of the Income Tax Act, capital gains arising from a compulsory acquisition of capital assets (like land or buildings) are chargeable to tax in the year in which compensation is received — not when the acquisition happens. This small shift makes a big difference. Since legal disputes or delayed payments are common in such cases, the law taxes the gain only when the taxpayer actually receives the compensation, not merely when the acquisition is notified.
So, even if your land is taken in 2023 but you get paid in 2025, your capital gain is taxable in FY 2024–25.
Components of Compensation
When the government acquires land, the landowner may receive several types of compensation. The Act recognises all of them:
- Initial compensation – The first payment received when land is taken.
- Enhanced compensation – Extra amount granted later by a court or authority after appeal."
- Interest on compensation – Interest paid for the period of delay in payment.
Section 45(5)(b) states that enhanced compensation is also treated as capital gains in the year it is received, ensuring that every part of the payout is appropriately taxed.
Also Read: Save Capital Gains Tax by Investing in Bonds
How Capital Gains Are Calculated
Capital gain = Compensation received – Indexed cost of acquisition
The cost of acquisition refers to the price at which the land was originally bought (adjusted for inflation using the Cost Inflation Index). If the property was inherited, the previous owner’s cost is considered.
For example, if your land acquired by the government was purchased in 2005 for ₹3 lakh & compensation of ₹15 lakh is received in 2024, the indexed cost may be around ₹8 lakh. The capital gain would then be ₹7 lakh, taxable as long-term capital gain (LTCG).
However, the story doesn’t end here — some acquisitions are fully exempt from tax.
Exemption Under Section 10(37)
To reduce hardship, Section 10(37) provides complete exemption from capital gains tax in specific cases. This section offers tax relief to taxpayers who receive capital gains from compulsory acquisition if the following conditions are met:
- The land must be agricultural land located in an urban area.
- It must have been used for agricultural purposes for at least two years before acquisition.
- Compensation should be received on or after April 1, 2004.
- The acquisition should be under any law relating to compulsory acquisition.
If all conditions are satisfied, the entire gain is tax-free.
In short, if your agricultural land is acquired by the government against any compulsory acquisition, & you receive fair compensation, you do not have to pay tax on it.
How Non-Agricultural Land Is Taxed
For non-agricultural land, such as commercial plots or residential properties, the capital gain is taxable in the year of receipt.
- Long-term gain (held for >24 months): Taxed at 20% with indexation benefits.
- Short-term gain (held ≤24 months): Taxed at normal income-tax slab rates.
But even here, certain capital gains exemptions under Sections 54, 54F, or 54EC may apply if you reinvest the proceeds in another property or specific bonds.
Special Reliefs for Enhanced Compensation
If you appeal for higher compensation & the court grants additional payment later, that enhanced amount is again taxed as capital gains — but separately in the year you receive it. However, the law allows taxpayers to adjust for legal expenses incurred during appeal or litigation. Interest received on delayed payment is taxed under “Income from Other Sources,” not as part of capital gains.
This separation prevents double taxation & gives clarity to landowners who receive multiple payments over the years.
Also Read: Save Tax on Capital Gains by Investing in a Residential House
Section 96 of the Land Acquisition Act – No TDS
An important point for landowners: compensation paid under the Right to Fair Compensation & Transparency in Land Acquisition Act, 2013, is fully exempt from TDS. This means that the government cannot deduct tax at source before paying compensation for compulsory acquisition of land.
The logic is simple — if the income is exempt or deferred under Section 10(37) or Section 45(5), no advance tax deduction should occur.
Example to Understand the Process
Let’s say Mr. Sharma owned 2 acres of agricultural land near Delhi, which the government acquired for building a highway.
- Original purchase cost: ₹5 lakh (in 2007)
- Compensation received: ₹40 lakh (in 2024)
- Type of land: Agricultural
- Purpose: Compulsory acquisition for public project
Since the land was used for agricultural purposes & acquired under the government’s notification, Section 10(37) applies. Hence, the entire capital gain is tax-free.
However, if it were non-agricultural land, Mr. Sharma would be liable to pay long-term capital gains tax on ₹35 lakh after applying indexation benefits.
Government’s Role and Fairness Intent
The purpose of these provisions is not just to collect taxes but to ensure fairness. When the government takes away private property for public projects, it compensates fairly — and the Income Tax Act ensures that people aren’t unfairly penalised through immediate tax on such compensation.
It balances public need with individual rights — acknowledging that compulsory acquisition is not a voluntary gain but a forced transaction.
Common Mistakes Landowners Make
- Failing to report enhanced compensation in the correct year.
- Confusing interest with compensation (they are taxed differently).
- Missing the exemption under Section 10(37).
- Not applying for Section 54 or 54F exemption when reinvesting proceeds.
Proper documentation — including land records, compensation orders, and bank credit proofs — ensures smooth tax treatment & avoids scrutiny.
Interconnection with Other Tax Provisions
Like other tax-saving sections, the law ensures relief is targeted & justified. Just as the Income Tax Act allows for deductions while computing taxes for expenses relating to scientific research, it also provides relief in cases of compulsory acquisition. Both aim to encourage fairness & national development — one through innovation, the other through infrastructure.
It also aligns with the broader principle that tax should not punish compliance or public contribution.
Also Read: Capital Gain Exemption on Sale of Agricultural Land
Judicial Support and Clarity
Courts have consistently upheld that the taxable event in compulsory acquisition arises only when the compensation is received, not when the land is taken. This clarity ensures predictability for taxpayers, especially when cases stretch across years.
Rulings by the Supreme Court and High Courts have reinforced that enhanced compensation & interest must be reported in separate years, bringing much-needed consistency.
Practical Tips for Taxpayers
- Keep copies of acquisition notices, award letters, and court orders.
- Verify if your land qualifies as “agricultural” under Section 10(37).
- Use exemptions like Section 54 or 54EC for reinvestment benefits.
- Consult a CA for tax computation when compensation spans multiple years.
Small planning steps can save thousands in taxes while keeping you compliant.
Final Thoughts
The compulsory acquisition of land by government income tax section reflects a fair balance between public interest & nindividual rights. It offers tax relief to taxpayers who receive capital gains and ensures that landowners are not overtaxed when their property is taken for national development. Whether through Section 45(5) (tax on receipt basis) or Section 10(37) (exemption for agricultural land), the law ensures that compensation is taxed only when it becomes real — not when it is promised.
If your land has been acquired by the government & you’re unsure about how to handle the compensation or claim exemptions, visit CallMyCA.com. Our tax professionals can help you understand eligibility, calculate capital gains, and file your return correctly — ensuring you claim every exemption you deserve.
