On Thursday the Bombay High Court ruled that income tax should not have been deducted from the interest on the compensation awarded by the court. The ruling was given by a bench of justices Akil Kureshi and S J Kathawalla on a plea by accident victim Rupesh Shah, a PTI report said.

When Shah, a resident of South Mumbai, was 8 years old, a car hit him while crossing the road in 1978. The accident put him in a 6-month coma after which he was told that the incident had left him with permanent brain damage.

His parents approached the Motor Vehicles Accident Claim Tribunal seeking a compensation from Oriental Insurance, the company that had insured the car.

After his plea was allowed, the insurance company went in appeals, first to the high court and then to the Supreme Court, where, in 2015, the Bombay High Court's ruling was upheld that Shah be awarded a compensation of Rs 39.92 lakh. It was also said that Shah (at present 48 years old) be paid interest at the rate of 9 percent on the principal compensation amount since the time he filed the insurance claim.

Shah later received Rs 1.42 crore as compensation in total but it arrived after a 30 percent tax deducted at source (TDS) on the interest amount.

Further, when Shah filed income tax returns, wherein he declared the compensation interest received, he was served with a notice to pay additional tax of Rs 37.97 lakh.

Shah then approached the high court challenging not just the fresh tax notice but also arguing that the department should not have deducted tax on the interest amount that he had received as part of compensation.

Under the Motor Vehicles Act, the principal amount of compensation is not taxable, so the interest accrued on the same should not have been taxed either, he argued.

The interest too was compensatory in nature, its rate decided after taking into account factors such as the passage of time, inflation, etc, he said.

The Income Tax Department, however, contended that the interest being distinct from the principal amount of compensation is taxable as income from an additional source.

On Thursday, the High Court held that the interest earned should not have been considered as income, and therefore, not taxed.

"We hold that the interest awarded in the motor accident claim cases from the date of the claim petition till the passing of the award or in case of appeal, till the judgment of the high court in such appeal, would not be eligible for tax, not being an income," it said.

The bench also said the IT Department assessor made a mistake in issuing the further tax liability notice to Shah. The tax notice was sent back, directing the department to re-assess the same.

With inputs from PTI