Salaried vs Self-Employed Income ITR: This SC ruling lays down key rules for motor accident compensation calculation

The Supreme Court has laid down uniform guidelines for calculating the annual income of deceased victims in motor accident compensation cases, drawing a clear distinction between salaried employees, self-employed individuals and those who did not file their income tax returns (ITRs). This crucial ruling, issued on July 1, seeks to standardise how Motor Accident Claims Tribunals (MACTs) -- or special courts that decide compensation in auto accident cases -- calculate road accident compensation.

Here's everything to know about this ruling in key points:

A two-judge apex court bench, comprising justices Sanjay Karol and N Kotiswar Singh, held that income tax refunds serve as statutory records and claimant income should be determined based on their sources of earnings.

The judges said that salaried employees' and self-employed persons' incomes cannot be gauged by using the same method.

Self-employed vs Salaried Income: A distinction must be drawn

While salaried employees' income should ordinarily be assessed using the latest ITR, self-employed individuals' should ideally be evaluated based on the average income reflected in their ITRs for up to three years, the bench ruled.

The bench observed that there is no "straitjacket formula" under the Motor Vehicles Act for assessing income and tribunals must adopt different approaches for salaried and self-employed individuals because of the nature of their earnings.

The court was hearing an insurer's appeal against a high court order that calculated compensation based on the deceased's highest income tax return from the preceding five years.

How will the new calculation work as per Supreme Court-laid guidelines?

Here's a summary of what the two-judge bench said:

Salaried employees: The court noted that tribunals should ordinarily rely on the ITR for the immediately preceding assessment year, noting that it generally reflects components like the latest salary, promotions and annual increments. If a recent promotion is not captured in the ITR, courts may consider promotion letters and other financial records.
Self-employed individuals: It ruled that courts should ordinarily calculate income by taking the average of ITRs for up to three years (since business earnings can vary from time to time depending on market conditions).

Special considerations

What happens when there is limited ITR history? Where only one or two ITRs are available, or income varies sharply between years, tribunals may consider surrounding circumstances before arriving at a fair assessment, said the bench.

What if business-related factors are present? In such cases, aspects that must be examined include:

• The nature and location of the business
• Its growth pattern
• Earning potential
• Capital-intensive initial years
• The impact of the victim's death on business operations

Will there be any flexibility from a case to case basis? The bench noted that tribunals should retain flexibility and evaluate evidence based on the facts of each case instead of following a common and rigid formula.

It was brought to the court's notice that authorities were adopting inconsistent approaches to calculate compensation under the Motor Vehicles Act -- the main law governing road transport in the country.

The apex court said that calculations against the deceased's highest ITR from the last five years could artificially inflate compensation and, in fact, place an unfair burden on insurers.

It concluded that separate methods were necessary to ensure fair, realistic and consistent compensation awards across the country, adding that salaried income generally remains stable while business income often fluctuates.

What will happen if there are unusual gains or no ITR is filed? The court said that tribunals are not bound to mechanically rely on ITRs in every case.

If a particular year's tax return reflects extraordinarily high income due to a one-time event -- due to reasons like the sale of property -- or unusually low income -- because of rare business losses, then tribunals may depart from the ITR while recording reasons, said the bench.

For claimants who did not file ITRs, compensation claims will not automatically fail. In such cases, tribunals may rely on Form 26AS, salary slips, bank statements and other reliable financial records to determine income. But courts must clearly explain why these documents were accepted instead of ITRs.

The bench also noted that variations and fluctuations in business income should be viewed taking into account aspects like the nature of business, growth trajectory, future prospects and the effect of the victim's death on the enterprise.

Guidelines notified to tribunals

To ensure implementation uniformity, the top court directed its registry to circulate the guidelines to Motor Accident Claims Tribunals as well as high courts across the country.

These directions will apply to both pending and future compensation cases.