Subsidy under Income Tax Act – ‘Whether a Privileged Tax’

The word `Subsidy’ is a word of pivotal importance and finds a mention in the American Heritage Dictionary of the English Language which quantifies it as `Monetary-assistance granted by a government to a person or group in support of an enterprise regarded as being in the public interest.’ Even since the dawn of mankind, there has been purposive and patent support extended from different quarters of the executive to raise the standard and channelize that section of society which can inaugurated and intensively contribute to meet the ever increasing requirements and desideratum of the society. But with the passage of time and coming into force the very advent of the stringency attributable to the tax laws, there had been a growing controversy in whether to classify the subsidy under reference as a capital receipt not exigible to tax or a case of revenue receipt to be taken into the clutch of taxability under the Income Tax Act, 1961. There has been consistent debates and dissension over the issue of its relative taxability but the assessees trying to have an edge over the grey area in force while the department continuously pressing for the requirements of bringing the same under the umbrella of tax net thereby leading to an apple of discord between the two sides. Whether the concessional receipt would be brought within the purview of tax as the same has been advanced for the purposes of stimulating and incrementing the profit earning capacity of business entities or to encourage and invigorate the very tenants of setting up industrial units in low profile areas, all has been a sphere subject to massive litigation.

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`Subsidy’, `Assistance’, `Grant’, `Cash Incentive’ or `Duty Drawback’ by whatever name designated is a paramount source of receipt and has been subjected to various ifs and buts of the taxing norms. Whether such chief and vital source of receipt is attributable towards the profit making activity of the business entity or towards capacity building and utility expansion has been the bone of contention. The issue having passed through the judicial scrutiny in a plethora of cases adjudicated and settled upon by the seats of various High Courts including that of the Hon’ble Supreme Court of India has entailed a consequential amendment in the Finance Act, 2015 with effect from 01/04/2016 which ultimate culminated into the taxing belt with the due insertion of Sub-Clause (xviii) in Section 2(24) of the Income Tax Act, 1961 providing an inclusive definition of the expression `Income’ under the taxing law. The relevant portion of Sub-Clause (xviii) is produced below:-

`2(24)(xviii) assistance in the form of a subsidy or grant or cash incentive or duty drawback or waiver or concession or reimbursement (by whatever name called) by the Central Government or a State Government or any other authority or body or agency in cash or kind to the assessee other than the subsidy or grant or reimbursement which is taken into account for determination of the actual cost of the asset in accordance with the provisions of Explanation 10 to clause (1) of section 43.

The consequential amendment in the statutory provisions certainly calls for enforcing the very taxability of the subsidy or concessional grants received whether from Central Government, State Government or any other constituted body, authority or agency thereby putting to rest all the major and cardinal issues governing its taxability with taking into consideration the effect of the due clarification issued by the Central-Government that, `LPG subsidy will not be subject to the rigors of taxability as it is for the wellbeing and welfare of the public at large’. On numerous occasions where the effect of the subsidy stood credited in the books of accounts, the intention of the revenue was to pave way for its taxability under the charter of Income Tax Act, 1961, since there seemed to be an element of voluntary declaration by the assessee which could further be not abandoned under the garb of the sanctity owing to the particulars reposed and reflected before the Income Tax Authorities. The issue was no longer res-integra and it was settled by the Hon’ble Supreme Court of India way back in 1968 in a case titled Commissioner of Income Tax vs. India Discount Company Limited, Civil Appeal No.2115 of 1968 [75 ITR 191 SC], ” But it is well established that a receipt which in law cannot be regarded as income cannot become so merely because the assessee erroneously credited it to the profit and loss account..

But despite the Supreme Court dictum in force, there still remains a vacuum and void to be filled later under the aegis of assorted decisions leading to the inference of `Subsidy’ whether being a capital receipt or an inference of revenue receipt can be built and consequently taken into the womb of taxability. The Hon’ble Supreme in a landmark dictum, Commissioner of Income Tax, Madras vs. Ponni Sugars & Chemicals Limited, Civil Appeal No.5694 to 5715 of 2008, [2008] 174 Taxman 87 (SC) has settled that, `It is the object for which subsidy/assistance is given, that truly which determines nature of subsidy. The character of the receipt in the hands of the assessee has to be determined with respect to the purpose for which the subsidy is given. In other words, in such cases one has to apply the `Purpose Test’. The point of time when the subsidy is paid is not relevant. The source is immaterial; the form of subsidy is also immaterial. If the object of the subsidy scheme was to enable the assessee to run the business more profitably, then the receipt was on revenue account. On the other hand, if the object of the assistance under the subsidy scheme was to enable the assessee to set up a new unit or to expand its existing units, then the receipt of the subsidy was on capital account. Therefore, it is the object for which the subsidy/assistance is given which determines the nature of incentive subsidy. The form of the mechanism through which the subsidy is given is irrelevant.

It would also be of immense merit to refer to another judgement of the Hon’ble Calcutta High Court in the case titled Commissioner of Income Tax vs. Rasoi Limited [2011] 335 ITR 438, wherein it has been settled by the Hon’ble Court by making a due reference to the judgement of the Hon’ble Apex Court in the case titled Commissioner of Income Tax vs. Ponni Sugars & Chemicals Ltd [2008] 174 Taxman 87 (SC) that one time subsidy received as a percentage of sales tax paid for modernization and expansion purposes would constitute a capital receipt not subject to the rigours of tax under the Income Tax Act, 1961. The Hon’ble Calcutta High Court further held that merely because subsidy received was equivalent a substantial percentage of the sales tax paid, it cannot be construed that the same was in form of refund of sales tax paid and exigible to tax. Hence one time subsidy received from the State Government under the scheme of industrial promotion for expansion of its facilities and for modernization purposes is capital receipt and cannot be brought into tax net.

It will also be of great significance to refer to another judgement of the Hon’ble Supreme Court of India titled Sahney Steel & Press Works Limited vs. CIT, Civil Appeal No.2193 of 1985 [1997] 94 Taxman 368 (SC), wherein the apex court settled the validity and fate of power subsidy including numerous concessions granted on an year to year basis as a constituent of Supplementary trade receipts. The Hon’ble Supreme Court affirming the decision of the Andhra Pradesh High Court titled Commissioner of Income Tax vs. Sahney Steel & Press Works Limited [1985] 152 ITR 39 has categorically and without any iota of doubt given clearance to the very factum that if assistance is given for the purpose of carrying on the business of the assessee, it would be classified as Revenue Receipt. Going by the rationale of the facts before the Hon’ble Court, where the assessee, Sahney Steel & Press Works Limited received certain incentives including concessions in the nature of power subsidy, refund of sales tax on raw materials, finished goods subject to certain conditions, concessions in nature of reduction of water rate, limited and reduced payments of taxes on land revenue assessments etc. on the sole and solitary condition that all these concessions would be made available to the assessee as and when the production activity stood commenced by the company and not before that and the availability of the incentives would be limited to a period of five years from the date of commencement of production. The incentives were to be given by way of refund of sales tax and also by subsidy on power consumed for production to the extent stated in the notification. So the entire gamut and compass of incentives were basically taken to be a part and parcel of production process to be carried on from year to year basis and made available initially for a period of five years failing which the incentives (including numerous concessions) would not be made available. Dismissing the appeal of the assessee i.e. Sahney Steel & Press Works Limited, the Hon’ble Supreme Court held in its wisdom, `The subsidies were granted year after year only after setting up of the new industry and commencement of production. Such a subsidy could only be treated as assistance given for the purpose of carrying on of the business of the assessee’ and by placing reliance upon the first proposition of Viscount Simons cited before the Hon’ble Supreme Court in the cases titled Ostimev. Pontypridd & Rhondda Joint Water Board 28.TC 262 “

`The first proposition is that, subject to the exception hereafter mentioned, payments in the nature of a subsidy from public funds made to an undertaker to assist in carrying on the undertaker’s trade or business are trading receipts, that is, are to be brought into account in arriving at the balance of profits or gains. The second proposition constitutes an exception. If the undertaker is a rating authority and the subsidy is the proceeds of rates imposed by it or comes from a fund belonging to the authority, the identity of the source with the recipient prevents any question of profits arising, The Hon’ble Supreme Court held, `In the instant case, the first proposition of Viscount Simon clearly applies. The amount paid to the assessee in the instant case is in the nature of subsidy from public funds. The funds were made available to the assessee to assist it in carrying on its trade or business. In our view, having regard to the scheme of the Notification of the Andhra Pradesh Government, there can be little doubt that the object of various assistances under the subsidy scheme was to enable the assessee to run the business more profitably hence the receipt was made pliant to tax under the taxing law.

The issue concerning the grant of `Power Subsidy’ also came under the lens of the Andhra Pradesh High Court in a case titled Commissioner of Income Tax vs. Rassi Cement Limited [2013] 351 ITR 169. The Hon’ble High Court placing its due reliance upon the verdict of the Supreme Court in Sahney Steel & Press Works Ltd vs. Commissioner of Income Tax, [1997] 94 Taxman 368 (SC) has held that subsidy received by the assessee from the State Government on the basis of actual consumption of power has to be treated as revenue receipt and not as having an element of capital receipt and hence subject to the realm of taxation.

In a settled matter, the Hon’ble High Court of Jurisdiction at Bombay in a case titled Commissioner of Income Tax vs. Kirloskar Oil Engines Ltd [2014] 364 ITR 88 (Bombay) has settled that when subsidy is received by the assessee for setting up a new unit, then receipt of subsidy is on capital account. In another path breaking judgement, the Hon’ble Bombay High Court has held in the case of Commissioner of Income Tax Vs. Chaphalkar Brothers [2013] 351 ITR 309 (Bombay) Where object of entertainment duty subsidy was to promote construction of multiplex theatre complexes, receipt of subsidy would be on capital account.

Section 2(24), Sub Clause (xviii) excepts that portion of subsidy or grant or reimbursement which is taken into account for determination of the actual cost of the asset in accordance with the provisions of Explanation 10 to clause (1) of section 43 to be taken as income. Explanation 10 appended to section 43(1) with effect from 01^st April 1999 provides:-

Explanation 10 – Where a portion of the cost of an asset acquired by the assessee has been met directly or indirectly by the Central Government or a State Government or any authority established under any law or by any other person, in the form of a subsidy or grant or reimbursement (by whatever name called), then so much of the cost as is relatable to such subsidy or grant or reimbursement shall not be included in the actual cost of the asset to the assessee:-

Provided – that where such subsidy or grant or reimbursement is of such nature that it cannot be directly relatable to the asset acquired, so much of the amount which bears to the total subsidy or reimbursement or grant the same proportion as such asset bears to all the assets in respect of or with reference to which the subsidy or grant or reimbursement is so received, shall not be included in the actual cost to the assessee.

In due furtherance of the Income Computation and Disclosure Standard VII (ICDS) dealing with Government Grants notified by the Central Board of Direct Taxes vide Notification No. SO 892(E) dated 31^st March, 2015 which are applicable for computation of income chargeable under the head `Profit & Gains of business or profession’ or `Income from other sources’, any government grant such as subsidies, cash incentives, duty drawbacks, waiver, concessions, reimbursements etc. in case it relates to:-

a) Depreciable assets – shall be deducted from actual cost of the asset or written down value of block of assets to which concerned asset or assets belonged to.

b) Where the Government grant relates to a Non-Depreciable asset or assets of a person requiring fulfillment of certain obligations, the grant shall be recognised as income over the same period over which the cost of meeting such obligations is charged to income.

c) Where the Government grant is of such a nature that it cannot be directly relatable to the asset acquired, so much of the amount which bears to the total Government grant, the same proportion as such asset bears to all the assets in respect of or with reference to which the Government grant is so received, shall be deducted from the actual cost of the asset or shall be reduced from the written down value of block of assets to which the asset or assets belonged to.

d) The Government grant that is receivable as compensation for expenses or losses incurred in a previous financial year or for the purpose of giving immediate financial support to the person with no further related costs, shall be recognised as income of the period in which it is receivable.

e) Any other government grant other than mentioned above shall be recognized as income over the periods necessary to match them with the related costs, which they are intended to compensate.

f) Non-Monetary Grants The Government grants in the form of non-monetary assets, given at a concessional rate, shall be accounted for on the basis of their acquisition cost.

In case of refunds attributable to depreciable assets, the amount refundable in respect of a Government grant related to a depreciable fixed asset or assets shall be recorded by increasing the actual cost or written down value of block of assets by the amount refundable. Where the actual cost of the asset is increased, depreciation on the revised actual cost or written down value shall be provided prospectively at the prescribed rate. In case of refunds attributable to non-depreciable assets, shall be applied first against any unamortised deferred credit remaining in respect of the Government grant. To the extent that the amount refundable exceeds any such deferred credit, or where no deferred credit exists, the amount shall be charged to profit and loss statement.

In case of any confliction between the provisions of the Income Tax Act, 1961 and the Income Computation and Disclosure Standards, the provisions of the Act shall prevail to that extent.

Conclusion

The ever growing dispute concerning the taxability of subsidy (by whatever name called) has been dealt prospectively as per the provisions mentioned above. Though through at the very outset, in case the very incidence of subsidy awarded is unknown, then as per the statutory provisions in force, it would be reckoned as an income liable for taxation in so far as the provisions of sub clause (xviii) appended to section 2(24) provides so, but to the excepting part concerning any award of subsidy (by whatever name called) made towards the cost of an asset, it will be dealt with by the explanation 10 appended to section 43(1) and will be designated as merely a capital receipt and followed by consequent deduction from the cost of asset. From a bare perusal of the above provisions one thing has been made certain that in legal spheres, the character, subsidy used to hold as a mere concession to boost the trade sector has now become what can effectively be called as a tax ridden and tax stubborn mechanism where concessions can no longer be construed as having any reference to subsidized channel or endowment free from the clutches of tax but has given way to an adversarial regime of taxing every funding coming from the side of government.

 (Article by – Advocate Sameer Bhatia, R/o 158/2, Guru Teg Bahadur Nagar, Opposite Mata Gujri Park, Jalandhar – 144003, Punjab Contact No:- 9041304900   Email Address: adv.sameerbhatia@gmail.com)

(Republished with Amendments by Team Taxguru)