Apex Court held ‘Purpose test’ is crucial factor to determine whether subsidy is capital or revenue in nature

CIT vs. Chaphalkar Brothers Pune (Supreme Court)

Brief Facts of the Case

• The Assessee, Chaphalkar Brothers Pune, one of the appellant from batch of appeals from Maharashtra and West Bengal, was engaged in the business of Multiplex Theatre in Pune, Maharashtra.
• The Govt. of Maharashtra, by way of ordinance before 4^th December, 2001, introduced subsidy scheme in the form of exemption of entertainment duty in Multiplex Theatre Complexes newly set up, for a period of three years, and thereafter payment of entertainment duty @25% for the subsequent two years.
• The object and reason of the ordinance [which later on became part of Bombay Entertainment Duty (Revised) Act, 2001] was to promote construction of new cinema houses in the state as the concept of a complete Family Entertainment Centre, more popularly known as Multiplex Theatre Complex, has emerged in recent times. Since it was highly capital intensive and their gestation period is quite long, Government decided to grant concession in entertainment duty to these Multiplex Theatre Complexes.
• Here, The Assessing officer found that aforesaid scheme was really to support the on-going activities of the multiplex and not for its construction, since the scheme took the form of a charge on the gross value of the ticket and contributed towards the day to day running expenses; and thus held that it was in the nature of revenue receipt. CIT(A) upheld the Assessment Order.
• The ITAT summarized that broadly speaking the subsidy can be of two types: (i) for the purpose of helping the growth of an industry; and (ii) for the purpose of supplementing the profits of an industry; and held that on close examination undisputedly it was noticed that the scheme in question has fallen in the first category. Though the collection was in the form of an entertainment Duty via sale of tickets for a limited period but its utilization was predetermined and granted with an assurance to cover up the cost of construction. HC dismissed the revenue’s appeal and upheld ITAT Order. Aggrieved by the order revenue appealed before the Apex Court.

Revenue contention

• The fact that subsidy kicks in only after the multiplexes started functioning and issued tickets on which entertainment duty is then waived, would show that in reality what has already been set up is not the immediate objects of the subsidy but that it is really in the nature of a helping hand for running of the day-to-day business of the multiplexes.

Assesse’s Contention

• It is only the purpose of the scheme that is the test for finding out whether the scheme is, in fact, capital or revenue in nature. The source of funds for the scheme and the form of the scheme are irrelevant and if it is clear that the purpose is in order that capital expenses be met out of the subsidy granted in the scheme, then the object of the scheme points towards receipt of funds being capital in nature.
• They also relied upon the statement that the grant of concession is truly capital intensive, the period is long and, therefore, they need government support to promote construction of new cinema houses in the state.

Apex Court’s Judgment

The Apex Court went on to discuss various case laws but most specifically analyzed and relied upon its own judgement in the case of Sahney Steel & Press Works Ltd., Hyderbad Vs. CIT [1997 (7) SCC 765] and CIT Vs. Ponni Sugars and Chemicals Limited [2008 (9) SCC 337] wherein the court has laid down the principle which reads as follows:

“What is most important is the ‘Purpose test’ that determines the character of the receipt in the hands of the assessee for which the subsidy is given. If the object of the subsidy scheme was to enable the assessee to run the business more profitably, the receipt is on revenue account. On the other hand, if the object of the assistance of subsidy scheme was to enable the assessee to set up a new unit or to expand the existing unit then the receipt is of capital nature.

Further, it was specifically held that the form of mechanism through which the subsidy is given; the point of time at which the subsidy is paid and the source of the subsidy is immaterial. Further, that the object is carried out in a particular manner, is irrelevant.”

In the present case, the object of the grant of the subsidy was in order that person come forward to construct Multiplex Complex, the idea being that subsidy scheme should go towards helping the industry to set up such highly capital intensive entertainment centers. The aforesaid object is clear and unequivocal and such subsidy scheme is capital in nature.

Further, since the facts in the West Bengal case is similar to the Maharashtra case, the judgement of Maharashtra case law will be followed.

Key take away:-

The Apex Court’s land mark ruling has once again affirmed the principle of ‘Purpose Test’ which determines whether the expenditure is capital in nature or revenue in nature; and the form of mechanism through which the subsidy is given, the point of time at which the subsidy is paid and the source of subsidy is immaterial. The judgement may lead to further reduction in litigation and help the assessee in various sectors facing the similar anomaly for categorizing the nature of expenses.