Government Subsidy: Whether Of Revenue Or Capital In Nature?

Advocate Akhilesh Kumar Sah

The Supreme Court, in Sahney Steel & Press Works Ltd. vs. CIT (1997) 141 Taxation 169, has laid down the basic principle to be applied for determining as to whether the subsidy payment is in the nature of capital or revenue. Hon’ble Supreme Court (at page 177) in the above case has held that if the purpose (of subsidy) is to help the assessee to set its business or complete a project the monies must be treated as to have been received for capital purpose. But if monies are given to the assessee for assisting him in carrying out the business operation and the money is given only after and conditional upon commencement of production, such subsidies must be treated as assistance for the purpose of trade.

In CIT vs. Ponni Sugars & Chemicals Ltd. (2009) 208 Taxation 59, SC has observed that one has to apply the purposive test to decide the nature of the subsidy & the form of subsidy is immaterial.

Recently, in CIT, Delhi vs. Bhushan Steels and Strips Ltd. [ITA Nos. 315/2003, 316/2003, 317/2003, 349/2003, 434/2005, decided on 13 July 2017]; CIT, Delhi vs. Vardhman Industries Ltd. [ITA Nos. 681/2004, 708/2004, 755/2004, 725/2004, decided on 13 July 2017], the following common question arose in these batch of nine appeals arising from orders of the Income Tax Appellate Tribunal (“ITAT”) hereafter:

“Whether the ITAT was correct in law in holding that the amount received by the assessee by way of exemption of sales tax payments was not a trading receipt but was a capital receipt, hence not liable to tax?”

Facts & Decision in Brief:

Bhushan was running the business of manufacture of cold rolled/galvanized steel strips and sheets etc.  Its two units, namely, cold rolling, coal units and galvanized unit was located at Sahibabad (Distt. Ghaziabad of UP).  The area was noticed as a “backward” area. The assessees Bhushan and Vardhman, claimed that in terms of Notification No. ST-2-7558/X- 1981-UP Act-XV/48-Order 85 dated 26.12.1983,  the UP Government,  in exercise of powers under Section 4-A of the UP Sales Tax Act, 1948   read with Section 221 of UP General Clauses Act, 1904 granted exemption from payment of the sales tax in respect of any goods manufactured in an industrial unit which is a new unit located in a specified backward area,  and that such exemption  was  allowed for a period of six years.  It was stated, by both assessees, that new units went into production on and w.e.f. 01.04.1990; the eligibility certificate in respect of these units effective from 07.03.1990 was issued by the Industries Department on 03.07.1992. In the batch of cases relating to the assessee Vardhman, the existing unit was expanded through a ghee manufacturing unit at Chhutmalpur, District Saharanpur, which commenced production on 20.09.1994. The assessees claimed that in terms of Notification No. STs.T.2-1093/11-7(42)/86-UP-Act-XV-48 Order-91 dated 27.07.1991 issued by the Government in exercise of powers under Section 4-A of UP Sales Tax Act read with Rule 25 of the UP Sales Tax Rules, certain exemption of sales-tax was granted to the industries set up in the specified backward area. Bhushan’s galvanizing unit started production in January 1994, the eligibility certificate in respect of this unit was issued by the Industries Department effective from 19.01.1994. The exemption in terms of the notification dated 27.07.1991, in respect of the galvanizing unit was available up to a period of 8 years based in fixed capital investment.

As the units were located at Sahibabad (Dist. Ghaziabad and Saharanpur,) which was such a specified area, while filing the return of income, the grant of exemption given by the State Government through the said notifications with the object of promotion and development of industries was  claimed by Vardhman. In Bhushan’s case, it was not taken into consideration at the time of filing the original return, notwithstanding the fact that the subsidy allowed in the form of exemption was in the nature of a capital grant according to it.  However, subsequently, Bhushan revised its return of income claiming that such amount of sales tax was in the nature of capital subsidy. Such amount was `7,27,71,570/-.  During the course of assessment proceedings, the assessee also relied on decisions of the Andhra Pradesh High Court (in CIT vs. Godavari Ply woods 168 ITR 632); Bombay High Court (in CIT vs. Elys Plastics (1991)188 ITR 11) and the decision reported as CIT vs. P.J. Chemicals 210 ITR 830 (SC).  However, the assessee’s claim was not accepted by the AO.

On appeal, the CIT(A) allowed the assessee’s claim. The CIT(A) held that the amount of sales tax collected as incentive for setting up industries in backward areas was not subject to tax as a trading receipt; but rather was to be towards establishment of the new unit and to buy machinery.  He, consequently, deleted 7,27,71,570 added by the AO. The Revenue’s appeal before the ITAT was dismissed.

In Ponni Sugars (supra), the Supreme Court observed the decision in Sahney Steel (supra) as follows:

“The importance of the judgment of this court in Sahney Steel case lies in the fact that it has discussed and analyzed the entire case law and it has laid down the basic test to be applied in judging the character of a subsidy. That test is that 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 at which the subsidy is paid is not relevant. The source is immaterial. The form of subsidy is immaterial. The main eligibility condition in the scheme with which we are concerned in this case is that the incentive must be utilized for repayment of loans taken by the assessee to set up new units or for substantial expansion of existing units.  On this aspect there is no dispute. If the object of the subsidy scheme was to enable the assessee to run the business more profitably then the receipt is 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 the existing unit 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 the incentive subsidy. The form or the mechanism through which the subsidy is given are irrelevant.  

One more aspect needs to be mentioned.  In Sahney Steel and Press Works Ltd. this court found that the assessee was free to use the money in its business entirely as it liked.  It was not obliged to spend the money for a particular purpose. In the case of Seaham Harbour Dock Co. the assessee was obliged to spend the money for extension of its docks.  This aspect is very important.  In the present case also, receipt of the subsidy was capital in nature as the assessee was obliged to utilize the subsidy only for repayment of term loans undertaken by the assessee for setting up new units/expansion of existing business.  

Applying the above tests to the facts of the present case and keeping in mind the object behind the payment of the incentive subsidy, we are satisfied that such payment received by the assessee under the scheme was not in the course of a trade but was of capital nature.”

The learned Judges of the Delhi High Court after considering facts & circumstances of the case, rival submissions, legal provisions in respect of the issue, government policies and intention in the above regard, relevant case laws held that how a state frames its policy to achieve its objectives and attain larger developmental goals depends upon the experience, vision and genius of its representatives. Therefore, to say that the indication of the limit of subsidy as the capital expended, means that it replenished the capital expenditure and therefore, the subsidy is capital, would not be justified. The specific provision for capital subsidy in the main scheme and the lack of such a subsidy in the supplementary scheme (of 1991) meant that the recipient, i.e. the assessee had the flexibility of using it for any purpose. Unlike in Ponni Sugars (supra), the absence of any condition towards capital utilization meant that the policy makers envisioned greater profitability as an incentive for investors to expand units, for rapid industrialization of the state, ensuring greater employment. Clearly, the subsidy was of revenue in nature.

The common question of law was answered in favor of the Revenue and against the assessees, in both cases.

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