CA Vinamar Gupta
Exemption available under Chapter VI-A in respect of profits of industrial undertakings is available only in respect of income qualifying the litmus test of “profits or gain derived from undertaking”. The revenue and assessees have been locking their horns over the issue of Subsidies for years together as to whether or not they are covered by term ““profits or gain derived from undertaking”
In this article while an attempt has been made to construe real meaning of words “profit derived from”, it also deals with purpose test of subsidy and its relevance after recent amendments in Finance Act 2015 and Finance Bill 2016.
It will be relevant to look into the issue through a few court rulings:
1. Cambay Electric Supply Industrial Company Limited Commissioner of Income Tax, Gujarat II, (1978) 2 SCC 644 (Supreme Court)
In this case Court had to construe Section 80-E of the Income Tax Act, which referred to “profits and gains attributable to the business” of generation or distribution of electricity. It was held that the expression “attributable to” is certainly wider in import than the expression “derived from”. Sale of old machinery and buildings cannot be regarded as profits and gains derived from the conduct of the business of generation and distribution of electricity. Whenever the Legislature wanted to give a restricted meaning it has used the expression “derived from” to cover receipts from sources other than the actual conduct of the business.
2. Commissioner Of Income Tax, Karnataka Sterling Foods, Mangalore, (1999) 4 SCC 98 (Supreme Court)
The issue is this case was whether income derived by the assessee undertaking engaged in export of processed sea food by sale of import entitlements was profit and gain derived from the industrial undertaking . This Court referred to its judgment in Cambay Electric Supply (supra) and emphasized the difference between the wider expression “attributable to” as contrasted with “derived from”. Supreme also stated the industrial undertaking itself had to be the source of the profit. The business of the industrial undertaking had directly to yield that profit. Hence the source of the import entitlements can not said to be the industrial undertaking of the assessee. The source of the import entitlements can, in the circumstances, only be said to be the Export Promotion Scheme of the Central Govt. whereunder the export entitlements become available. There must be for the application of the words “derived from”, a direct nexus between the profits and gains and the industrial undertaking. In the instant case the nexus is not direct but only incidental. The assessee is entitled to import entitlements under export promotion scheme, which it can sell. The sale consideration therefrom cannot be held to constitute a profit and gain derived from the assessees’ industrial undertaking.
3. Pandian Chemicals Limited Commissioner of Income Tax, 262 ITR 278(Supreme Court)
The question before the Court was as to whether interest earned on a deposit made with the Electricity Board for the supply of electricity to the appellant’s industrial undertaking should be treated as income derived from the industrial undertaking. Supreme Court held that although electricity may be required for the purposes of the industrial undertaking, the deposit required for its supply is a step removed from the business of the industrial undertaking. The derivation of profits on the deposit made with the Electricity Board could not be said to flow directly from the industrial undertaking itself.
The question was whether DEPB credit or Duty drawback receipt could be said to be in respect of profits and gains derived from an eligible business. Again Supreme Court first made the distinction between “attributable to” and “derived from” stating that the latter expression is narrower in connotation as compared to the former. The court further went on to state that by using the expression “derived from” Parliament intended to cover sources not beyond the first degree. DEPB is an incentive. It is given under Duty Exemption Remission Scheme. Essentially, it is an export incentive. No doubt, the object behind DEPB is to neutralize the incidence of customs duty payment on the import content of export product. This neutralization is provided for by credit to customs duty against export product. Under DEPB, an exporter may apply for credit as percentage of FOB value of exports made in freely convertible currency. Credit is available only against the export product and at rates specified by DGFT for import of raw materials, components etc. DEPB credit under the Scheme has to be calculated by taking into account the deemed import content of the export product as per basic customs duty and special additional duty payable on such deemed imports. Therefore DEPB/Duty Drawback are incentives which flow from the Schemes framed by Central Government or from S. 75 of the Customs Act, 1962, hence, incentives profits are not profits derived from the eligible business.
5. Calcutta High Court in Merino Ply & Chemicals Ltd. CIT, 209 ITR 508 ,
It was held that transport subsidies were inseparably connected with the business carried on by the assessee. Transport expenditure is an incidental expenditure of the assessee’s business and it is that expenditure which the subsidy recoups and that the purpose of the recoupment is to make up possible profit deficit for operating in a backward area. Therefore, it is beyond all manner of doubt that the subsidies were inseparably connected with the profitable conduct of the business
In CIT v. Andaman Timber Industries Ltd., 242 ITR 204 , however Calcutta High Court arrived at an opposite conclusion in considering whether a deduction was allowable under in respect of transport subsidy without noticing its own judgment in Merino Plywood(supra). A Division Bench of the Calcutta High Court in C.I.T. v. Cement Manufacturing Company Limited, by a judgment dated 15.1.2015, distinguished the judgment in CIT v. Andaman Timber Industries Ltd. and followed the impugned judgment of the Gauhati High Court in Meghalya Steels which is the subject matter of discussion in this Article.
6. Sahney Steel and Press Works Ltd. Commissioner of Income Tax, A.P. – I, Hyderabad, (1997) 7 SCC 764 (Supreme Court)
It was held by the apex Court on power subsidy that subsidy on power was confined to ‘power consumed for production’. In other words, if power is consumed for any other purpose like setting up the plant and machinery, the incentives will not be given.
On refund of sales tax it was held that Refund of sales tax will also be in respect of taxes levied after commencement of production and up to a period of five years from the date of commencement of production. It is difficult to hold these subsidies as anything but operation subsidies. These subsidies were given to encourage setting up of industries in the State by making the business of production and sale of goods in the State more profitable
7. Delhi High Court in Dharampal Prem Chand 317 ITR 353
It was held by Delhi High Court that refund of excise duty should not be excluded in arriving at the profit derived from business for the purpose of claiming deduction under Section 80-IB of the Act. SLP of the department against this decisions has been dismissed by Supreme Court.
8. Contrary Judgements of Himachal Pradesh High Court in Kiran Enterprises (2010) 327 ITR 520 and Supriya Gill [ITA 27 & 28/2010 dtd 16-6-2010]
The question was whether the freight subsidy is income derived from the business of the industrial undertaking and can be included in the profit eligible for deduction under section 80-IA. The Court held that the source of transport subsidy is not the business of the assessee but the scheme framed by the Central Government. Held that the subsidy received by the assessee was not a profit derived from the business since it was not an operational profit and that the source of the subsidy is not the business of the assessee but the scheme of the Government
Adverse Judgement of Punjab and Haryana High Court in H.M. Steels Ltd. [ITA 352/2013 dated 04-08-2015]
P&H High Court expressed agreement with view taken by Himachal High Court and also held that sales tax rebate is not profit derived from eligible business and hence entitled for deduction.
10. Purpose Test of Subsidy
a) Ponni Sugars & Chemicals Ltd.  174 TAXMAN 87 (SC [16-09-2008](Supreme Court)
The assessee-company had received subsidy under the incentive subsidy scheme, 1980. The incentives conferred under the scheme were two fold; first, in nature of a higher free sale sugar quota and second, in allowing the manufacturer to collect excise duty on the sale price of the free sale sugar in excess of the normal quota, but to pay to the Government only the excise duty payable on the price of levy sugar. As per the scheme, the assessee was obliged to utilize the subsidy only for repayment of term loans undertaken by it for setting up new units/expansion of existing business.
Held by apex Court 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 when the subsidy is paid is not relevant. The source is immaterial; the form of subsidy is also immaterial. The main eligibility condition in the scheme in the instant case was that the incentive must be utilized for repayment of loans taken by the assessee for setting up of new units or for substantial expansion of its existing units. 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 the incentive subsidy. The form of the mechanism through which the subsidy is given is irrelevant.
In the instant 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 it for setting up of new units/expansion of its existing business.
b) Jammu and Kashmir High Court in Shree Balaji Alloys
The assessee, pursuant to the New Industrial Policy announced for the State of J&K, received excise refund and interest subsidy, etc which it claimed to be a capital receipt. In the alternative, it was claimed that the same was eligible for deduction u/s 80-IB. The AO, CIT (A) and Tribunal rejected the claim and held the receipts to be revenue on the ground that the subsidy (i) was for established industry and not to set up a new one, (ii) it was available after commercial production, (iii) it was recurring in nature, (iv) it was not for purchasing capital assets and (v) it was for running the business profitably. On appeal by the assessee, HELD reversing the lower authorities:
If the object of the subsidy scheme is 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 subsidy scheme is 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. 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 is irrelevant; Since the object of the subsidy scheme was (a) to accelerate industrial development in J&K and (b) generate employment in J&K. Such incentives, designed to achieve a public purpose, cannot, by any stretch of reasoning, be construed as production or operational incentives for the benefit of assesses alone. It cannot be construed as mere production and trade Incentives; The fact that the incentives were available only after commencement of commercial production cannot be viewed in isolation.
Question whether the subsidy receipts are eligible u/s 80-IB as being derived from industrial undertaking was not decided.
Purpose Test is no longer relevant
As per clause (xviii) inserted in section 2(24) by Finance Act 2015 wef AY 2016-17, definition of income includes:
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 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;
Finance Bill 2016 further excludes the subsidy or grant by the Central Government for the purpose of the corpus of a trust or institution established by the Central Government or a State Government from the scope of 2(24)(xviii)
Hence wef AY 2016-17, all subsidies except specifically excluded shall be revenue in nature and shall no longer retain capital character.
Hence the issue whether subsidy is derived from eligible business for determining its eligibility for deduction under Chapter VI-A becomes all the more important for assessee.
11. Supreme Court in Meghalya Steels decided on 09-03-2016
In this case the issue before apex court was whether transport subsidy, interest subsidy and power subsidy can be said to be “ profits derived from industrial undertaking”
It was held by apex court confirming the decisions of Gauhati High Court that all these subsidies in the present case are revenue receipts which are reimbursed to the assessee for elements of cost relating to manufacture or sale of their products, there can certainly be said to be a direct nexus between profits and gains of the industrial undertaking or business, and reimbursement of such subsidies. However Revenue stressed the fact that the immediate source of the subsidies was the fact that the Government gave them and that, therefore, the immediate source not being from the business of the assessee, the element of directness is missing. However it was held by apex Court that So long as profits and gains emanate directly from the business itself, the fact that the immediate source of the subsidies is the Government would make no difference, as it cannot be disputed that the said subsidies are only in order to reimburse, wholly or partially, costs actually incurred by the assessee in the manufacturing and selling of its products. The “profits and gains” spoken of by Sections 80-IB and 80-IC have reference to net profit. And net profit can only be calculated by deducting from the sale price of an article all elements of cost which go into manufacturing or selling it. Thus understood, it is clear that profits and gains are derived from the business of the assessee, namely profits arrived at after deducting manufacturing cost and selling costs reimbursed to the assessee by the Government concerned.
Head of Income for Subsidies also decided by Supreme Court in Meghalya Steels decided on 09-03-2016
It is also held by Supreme Court in Meghalya Steels that Section 28(iii)(b) specifically states that income from cash assistance, by whatever name called, received or receivable by any person against exports under any scheme of the Government of India, will be income chargeable to income tax under the head “profits and gains of business or profession”. If cash assistance received or receivable against exports schemes are included as being income under the head “profits and gains of business or profession”, it is obvious that subsidies which go to reimbursement of cost in the production of goods of a particular business would also have to be included under the head “profits and gains of business or profession”, and not under the head “income from other sources”.
Comments on Himachal Pradesh High Court Judgement [Supreme Court in Meghalya Steels decided on 09-03-2016]
The Himachal Pradesh High Court, having wrongly interpreted the judgments in Sterling Foods and Liberty India to arrive at the opposite conclusion, is held to be wrongly decided.
Comments on Delhi, Calcutta and Gauhati High Court Judgements: [Supreme Court in Meghalya Steels decided on 09-03-2016]
The Supreme Court in its concluding para has said that following judgements have correctly construed section 80-IB and Section 80-IC
i) Delhi High Court in Dharam pal Prem Chand [Thus the isuue of excise subsidy also attains finality]
ii) Calcutta High Court in Merino Ply and Chemicals [Transport Subsidy]
iii) Gauhati High Court in Meghalya Steels [Interest, Power, Transport Subsidy]
Conclusion: The Judgment of Supreme Court shall put to rest the long drawn controversy over reletability of subsidies to profits derived from eligible business. Since Finance Act 2015 has defied the purpose test of subsidies wef AY 2016-17, the judgment in author’s view is shot in the arm just before the commencement of AY 2016-17 before planning for last installment of AY 2016-17.