Background and facts
- The ITL permits deduction of expenditure representing statutory liabilities like sales tax etc., only upon actual payment.
- Under a specific provision of the ITL, if any allowance or deduction is made by way of expenditure, loss or trading liability in previous tax years and, subsequently, the taxpayer is in receipt of the amount of the loss or expenditure or certain benefit accrues to the taxpayer by way of remission or cessation of trading liability, the same is chargeable to tax as business income.
- The Taxpayer set up an industrial unit in a notified backward area eligible for certain package of fiscal incentives announced by the state government. As part of the incentive scheme, the Taxpayer was eligible for sales tax deferral for a specified period in terms of which the liability to pay sales tax collected during the specified period was deferred and the same was payable after 12 years in six equal installments.
- The Taxpayer treated the amount of sales tax deferral as an unsecured loan in its books. Furthermore, based on a circular issued by The Central Board of Direct Taxes (Circular), for income tax purposes, the Taxpayer claimed deduction of the sales tax deferral liability which was allowed by the Tax Authority in previous tax years. The Circular clarified that if the state governments make an amendment in the relevant sales tax laws to the effect that the sales tax deferred under the incentive scheme shall be treated as actually paid, then, such a deeming provision will meet the actual payment condition for income tax purposes also.
- Subsequently, during tax year 2002-03, the sales tax authority announced a scheme of pre¬payment of sales tax deferral which permitted the taxpayers who availed the deferral benefit to settle the liability by paying the NPV of the liability computed in terms of formula prescribed in the pre- payment scheme. The pre¬payment scheme was stated to be in public interest.
- The Taxpayer availed the benefit of the pre¬payment scheme and paid NPV of INR33.71m in respect of sales tax deferral of INR75.20m. The Taxpayer credited the difference between the two amounts viz., INR41.49m to capital reserve in its books and claimed it as not chargeable to tax.
- The Tax Authority taxed the difference of INR41.49m as benefit obtained in respect of remission of trading liability.
- The first appellate authority upheld the action of the Tax Authority. The Taxpayer appealed further to the Tribunal.
- The issue was referred to the SB of the Tribunal in view of conflicting rulings of different benches of the Tribunal.
Issue before the SB
Whether the difference between NPV and sales tax deferral payable in future is chargeable to tax as benefit obtained in respect of remission of trading liability.
- The NPV represents present economic value of the future liability. There is no remission involved when a liability payable in future is permitted to be settled at NPV. Neither the Taxpayer nor the sales tax authority obtained any benefit or incurred any loss on settlement of future liability at NPV. Therefore, the question of treating the difference of INR41.49m as income by way of benefit obtained on remission of trading liability does not arise.
- Alternatively, the benefit, if at all, is in the nature of capital subsidy received from the state government under the incentive scheme aimed at dispersal of industries outside the congested industrial belt and linked to fixed capital investment made by a taxpayer. Being a capital subsidy, it is a capital receipt not chargeable to tax.
- Alternatively, by virtue of the deferral, the amount of sales tax collected from customers got converted into a loan. The pre- payment of the loan at NPV is on capital account and not chargeable to tax.
Tax Authority’s contentions
- All the conditions attracting taxation of benefit obtained by way of remission of trading liability were fulfilled in the Taxpayer’s case. Sales tax charged on goods sold in the course of a trading activity represented a trading liability. It was allowed as deduction in the past by virtue of the Circular. The settlement of the trading liability at NPV resulted in obtaining a benefit by way of remission of such liability to the extent of the difference of INR41.49m. Hence, the amount of INR41.49m was chargeable to tax as business income.
- Since the incentive was granted after the industrial unit was set up and started functioning, it was not in the nature of capital subsidy. It was in the nature of operational subsidy and revenue.
- The sales tax deferral does not have the effect of converting the sales tax liability into a loan since specific procedures are prescribed in the relevant scheme and statute for such procedures were not complied with in the Taxpayer’s case.
The SB held that the difference between NPV and sales tax deferral payable in future is not chargeable to tax as benefit obtained in respect of remission of trading liability for the following reasons:
- The remission of trading liability triggers taxation under the ITL only if the following conditions are fulfilled:
o The trading liability has been allowed as deduction in the earlier tax years.
o Subsequently, the taxpayer obtains any benefit in respect of such trading liability by way of remission or cessation.
- In the instant case, in view of the Circular, the sales tax deferral was treated as discharged for the limited purpose of compliance of actual payment condition. It was, as such, not allowed as deduction for the purpose of the ITL.
- The NPV of sales tax deferral of INR75.20m was computed at INR33.71m in terms of the formula prescribed by the state government. The concept of NPV itself recognizes that it is the present equivalent of liability payable in future. On payment of INR33.71m in lieu of INR75.20m payable in future, neither has the Taxpayer enjoyed any benefit nor has the state government remitted any part of the deferred amount.
- Furthermore, placing reliance on The Indian Contract Act, the SB held that remission is possible only in the present and not in the future. In the Taxpayer’s case, the amounts were payable after 12 years which means that the liability was payable in future and would be discharged at the NPV. Since the state government did not waive any part of the liability, it cannot be construed as remission of liability. The remission or cessation would have occurred if the state government had accepted an amount lesser than INR75.20m after 12 years or reduced such installments. In the present case, it is a simply collecting the amount which is due at a later date at today’s N PV.
A Special Bench is generally constituted when there are conflicting decisions of Tribunals or the matter pending for adjudication is of considerable importance. It is also a well-settled convention to consider the Special Bench’s decision as binding on the division benches of Tribunals.
Though the principles of taxation of remission of trading liability are well-settled, the application of principles in the context of pre- payment of sales tax deferral poses difficulty in view of the multiplicity of incentive schemes of different state governments and peculiarities involved in each scheme. The present ruling provides guidance that, where a liability payable in future is settled at NPV, no benefit or remission arises since the NPV represents the equivalent value of the future liability.