Subsidy a capital or revenue expense: Recent decision of Delhi HC in Bhushan Steel

Advocate Divesh Chawla

The government would introduce a scheme to provide a subsidy for advancing the development of industries mainly in backwards areas. The assistance was provided primarily for recouping the assessee on the expenditure incurred for the establishment of the industry. The key question which arises for determination: What the character of the subsidy under the scheme? Whether they should be considered as revenue or capital receipt? This is a matter that has often arisen for consideration before the courts. Broadly speaking, the accepted test is that a subsidy is a capital receipt when it is to promote a new industry or expand an existing unit, while it is a revenue receipt liable to tax if it is granted to enable the assessee to run the business more profitable.

The Legislature by the Finance Act, 2015, amended section 2(24) of the Income Tax Act and inserted clause (xviii) with effect from 1^st April 2016. The clause stipulates that the assistance provided by way of a subsidy or by whatever name called, and furnished by the government or authorities or non-government agencies shall be included in the term income, thereby making it liable to tax. The amendment is prospective, which means that the assistance is taxable from the Financial Year 2016-17. The relevant question to determine whether the incentives are liable to tax for the prior fiscal years?

The Hon’ble Supreme Court in each of the case of Sawhney Steels & Press Works Ltd. 228 ITR 253 and Ponni Sugar and Chemical Ltd 306 ITR 392, has characterized the subsidy as capital and revenue respectively based on the relevant facts. Therefore it would be pertinent to understand the circumstances of each instance while characterizing the receipt.

In Sawhney Steels & Press Works Ltd (supra) the assessee was entitled to a subsidy by way of sales tax refund and the relief on account of water rate’s, land revenue as well as electricity charges. The subsidy was provided after it commences production, and there was no obligation to use the funds in any manner.  The Court on these facts held that the scheme did not make any payment directly or indirectly for setting up the industries and was to carry on the business efficiently. The assessee was free to use the money as it liked and was under no obligation to spend the money for a particular purpose. The payments were nothing but supplementary trade receipts and not capital.

In Ponni Sugar and Chemical Ltd (supra) the assessee was entitled to a subsidy on two folds; first, in nature of a higher free sale sugar quota and second; the manufacturer collected the excise duty on the sale more than the usual quota but not liable to pay off the duty to the revenue. One of the conditions was to utilize the subsidy only for repayment of the term loan undertaken for setting up new unit/ expansion of the existing business.  The Supreme Court held that the character of the receipt in the hands of the assessee has to be determined concerning the purpose for which the subsidy was given. The purpose was a crucial test and the point of time, the source or the form of receipt is immaterial and irrelevant. As one of the conditions was the utilising of the subsidy for repayment of term loans undertaken for setting up new units or expansion of existing business the subsidy was capital in nature.

The decision of Sawhney Steels and Ponni Sugar are not contrary to each other, but they complement each other. Both the decision have laid down the fundamental question which requires determination while characterizing  an assistance as capital or revenue in nature:

1. When the assistance is granted for starting a new industry or expansion of the existing industry, it should be considered as capital receipt not liable to tax, while it will be revenue receipt liable to tax when it is granted to enable the assessee to run the business more profitable.
2. The crucial test is the purpose of the subsidy, and the manner in which it is given is of no consequence.

Considering the decision of Ponni Sugar (Supra) various High Court and the Tribunal considers a subsidy to be capital, until the recent ruling of the Delhi High Court in the case of  Commissioner of Income Tax-Delhi v/s M/s Bhushan Steels and Strips Ltd 83 Taxmann.com 204.  In this case, the assessee had claimed the subsidy received as a capital receipt not liable to tax. The scheme was notified for the development of industries in the backwards area. The exemption was provided in the rate of tax to new units and also to units which have undertaken expansion, diversification or modernization. There was limited up to which exemption from or reduction in the rate of tax was admissible. The Revenue had stressed on the lack of any condition to use the subsidies towards capital expenditure. The High Court after considering the decision of Sawhney Steels (supra) and Ponni Sugar (supra) held that even though the capital expenditure could be linked to underlying intention to recouped the capital outlay, there was an absence of the condition to utilise for a capital purpose, and therefore the subsidy is not capital but revenue in nature.

Points that require reconsideration in Bhushan Steel in light of the Supreme Court

1. The condition of use of funds would be an important aspect for a determination whether the subsidy would be capital or revenue but could not overlook the Purpose Test.
2. In the decision of Ponni sugar, the court ‘looking at’ the condition held that underline objective behind the payment of the incentive is for capital outlay and did not determine it merely on the fact that there was a condition.

Conclusion

Ultimately whether the assistance was on capital or revenue receipt would be driven by the scheme and the documentation issued by the competent authority. A lack of condition on the use of funds could not be the ultimate test in determining the characterization.