Recently the Supreme Court while disposing off the batch of cases along with Chaphalkar Brothers [TS-589-SC-2017] held that grant of subsidies by the State Governments of India by way of exemption from entertainment tax to newly constructed multiplexes would qualify as capital receipt under the Indian Tax Act. The object of the subsidy was granted for promoting the construction of new cinema houses in the State. It was not given to support the working capital requirements of the multiplexes.

Hence, Supreme Court held that it is of capital in nature by applying the “purpose test”. Even the same stand was taken by the Supreme Court in the earlier rulings of  Sahney Steel & Press Works Ltd. (1997) 228 ITR 253 (SC) and, Ponni Sugars and Chemicals Ltd. (2008) 306 ITR 392 (SC).

The source of subsidy is what is need to be considered and not the form in which it is given and used.

Objective of the Subsidy:

Since the gestation period of recovering the cost of multiplexes is longer, the government under the gambit of family entertainment scheme under one roof, provide for concession of the entertainment duty levied.

When subsidy is granted, it might reduce the burden of the multiplexes built on high capital outlay. Accordingly, a concession in entertainment duty was announced by the State Government to the newly set up multiplexes or on conversion of an existing cinema theater into a multiplex.

Such subsidy was provided in the form of total exemption from levy of entertainment duty to newly set up multiplexes for a period of three years, and thereafter, payment of entertainment duty at 25% of its levy for the subsequent two years.

The main condition was that the multiplex shall operate continuously for 10 years and no facilities provided in the multiplex shall be discontinued or curtailed, without the prior permission of the Government.

Dis allowance by Tax Officer

The Tax Officer considered subsidy received as revenue in nature, as it is collected as part of the gross amount of cinema ticket and not remitted. Also, the other important contention was that it is given post construction of the multiplexes and not given in the course of construction.

Before the Appellate Authority, it was noted that even though the collection was in the form of an entertainment duty by way of cinema tickets for a limited period, its utility was mainly for offsetting the cost of heavy investments made in the multiplexes. It was adjudicated in favor of the taxpayer.

On appeal before the High Court by the Tax Officer, it was adjudicated that if the object of the subsidy was to promote construction of multiplexes, then irrespective of the fact that the multiplexes have been constructed out of own funds or borrowed funds, the receipt of subsidy shall accrue to that account only by way of a capital incentive.

On appeal before the Supreme Court by the Tax Officer, it was noted that the character of subsidy is to be determined based on the “purpose test” and not the time of passing on such subsidy. The Supreme Court ruled that the subsidy was of capital in nature. It was clearly laid out that the object of the subsidy was for development of industrial growth in a particular sector and to generate more employment in the State. Given that, it shall be capital in nature despite the fact that it was granted after the commencement of operations. This was held in the case of Shri Balaji Alloys by the Supreme Court on April 19, 2016.

One should take note of the amendment to Income Tax Act, 1961 , widening the scope of income by introduction of Sec.2(24)(xviii) w.e.f. April 1, 2016 wherein “capital subsidy or grant from the government in any form, whatsoever, shall be treated as income unless it is reduced from the cost of capital asset”. So, if the same is identified to the capital asset and reduced therefrom, then it shall be capital in nature.

To conclude, the case narrated above on construction of multiplexes, put to rest the question of utilization as well as the form in which the subsidy is received. The purpose of the subsidy is the determining factor to decide whether it is of capital or revenue in nature.

Author-  Vasan MS, Sr. Vice President – Global Taxation, Hinduja Global Solutions

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March 2021