Tax shelter for government grants

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: Several schemes are announced by the Government from time to time for promoting certain commercial and industrial activities through private investments or private-public partnerships. In some circumstances, such grants may be treated as capital receipts if they do not have the character of revenue or trading inflows.

A specific provision in the Income-tax Act, 1961, Explanation to section 43(1), states that if a portion of the cost of an asset is given as subsidy or as a grant, such amount should be reduced from the actual cost of that asset for the purpose of claiming depreciation on the net amount.

However, the moot question is whether such amount would be liable to tax as income if the main object of the grant is developing a backward area or for setting up a particular business which the Government wants to encourage.

Under section 28 certain benefits relating to exports have been deemed to be business income and, therefore, made liable to tax. However, for other types of businesses, Courts have taken a broad and liberal view to treat such income as capital receipts.

In Kalpana Palace v. C.I.T. (275 I.T.R. 365) the facts were that the State Government had issued order dated July 21, 1986, for providing grant-in-aid and incentives for construction of permanent cinema halls during a specified period.

During the accounting year relevant to the assessment year 1990-91, the assessee completed construction of a cinema theatre and started its business of exhibiting cinema films. It claimed that the grant-in-aid amounting to Rs.3,06,752 received from the State Government was a capital receipt. The claim was not accepted by the Assessing Officer or the Tribunal.

On a reference, the Allahabad High Court first considered the decision of the Supreme Court in Sahney Steel and Press Works Ltd. v. C.I.T. (228 I.T.R. 253). In this case, the apex Court held that the basic principle to be applied for determination as to whether a subsidy payment is in the nature of capital or revenue, is to consider whether the subsidy is meant to assist in carrying on the trade or business.

The apex Court further held that subsidy payments were made only after the industries were set up, and not for the purpose of setting up of the industries. However, the package of incentives was given to the industries to run more profitably for a period of five years from the date of commencement of production.