Various state governments give incentives for setting up industries. One such incentive pertains to giving a subsidy which has to be utilized for repaying a loan. The taxability of this amount has been recently considered by the Supreme Court. The principle which immerges from this judgment is that the character of the receipt of a subsidy in the hands of the assessee under a scheme has to be determined with respect to the purpose for which the subsidy is granted. In other words, one has to apply the purposive test. The point of time at which the subsidy is paid is not relevant. The source is immaterial. If the object of the subsidy is to enable the assessee to run the business more profitably, the receipt is on revenue account. On the other hand, if the object of the assistance under the subsidy scheme is to enable the assessee to set up a new unit or to expand an existing unit, the receipt of the subsidy would be on capital account.
In CIT v Ponni Sugars And Chemicals (306 I.T.R. 392), the assessee was a co-operative society running a sugar mill. During the relevant year in question, on account of economic factors, it was not economically viable to run new sugar factories. Due to high financial costs, financial institutions did not come forward to advance loans to the entrepreneurs of new sugar factories. The tempo of establishing new sugar factories received a serious setback.
A committee appointed by the Government recommended that four incentives for making a sugar plant economically viable could be provided for capital subsidy, viz. larger percentage of free sale of sugar, higher levy sugar price, allowing rebate on excise duty and remission of purchase tax. Following that report, schemes were formulated giving the following benefits: (i) incentive subsidy available only to new units and to substantially expanded units; (ii) minimum investment for new units and expansion of existing units; (iii) increase in free sugar sale quota. The benefit of the schemes had to be utilised only for repayment of loans.
The income tax department and the High Court held that the receipts from the Government under the incentive schemes were in the nature of income. The Supreme Court held, reversing the decision of the High Court on this point, that the main eligibility condition in the schemes was that the incentives had to be utilized for repayment of loans taken by the assessee to set up new units or for substantial expansion of an existing unit. The subsidy received by the assessee was not in the course of a trade but was of a capital nature. In coming to this conclusion, the Court relied on its decision in Sahney Steel and Press Works Ltd v C.I.T (228 ITR 253 (SC)). In this case, the Court held that the main eligibility condition in the scheme is that the incentives must be utilized for repayment of loans taken by the assessee to set up new units or for substantial expansion of existing units.
If the object of the subsidy scheme is to enable the assessee to run the business more profitably, the receipt is on revenue account. On the other hand, if the object of the assistance under the subsidy scheme is to enable the assessee to set up a new unit or to expand the existing unit, the receipt of the subsidy would be on capital account. Therefore, it is the object for which the subsidy/assistance is given which determines the nature of the incentive. The form or the mechanism through which the subsidy is given are irrelevant.
In the decision of the House of Lords in Seaham Harbour Dock Co v. Crook ([1931] 16 T.C. 333), the Harbour Dock Co. had applied for grants from the Unemployment Grants Committee from funds appropriated by Parliament. The grants were paid as the work progressed; the payments were made several times for some years. The Dock Co had undertaken the work of extension of its docks. The extended dock was for relieving unemployment.
Therefore, the House of Lords held that the financial assistance given to the company for dock extension cannot be regarded as a trade receipt. It was found by the House of Lords that the assistance had nothing to do with the trading of the company because the work undertaken was dock extension. According to the House of Lords, the assistance in the form of a grant was made by the Government with the object that by its use, workers might be kept in employment. Therefore, its receipt was capital in nature.
The importance of the judgment lies in the fact that the company had applied for financial assistance to the Unemployment Grants Committee. The committee gave financial assistance from time to time as the work progressed and the payments were equivalent to half the interest for two years on approved expenditure met out of loans. Even though the payment was equivalent to half the interest amount (interest subsidy), the House of Lords held that money received by the company was not in the course of trade but was of capital nature.
The judgment of the House of Lords shows that the source of payment or the form in which the subsidy is paid or the mechanism through which it is paid is immaterial and that what is relevant is the purpose for payment of assistance. Ordinarily, such payments would have been on revenue account but since the purpose of the payment was to curtail unemployment and since the purpose was dock extension, the House of Lords held that the payment made was of capital nature.
In Sahney Steel and Press Works Ltd., the apex Court found that the assessee was free to use the money in its business entirely as it liked. It was not obliged to spend the money for a particular purpose. In the case of Seaham Harbour Dock Co., the assessee was obliged to spend the money for extension of its docks.
This aspect is very important. In the case of Ponni Sugars and Chemicals Ltd. 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 the assessee for setting up new units/expansion of existing business. The aforesaid decision of the Apex Court rests all controversies on this subject.
The author is advocate, Supreme Court