The Hindu Business Line : The tussle over receipt type

ONE of the basic principles to decide the taxability of a receipt under the Income-tax Act, 1961 is to distinguish between capital and revenue receipts. The distinction between the two is vital because capital receipts are exempt from tax unless specifically taxable — capital gains, for instance.

Conversely, revenue receipts are taxable unless expressly exempt in accordance with the provisions of law. The Act does not define `capital receipt' and `revenue receipt', but then one has to depend on the natural meaning of the concepts and also draw support from various case laws on the subject. Recently, the Madras High Court had to decide the issue of capital versus revenue receipts in the context of subsidy granted by the Tamil Nadu Government for welfare and uplift of weaker sections of the community in the Commissioner of Income-tax vs Kanyakumari District Co-operative Spinning Mills Ltd (2003 264 ITR 684) case.

Facts, issues

The assessee, Kanyakumari District Co-operative Spinning Mills Ltd, received certain amount of subsidy from the Tamil Nadu Government, and, in the assessment proceedings for assessment year (AY) 1985-86, the assessee claimed that the amount received was a capital receipt and not liable to tax.

The assessee received the subsidy in the following circumstances. The State Government, taking into account the welfare of Adi Dravidas and their poor representation in the assessee-firm, sanctioned financial assistance of Rs 10.5 lakh under a special component plan to the assessee to recruit 70 Adi Dravidas and the assessee received the same.

The total number of workers belonging to the Adi Dravida community in the assessee-mill was only 90 against the sanctioned strength of 912 persons, of which, 832 permanent workers were employed. The Director of Handlooms and Textiles requested the Tamil Nadu Government to sanction some amount for the recruitment of 70 Adi Dravida workers in the assessee-mill under the special component plan and, on that basis, Rs 10.5 lakh was sanctioned in favour of the assessee.

The assessee also recruited 70 additional workers from the Adi Dravida community. The income-tax officer (ITO) held that the amount received as subsidy was revenue in nature and assessed the same. The Commissioner of Income-tax (Appeals) confirmed the ITO order holding that the subsidy was received in the course of business and, therefore, income in nature.

However, on appeal, the Appellate Tribunal took a different view and held that the amount was granted and paid for a benevolent and beneficial purpose — to provide employment to 70 workers belonging to the Adi Dravida community and promote the weaker sections of society — and the subsidy amount received by the assessee was not its income and, therefore, not assessable to income-tax.

The Department took up the matter to the Madras High Court. The issue for consideration was whether the financial assistance of Rs 10.5 lakh partakes the character of capital or revenue receipt.

Court decision

The Madras High Court held that the subsidy granted has to be in the capital field and is not taxable in the hands of the co-operative society. The court reasoned that the amount received by the assessee had nothing to do with the assessee's trade or business and nor was it a reimbursement of salary. It was not for the normal working of the mill or the benefit of the assessee, but was paid with a social objective in mind — to provide employment to the socially depressed class of people and offer a salary that would help them lead a normal life.

The court accordingly upheld the view of the Tribunal in holding that the amount received by way of subsidy under the scheme was capital in nature. The Madras High Court relied heavily on the Supreme Court's ruling in the Sahney Steel and Press Works Ltd vs CIT (1997 228 ITR 253) case, wherein the apex court had to decide the taxability of amounts received by the assessee-company by way of incentives by the Andhra Pradesh Government representing refund of sales tax on purchase of raw materials and finished goods.

The apex court observed that "if payments in the nature of subsidy from public funds are made to the assessee to assist him in carrying on his trade or business, they are trade receipts. The character of the subsidy in the hands of the recipient, whether revenue or capital, will have to be determined having regard to the purpose for which the subsidy is given.

"The source of fund is quite immaterial. However, if the purpose is to help the assessee to set up its business or complete a project the monies must be treated as having been received for capital purposes. But if monies are given to the assessee for assisting him in carrying out the business operations and the money is given only after and conditional upon commencement of production, such subsidies must be treated as assistance for the purpose of the trade."

There cannot be solutions to all situations within the framework of law. Over the years various controversies have arisen over the question of what constitutes revenue and capital expenditures. Similarly, on the other side, the courts have their hands full in deciding what are revenue and capital receipts.

At times, ingenious assessees convert revenue receipts into capital receipts, and the matter gets dragged to courts. The basic contractual arrangement and the initial papers on facts form the foundation to decide such matters. The legal twist is provided by various case laws on the subject, which include certain classic decisions. This is certainly one area where no clarifications or circulars can settle the matter, as they are essentially driven by facts.

It is submitted that to provide leeway and flexibility to all parties concerned decision on issues of such nature should be left to the wisdom of the appellate authorities, taking into consideration the facts and circumstances in each case.