The Hindu Business Line : Taxability of income from government funds

Income which is earned, whether received or not, is taxable unless there are specific provisions for granting exemption. Even if income is earned before a business has commenced, it would be taxable under the head "Income from other sources". In short, taxability of income earned can never be avoided.

However, the government is not liable to tax. There can be peculiar circumstances where funds are granted by the government to a corporation, a special purpose vehicle (SPV), or a nodal agency for executing a project of public importance. When the funds are parked in temporary investments pending utilisation thereof, an interesting question arises whether the interest earned on such investments would be liable to tax in the hands of the corporation, the SPV or the nodal agency.

Karnataka case

This point came up before the Karnataka High Court in CIT vs Karnataka Urban Infrastructure Development and Finance Corpn. (2006; 155 Taxman 228). The facts in this case were that the assessee was appointed the nodal agency for the implementation of the mega-city scheme worked out by the Planning Commission and the Ministry of Urban Development in respect of urban infrastructure of Bangalore. The Central Government had provided the money to the assessee for implementing the scheme. This money was parked by the assessee in various bank deposits when not in use.

The interest earned during the year on these deposits was transferred to the mega-city scheme account directly with an appropriate disclosure in the notes to the accounts. The assessee has been involved in other projects of development of infrastructure apart from the activity as a nodal agency for the implementation of the mega-city scheme undertaken by the Government of India. The interest earned and received by the assessee out of the amount which it had received from the Central and State governments and deposited in various banks, was treated as income of the assessee and the Assessing Officer brought the amount to tax.

The assessee preferred an appeal that was dismissed, affirming the order of the Assessing Officer. Then, the assessee preferred an appeal to the Tribunal. The Tribunal looked into the guidelines, which provided the background of the scheme. The Tribunal also looked into the terms of the scheme. The Tribunal held the assessee was a trustee of the funds entrusted to carry out the objects of the Government.

The assessee in fact acted as an agent of the governments of both the Central and the States for implementing the scheme of developing the mega-city. This being the factual position, the lower authorities committed serious error in treating the interest as income of the assessee and bringing the same to tax, according to the Tribunal. Counsel for the revenue submitted before the High Court that all incomes not exempted under Section 10 of the Act, are liable to tax under Section 4 of the Act. Therefore, the order of the Tribunal had to be set aside.

The High Court observed that the material on record clearly showed that the very purpose of constitution of the assessee was to act as a nodal agency for implementation of mega-city scheme worked out by the Planning Commission. Both the Central and the State governments were expected to provide requisite finances for implementation of the project. The funds from the Central and State governments would flow directly to the specialised institution or nodal agency as grant and the nodal agency would constitute a revolving fund with the help of Central and State shares out of which finance could be provided to various agencies such as water, sewage boards, municipal corporations, and so on.

No profit motive

There was no profit motive as the entire fund was earmarked for a specific object and the interest accrued on deposits in banks, though in the name of the assessee, had to be applied only for the specific purpose as provided in the guidelines. The whole of the fund belonged to the State Exchequer and the assessee had to channel them to the objects of the centrally sponsored scheme of infrastructure development for the mega-city of Bangalore. Funds of one wing of the government were disbursed to the other wing(s) for a public purpose as per the guidelines issued.

The monies so received, until they were utilised, were parked in a bank. The finding recorded by the Tribunal clearly showed that the entire money in question was received for implementation of the scheme, which was for a public purpose. The scheme was implemented as per the guidelines of the Central government and, therefore, the assessee was only acting as a nodal agency of the Central government for implementation of these projects. It was not the case of the revenue that the assessee was carrying on any business or activities of its own while implementing the scheme in question.

Interest reutilised

The unutilised money during the period the project could not be fully implemented, was deposited in a bank to earn interest. That interest earned was again utilised for the implementation of the mega-city project.Therefore, in computing the total income of the assessee for any previous year the interest accrued on bank deposits cannot be treated as income of the assessee as the interest was earned out of the money given by the Government of India for the purpose of implementation of mega-city project.

The aforesaid judgment lays down the correct principle of law. There is no doubt that the Karnataka High Court was guided by the principle of trusteeship because the nodal agency received the funds which were impressed by a mandate to utilise the same for infrastructure development, as an agent of the Government. It is a well-established principle that a trustee is liable to tax in like manner and to the same extent as a beneficiary. Therefore, if the Government is exempt from income-tax under the Constitution, the trustee or agent of the Government would equally not be taxable.

Needless to add, in every case the agreement entered into between the Government and the nodal agency would have to be considered. If the implementation of the project is undertaken by the special purpose vehicle or the nodal agency as part of its own business activity and not as an agent of the Government from funds earmarked upon trust, the income earned from investment of the funds would undoubtedly be taxable in the hands of the SPV or the agent.

(The author, a Mumbai-based advocate specialising in tax laws, can be contacted at ranina@bom2.vsnl.net.in)