The Hindu Business Line : Subsidies: Revenue or capital in nature?

The dividing line between taxability and non-taxability of a subsidy is thin. The object of a scheme and the utilisation of subsidy will have to be examined.

T. C. A. Ramanujam

The issue of taxing subsidies has been engaging the attention of courts for the past two decades. Subsidy is a grant by the government to the promoters of any enterprise in which the government desires to participate, or which is considered a proper subject for government aid. Such purpose is likely to be of benefit to the public.

Subsidy given to a company for running its business is considered taxable. Grant from the government after completion of, say, a film is revenue receipt. Subsidy under export promotion schemes, power subsidy, purchase tax subsidy and sales tax subsidy have all been considered by various High Courts as revenue receipts taxable in the hands of the recipient.

The Sahney Steel case

The leading case on the subject is that of Sahney Steel and Press Works Ltd, decided by the Supreme Court in 1997. In a well considered ruling, the apex court observed that payments from public funds to assist companies in carrying on trade or business are revenue receipts.

In that case, refund of sales tax, subsidies on power consumed and exemption from payment of water charges, etc., were considered by the court as amounts received by way of production incentives. They were operational subsidies and not capital subsidies. They were therefore revenue in nature.

In the case before the court, the Andhra Pradesh Government issued a Notification authorising payment of subsidies to assist new industries at the commencement of business to carry on their business. These were considered supplementary trading receipts. The company was barred from using the money for distribution of dividends to shareholders. But it was otherwise free to use the money in its business entirely as it liked and was not obliged to spend the money for a particular purpose.

The subsidies were not granted for production of or bringing into existence any new asset. Grant was made year after year, only after the setting up of the new industry and commencement of production. Such a subsidy could only be treated as assistance given for carrying on of the business of the company. The subsidies were of revenue nature and would have to be taxed accordingly.

The Ponni Sugars case

In 1980, on account of economic factors new sugar factories could not come up. Financial institutions were reluctant to advance loans for establishing new factories. On the basis of the recommendations of the Sampath Committee, the Central Government formulated a scheme for grant of subsidies to new units and for expansion of old ones.

Companies were allowed to increase free sale sugar quota if they increased production capacities. Benefit of the scheme was to be utilised only for repayment of term loan. The Government of India, financial institutions and sugar companies were made parties to the scheme. Incentives were given through the mechanism of price and duty differentials.

The Revenue contended that price-related mechanism led to the presumption that the subsidies were revenue in nature. The sugar company argued that the object of the scheme must be examined. The incentive was utilised for repayment of loans to set up new units or for substantial expansion of existing units. It is the object for which the assistance is given which determines the nature of the incentive subsidy. The form of the mechanism through which subsidy is given is irrelevant.

The Supreme Court considered its earlier ruling in the Sahney Steel case. It distinguished that case on the ground that Sahney Steel 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 Ponni Sugars, there was an obligation on the part of the company to utilise the subsidy only for repayment of term loans undertaken by the company for setting up new units/expansion of existing business.

Keeping in mind the object behind the payment of subsidy, the Supreme Court took the view that the subsidy payment received by Ponni Sugars under the scheme formulated by Central Government was not in the course of trade but was of capital nature. It upheld the view of the Madras High Court in this regard.

The Madras High Court had also held in the Ponni Sugars case that purchase tax benefit in the form of subsidy extended by the Government to sugar factories was in no way linked to the expenditure incurred in setting up the unit and was, therefore, taxable.

The dividing line between taxability and non-taxability is thin. The object of the scheme and the utilisation of subsidy will have to be examined.

(The author is a former Chief Commissioner of Income-Tax. blfeedback@thehindu.co.in)

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