Prior to the Finance Act, 2015, there was no specific provision dealing with the taxability of subsidy. The judicial precedents on this issue have held that the nature of a subsidy (i.e. capital receipt or trading receipt) is to be determined with reference to the purpose for which such subsidy is given, i.e. ‘purpose test’. In case the subsidy is qualified as ‘capital receipt’, the same would not be chargeable to tax. However, the amendment made by the Finance Act, 2015 seeks to overturn the said judicial precedents.

Section 2(24) of the Income-tax Act, 1961 (the Act) defines the term ‘income’ in an inclusive manner. In the case of CIT v. Ramdeo Samadhi (1986) 160 ITR 179 (Raj.), the Rajasthan High Court observed that “The ingredients of “income” are:

(i) it must be a periodical monetary return,
(ii) coming in with regularity or expected regularity,
(iii) from definite sources, and
(iv) excluding a receipt in the nature of a mere windfall.

Definition of ‘income’

The definition of ‘income’ has been amended from time to time, to specifically provide for taxation of certain capital receipts. Some of the instances where capital receipts have been specifically held liable to income tax are:

• Non-compete fee (with effect from 01.04.2003),
• Money received in excess of fair value on issue of share (with effect from 01.04.2013),
• Receipt of immovable property without consideration (with effect from 01.10.2009),
• Receipt of shares without consideration or for a value less than their fair market value (with effect from 01.06.2010), etc.

In this regard, it is also pertinent to mention that the Courts on several occasions have held that the term ‘income’ should not be interpreted to include receipts of ‘capital nature’, unless such receipts are deemed to be ‘income’ because of a specific provision in the of the Act. A capital receipt, therefore, can be brought to tax under the inclusive definition of term ‘income’ as defined in Section 2(24) of the Act, only if it is expressly covered within the scope of the said definition.

Prior to such specific inclusion of these capital receipts in the definition of income under Section 2(24) of the Act, no tax could have been charged on such receipts. In view of the above, the subsidy received by a taxpayer would not be liable to tax if the following conditions are satisfied cumulatively:

(a) Such subsidy is regarded as ‘capital receipt’; and
(b) There is no specific provision under the Income-tax Act deeming such subsidy as ‘income’

Position prior to the Finance Act, 2015

There was no provision in the Income-tax Act, 1961 prior to the Finance Act, 2015, which explicitly dealt with taxability of subsidies. However, the Courts have had the occasions to deal with the issue of taxability of subsidy. In such judicial precedents, the Courts perused the governing scheme (under which the relevant subsidy was given to the assessee) in detail to determine the nature of the subsidy, i.e. ‘capital receipt’ v. ‘revenue receipt’. In this regard, it would be useful to note the following judicial precedents:

Apex Court held ‘Purpose test’ is crucial factor to determine whether subsidy is capital or revenue in nature – Subsidy in the form of concession of entertainment tax to new multiplex complexes is capital in nature

The receipt of subsidy is capital or revenue will have to be determined by having regard to the purpose for which the subsidy is given. A subsidy granted by the Government to achieve the objects of acceleration of industrial development and generation of employment is capital in nature and not revenue. The fact that the incentives are not available unless and until commercial production has started, and that the incentives are not given to the assessee expressly for the purpose of purchasing capital assets or for the purpose of purchasing machinery is irrelevant. The object has to be seen and not the form in which it is granted. – [CIT v. Chaphalkar Brothers – Date of Judgement 07.12.2017 (SC)]

In this case, the Gujarat High Court examined the nature of subsidy received by a company engaged in the business of multiplexes/theaters from respective State Governments. The subsidy was given by the State Governments by way of exempting the assessee company from levy of entertainment tax; in one of the schemes, the amount of subsidy was linked with the capital investment. Based on the analysis of facts of the case, the High Court held that objective of the schemes was to give incentive to the multiplex units which were highly capital intensive and therefore, the subsidy received by the assessee company was capital in nature i.e., not liable to tax under provisions of the Income Tax Act. – [DCIT v. Inox Leisure Ltd. (2013) 351 ITR 314 (Guj.)]

Subsidy for industrial development – 90% of sales tax paid – is capital receipt
Subsidy received by assessee from the State Government under a scheme of industrial promotion, which was meant to provide financial assistance to specified industries for expansion of capacities, modernization and improving their marketing capabilities, is capital receipt, though the amount of subsidy is equivalent to 90 percent of the sales-tax paid by the beneficiary. (Related Assessment year : 1995-96). – [CIT v. Rasoi Ltd. (2011) 335 ITR 438 : 245 CTR 667 : 59 DTR 369 (Cal.)]

Subsidy received by the assessee from Government of India in pursuance to a New Industrial Policy of Government which was aimed at acceleration of industrial development and generating employment in the State in public interest were held to be capital receipt in the hands of the assessee

In this case, the Jammu and Kashmir High Court examined the taxability of subsidy received by the assessee company under new industrial policy and other concessions announced by the Government of India for Jammu and Kashmir. The High Court applied the ratio affirmed by Supreme Court in case of Sahney Steel and Press Works Ltd. v. CIT (1997) 228 ITR 253 (SC) and CIT v. Ponni Sugars and Chemicals Ltd. (2008) 306 ITR 392 (SC) and held that as the intent of the new industrial policy was to generate employment through acceleration of industrial development of the State, the subsidy received by assessee company was capital in nature and thus, not liable to tax under provisions of the Income Tax Act. Further, the Jammu and Kashmir High Court also held that merely because the subsidy was available to the eligible industrial units from the date of commencement of the commercial production, and that it was not required for creation of new assets, cannot be viewed in isolation to treat the subsidy as a revenue receipt. – [Shree Balaji Alloys & Ors. v. CIT (2011) 333 ITR 335 : 239 CTR 70 : 198 Taxman 122 : 51 DTR 217 (J&K)]

Capital or Revenue – Concession in rate of Excise duty

The receipts from the sale of levy free sugar and concession in the rule of excise duty rebate were capital receipts not liable to tax. – [CIT vs. Tiruttani Co-op. Sugar Mills Ltd. (2010) 322 ITR 59 (Mad.)]

Nature of the subsidy is to be determined with reference to the purpose for which such subsidy is given (i.e. the ‘purpose test’)

In this case, the Supreme Court examined taxability of subsidy received by sugar factories from the Government under identical schemes for different years. The Supreme Court referred to its earlier decision in the case of Sahney Steel and Press Works Ltd. v. CIT (1997) 228 ITR 253 (SC) and held that nature of the subsidy is to be determined with reference to the purpose for which such subsidy is given (i.e. the ‘purpose test’). Factors such as the source/form of the subsidy, time of payment of the subsidy are not relevant. Based on analysis of facts of the case, the Supreme Court held that as subsidy must be utilised for repayment of loans taken by sugar factories for setting up of new units or for substantial expansion of existing units, such subsidy would be of capital nature and thus, not includible in total income of the sugar factories. – [CIT v. Ponni Sugars and Chemicals Ltd. (2008) 306 ITR 392 (SC)]

Nature of Subsidy – Capital or Revenue

The Supreme Court, in this case, examined the taxability of subsidy received by the assessee company from State Government. The subsidy was received by way of refund of sales tax paid on purchase of machinery, raw material, etc., only after the commencement of production. Referring to the decisions pronounced in the past by the foreign courts and the Indian courts, the SC held that the nature of a subsidy, whether capital or revenue, depends on the purpose for which such subsidy is given. In case purpose of the subsidy is to support the assessee to set up its business, to complete a project, or to acquire a capital asset, the subsidy would be regarded as capital receipt. However, if the subsidy is given to the assessee for assisting him in carrying out the trade/business operations only after commencement of production, such subsidy would be regarded as a revenue receipt.
Based on the analysis of facts of the case, the Supreme Court held that as subsidies were not granted for production of any new asset and were granted year after year only after setting up of the new industry and commencement of production, such subsidy would be regarded as assistance given for the purpose of carrying on of the business of the assessee and thus, would be taxable in the hands of the assessee company. – [Sahney Steel and Press Works Ltd. v. CIT (1997) 228 ITR 253 (SC)]

Thus, prior to amendment made by the Finance Act, 2015, based on a reading of the aforementioned judicial precedents, the following key principles can be culled out in relation to characterisation of subsidy as a capital receipt or a revenue receipt:

(i) Nature of a subsidy (i.e. capital receipt or trading receipt) is to be determined with reference to the purpose for which such subsidy is given, i.e. ‘purpose test’.

(ii) In case objective of the subsidy scheme is to enable the assessee to carry on the business in a profitable manner, the subsidy would be regarded as a revenue receipt. However, if objective of the scheme is to support the assessee to set up its business, to complete a project, or to acquire a capital asset, the subsidy would be regarded as capital receipt.

(iii) Factors such as the source/form of the subsidy, time of payment of the subsidy, etc. are not relevant for determining nature of the subsidy.

(iv) The obligation/(s), if any, attached to the permissible end-use of the subsidy (such as, repayment of loan taken for acquisition of fixed assets) should be considered while determining whether the subsidy is a capital receipt or a trading receipt.

Position after amendment by the Finance Act, 2015

The Finance Act, 2015 with effect from 01.04.2016 has inserted sub-clause (xviii) in Section 2(24) of the Act,1961 so as to provide that “Income” shall include assistance in the form of a subsidy or grant or cash incentive or duty draw back or waiver or concession or reimbursement (by whatever name called) by the Central government or state government or any other authority or body or agency in cash or kind to the assessee other than the subsidy or grant or reimbursement which is taken into account for determination of the actual cost of the asset in accordance with the provisions of explanation 10 to clause (1) of section 43.

Thus, evergreen litigation concerning the taxability of subsidy has been dealt by the Finance Act, 2015, by amending the definition of income under section 2(24)(xviii) of the Act with effect from 01.04.2016 (Assessment year 2016-17). Therefore, no more the principle of determining the ‘purpose’ for which subsidy is given to the Assessee holds good.

Subsidy of Revenue Nature

By virtue of above amendment, subsidy, grant (except those of capital nature) etc. has been included in the definition of “Income” and so it is specifically made taxable.

Subsidy of Capital Nature

Subsidy of capital nature is now required to be reduced from actual cost of the asset or written down value of block of assets to which concerned asset or assets belonged to and depreciation shall be admissible on the balance amount only.
In other words, assessee shall not be allowed depreciation on cost of the asset which has been met by way of the subsidy/grant amount received. Where the Government grant is of such a nature that it cannot be directly relatable to the asset acquired, so much of the amount which bears to the total Government grant, the same proportion as such asset bears to all the assets in respect of or with reference to which the Government grant is so received, shall be deducted from the actual cost of the asset or shall be reduced from the written down value of block of assets to which the asset or assets belonged to.

Text of Section 2(24)(xviii)

(xviii) assistance in the form of a subsidy or grant or cash incentive or duty drawback or waiver or concession or reimbursement (by whatever name called) by the Central Government or a State Government or any authority or body or agency in cash or kind to the assessee other than, —

(a) the subsidy or grant or reimbursement which is taken into account for determination of the actual cost of the asset in accordance with the provisions of Explanation 10 to clause (1) of section 43; or

(b) the subsidy or grant by the Central Government for the purpose of the corpus of a trust or institution established by the Central Government or a State Government, as the case may be;

The sub-clause (xviii) to Section 2(24) of the Act as inserted by Finance Act, 2015 was amended by the Finance Act, 2016 with effect from 01.04.2017, where one more exception was inserted as :

“ other than –

(a) the subsidy or grant or reimbursement which is taken into account for determination of the actual cost of the asset in accordance with the provisions of Explanation 10 to clause (1) of Section 43”. (i.e. any subsidy or reimbursement, etc. which is not reduced from the actual cost of the asset under Explanation 10 to Section 43(1) shall be chargeable to income under the head ‘profits and gains of business and profession’); or

(b) the subsidy or grant received by the Central Government for the purpose of the corpus of a trust/institution established by the Central or State Government, shall not be considered as income.”

An amendment was made in the definition of income under section 2(24) of the Act by the Finance Act, 2015. A new sub-clause (xviii) was inserted to the said section which came into force with effect from 01.04.2016 and shall accordingly apply to Assessment year 2016-17. As per the amendment, assistance of any sort (by whatever name called) given by the Central Government or a State Government or any authority or body or agency, shall be considered as income of the Assessee except where the assistance is taken into account for determination of actual cost of asset in accordance with the provision of Explanation 10 to Section 43(1) of the Act.

Definitions of certain terms relevant to income from profits and gains of business or profession [Section 43]

43(1) “actual cost” means the actual cost of the assets to the assessee, reduced by that portion of the cost thereof, if any, as has been met directly or indirectly by any other person or authority:

Explanation 10 to Section 43 of the Act, states about treatment of subsidy, where a portion of the cost of an asset acquired by an assessee has been met directly or indirectly, in the form of a subsidy or grant or reimbursement (by whatever name called) by the specified persons, then so much of the cost as is relatable to such subsidy or grant or reimbursement shall not be included in the actual cost of the asset to the assessee. Implication of said treatment is that assessee would not be allowed depreciation on cost of the asset which has been met by way of the subsidy/grant amount received.

Text of Explanation 10 to Section 43

Where a portion of the cost of an asset acquired by the assessee has been met directly or indirectly by the Central Government or a State Government or any authority established under any law or by any other person, in the form of a subsidy or grant or reimbursement (by whatever name called), then, so much of the cost as is relatable to such subsidy or grant or reimbursement shall not be included in the actual cost of the asset to the assessee .

PROVIDED that where such subsidy or grant or reimbursement is of such nature that it cannot be directly relatable to the asset acquired, so much of the amount which bears to the total subsidy or reimbursement or grant the same proportion as such asset bears to all the assets in respect of or with reference to which the subsidy or grant or reimbursement is so received, shall not be included in the actual cost of the asset to the assessee.

It is pertinent to mentioned here that under Section 2(24)(xviii) of the Act, there is no distinction in the nature/kinds of assistances to consider the same as income of an Assessee. Therefore, all sorts of subsidy received by an assessee from the specified persons, irrespective of its nature as capital or revenue shall be taxable as income of the assessee unless the same falls in the exclusion category. The impact of the aforesaid amendment shall be that principle laid down by the Apex Court in Sahney Steel & Press Works Ltd.(1997) 228 ITR 253 (SC) and Ponni Sugars and Chemicals Ltd. (2008) 306 ITR 392 (SC) laying down the ‘purpose test’ to classify it as capital or revenue receipt, shall no more hold good for subsidies received on or after 01.04.2015.

Taxability even if subsidy is subject to terms, conditions & other stipulations [Section 145B(3)]

In order to align the recognition principles laid in various Income Computation and Disclosure Standards with the provisions of the Act, Section 145B of the Act is inserted vide the Finance Act, 2018. As per Section 145B(3) of the Act, income referred in Section 2(24)(xviii) of the Act shall be deemed to be the income of the previous year in which it is received, if it is not charged to income tax in any earlier previous year. Therefore, Section 145B(3) of the Act provides that subsidy should be deemed to be the income of the previous year in which it is received which may have not accrued.

Text of Section 145B(3)

(3) The income referred to in sub-clause (xviii) of clause (24) of section 2 shall be deemed to be the income of the previous year in which it is received, if not charged to income-tax in any earlier previous year.

‘Income Computation and Disclosure Standards (“ICDS”)

[Notified by the CBDT under Section 145(2) of the Act vide Notification dated 31.03.2015]

The amendment under Section 2(24)(xviii) of the Act, has also been made in order to align the provision of Income Computation and Disclosure Standard-VII, Governments Grants (“ICDS-VII”, in short) with the provisions of the Act. ICDS-VII is applicable with effect from Assessment year 2017-18 and hence, from the said Assessment year, for computing income under the Act, the government grants shall be recognised and dealt with as per the provisions of the said ICDS.

The intention of the Government is to align the provisions of the Income-tax Act with the corresponding treatment provided by ‘Income Computation and Disclosure Standards’ (“ICDS”).

As per ICDS-VII, government grants shall not be recognised until (a) there is reasonable assurance that the person in receipt of the government grant shall comply with the conditions attached to them and (b) the grants shall be received.

ICDSs are applicable only for the purpose of computation of taxable income whereas Accounting Standards are applicable for the purpose of maintenance of books of accounts. Assessee would recognize receipt of subsidy in the books of accounts as per Accounting Standard – 12, Accounting of Government Grants (“AS-12”, in short) or Indian Accounting Standard – 20, Accounting for Government Grants and Disclosure of Government Assistance (“Ind-AS 20”, in short) as applicable. Government grants available to an Assessee are recognized in books of accounts as per AS-12, when (i) there is reasonable assurance that the Assessee will comply with the conditions attached to it and (ii) where such benefits have been earned by the Assessee and it is reasonably certain that the ultimate collection will be made. Therefore, mere receipt of government grant is not sufficient. Further, AS-12 provide for postponement of government grant beyond the date of actual receipt where condition attached to the grant are not fulfilled. Similar provisions are in Ind-AS 20.

The ICDS VII relating to Government Grants prescribes the following treatment for computation of taxable income :

S. No. Nature of Government Grant Treatment Prescribed by ICDS VII

(a) Government grant pertains to a depreciable fixed asset or assets The grant shall be deducted from the actual cost of the asset or assets concerned or from the written down value of block of assets to which concerned asset or assets belonged.

(b) Government grant pertains to a non-depreciable asset or assets of a person requiring fulfillment of certain obligations The grant shall be recognised as income over the same period over which the cost of meeting such obligations is charged to income.

KEY NOTE

In case of any confliction between the provisions of the Income Tax Act, 1961 and the Income Computation and Disclosure Standards, the provisions of the Act shall prevail to that extent.

Thus, from the combined reading of Sections 2(24)(xviii) and 145B(3) of the Act and ICDS-VII, it can be concluded to state that :-

(a) Subsidy shall be recognised as an income of an Assessee as per Section 2(24)(xviii) of the Act, unless the same falls in the exclusion any part the Section 2(24)(xviii) of the Act.

(b) As per Section 143B(3), read with ICDS-VII, recognitions of the subsidy as an income shall not be postponed beyond the date of receipt. Therefore, even if the subsidy has not accrued but the same is received then it shall be recognised as an income of the previous year in which it is received.

Posted on: May 12th, 2021