Taxation of Subsidy under Income Tax Law

General Definition of Subsidy

A subsidy is a form of financial aid or support extended to an economic sector (or institution, business, or individual) generally with the aim of promoting economic and social policy.

Debatable points regarding the Taxability of Subsidy

  • Whether the concessional receipt would  be  brought within the purview of tax as the same has been advanced for the purpose of stimulating and incrementing the profit earning capacity of business entities or to encourage setting up of industrial units in low profile areas?
  • Whether such chief and vital source of receipt is attributable towards the profit making activity of the business entity or towards capacity building & utility expansion?

These issues have passed through the judicial scrutiny in plethora of cases adjudicated and settled upon by  various High courts & including the Hon’ble Supreme Court of India. The ever growing dispute concerning the taxability of subsidy (by whatever name called) has been dealt prospectively by the provision of Finance Act,2015 w.e.f 01.04.2016.

Prior to the amendments made in Finance Act 2015, Court’s settled the law on the distinction between subsidy of a capital nature and that of a revenue nature:-

  • Hon’ble Supreme Court in the case of Sahney Steel & Pressworks Limited and Ponni Sugars & Chemicals Limited have principally applied the ‘motive’ or ‘purpose’ test to determine the nature of subsidy. If the object of the subsidy scheme is to enable the tax payer to run the business more profitably or reimburse the costs incurred in running the business, then the subsidy would qualify as taxable revenue receipt. On the other hand, if the object of the assistance under the subsidy scheme is to enable the tax payer to set up a new unit or to expand the existing unit then the subsidy would qualify as capital receipt. Capital subsidies were held as not taxable – subject, to reduction from ‘actual cost’ of asset in case of depreciable assets.
  • The Hon’ble High Court of Bombay in Commissioner of Income Tax vs. Kirloskar Oil Engines Ltd [2014] 364 ITR 88 (Bombay)has settled that when subsidy is received by the assessee for setting up a new unit, then receipt of subsidy is on capital account.
  • The grant of `Power Subsidy’ also came under the lens of the Andhra Pradesh High Court in Commissioner of Income Tax vs. Rassi Cement Limited [2013] 351 ITR 169.The Hon’ble High Court placing its due reliance upon the verdict of the Supreme Court in Sahney Steel & Press Works Ltd vs. Commissioner of Income Tax, [1997] 94 Taxman 368 (SC) has held that subsidy received by the assessee from the State Government on the basis of actual consumption of power has to be treated as revenue receipt and not as having an element of capital receipt and hence subject to taxation.
  • The Hon’ble Bombay High Court has held in the case of Commissioner of Income Tax Vs. Chaphalkar Brothers [2013] 351 ITR 309 (Bombay)Where object of entertainment duty subsidy was to promote construction of multiplex theatre complexes, receipt of subsidy would be on capital account.

Finance Act,2015 w.e.f 01/04/2016 with due insertion of Sub clause (xviii) in section 2(24) of the Income Tax Act,1961 providing an inclusive definition of the expression ‘Income ‘ under the taxing law.

Relevant portion of Sub-clause (XVIII) is:-

2(24)(xviii) 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.

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

(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

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.

The amendment made in Section 2(24) of the Income Tax Act that pertains to income apply to all taxpayers. Even if the intent was to only tax business income, a plain reading of the law encapsulates all subsidies. Clarification was issued by the Central-Government that, “The provision in the Finance Bill, 2015, will not affect the LPG subsidy and other welfare subsidies received by individuals.”

To clarify the intent behind the proposed amendment, Ministry of Finance issued a Press Release on 5 May 2015 to state that the amendment was made to align the provisions of the IT Act with those in ICDS.

  • It deals with Government Grants notified by the Central Board of Direct Taxes vide notification No. SO 892(E) dated 31st March 2015
  • It is applicable for computation of income chargeable under the head ‘PGBP’ or ‘Income from other sources’, any government grant such as subsidies, cash incentives, duty drawbacks, waiver, concessions, reimbursements etc.
  • It does not deal with:

       (a) Government assistance other than in the form of Government grants;

       (b) Government participation in the ownership of the enterprise.

  • “Government” refers to the Central Government, State Governments, agencies and similar bodies, whether local, national or international.
  • It exclude those forms of Government assistance which cannot have a value placed upon them and the transactions with Government which cannot be distinguished from the normal trading transactions of the person.

 

Recognition of Government grants

  • Government grants should not be recognized until there is reasonable assurance that the person shall comply with the conditions attached to them, and the grants shall be received.
  • Recognition of Government grant shall not be postponed beyond the date of actual receipt.

All the Government grants which meet the recognition criteria on or after 1st day of April, 2015 shall be recognised for the previous year commencing on or after 1st day of April, 2015 in accordance with the provisions of this standard after taking into account the amount, if any, of the said Government grant recognised for any previous year ending on or before 31st day of March, 2015

 Treatment of Government grants

a) Depreciable assets – shall be deducted from actual cost of the asset or written down value of block of assets to which concerned asset or assets belonged to.

b)Where the Government grant relates to a Non-Depreciable asset or assets of a person requiring fulfilment 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.

c) 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.

d) The Government grant that is receivable as compensation for expenses or losses incurred in a previous financial year or for the purpose of giving immediate financial support to the person with no further related costs,shall be recognised as income of the period in which it is receivable.

e) Any other government grant other than mentioned above shall be recognized as income over the periods necessary to match them with the related costs, which they are intended to compensate.

f) Non-Monetary Grants :The Government grants in the form of non-monetary assets, given at a concessional rate, shall be accounted for on the basis of their acquisition cost.

In case of refunds attributable to depreciable assets, the amount refundable in respect of a Government grant related to a depreciable fixed asset or assets shall be recorded by increasing the actual cost or written down value of block of assets by the amount refundable. Where the actual cost of the asset is increased, depreciation on the revised actual cost or written down value shall be provided prospectively at the prescribed rate.

In case of refunds attributable to non-depreciable assets, shall be applied first against any unamortised deferred credit remaining in respect of the Government grant to the extent that the amount refundable exceeds any such deferred credit, or where no deferred credit exists, the amount shall be charged to profit and loss statement.

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.