Subsidies received from govt, under various schemes may be subject to taxes: Case Analysis
Lakshay Parmar 7 Feb 2020

Subsidies received from govt, under various schemes may be subject to taxes: Case Analysis

The term ‘subsidy’ comes from the Latin word subsidy, meaning 'reserve-stationed soldiers’, which essentially means ‘support from behind’. Subsidy means grant in the most common sense. This grant can be either in the form of cash or kind and is usually given to support an economic policy.

Subsidy is generally understood to be a Government-issued grant but this is not a very strict definition. The various forms of subsidy include direct subsidies such as cash grants, interest-free loans, indirect subsidies such as tax breaks, premium-free insurance, low interest loans, write-offs on depreciation, rent rebates etc. Subsidies have been recognized extensively around the world as a tool for enforcing government policies.

Objective of a subsidy and understanding Revenue and Capital receipts

The basic objective of granting a subsidy is to compensate the extra amount of expenditure incurred by the assessee.  Subsidies can be given for many reasons such as setting up of industries etc. Talking about capital receipts and sales receipts in this report, simply put, capital receipts don't impact the company's profit or loss, for example, we might say long-term asset sales are one kind of capital receipts.

Yet tax receipts do impact a company's profit or loss. As an example, it may be assumed that revenue receipts are the selling of goods, the commission obtained etc. The nature and function of capital receipts and revenue receipts are completely different.

In the landmark case of Sahney Steel and Works Ltd. v Commissioner of Income Tax, Andhra Pradesh 1997 228 ITR 253 (SC), in the above case, Hon'ble Supreme Court held that if the object (of subsidy) is to assist the assessee in setting up his business or expanding a project, the money must be regarded as obtained for capital purpose. But if the assessee receives money to assist him in carrying out the business operation and the money is only provided after and conditional upon the start of production, these subsidies must be regarded as aid for the purpose of trade and must be subject to taxes as those subsidies directly affect the profits of the company. The Supreme Court said that ‘motive’ and ‘purpose’ test needs to be applied to determine the nature of subsidy.

In this case the Andhra Pradesh Government gave certain relaxations to the company with regards to its operations. Benefits such as refund on sales tax on raw materials, machinery and finished goods, subsidies relating to power consumption, exemption of water bill when water is taken from sources not maintained by any govt or local body, etc.

In furtherance to this, there were certain conditions regarding the grant of subsidies under this scheme; (1) the subsidies will only be granted when the production has commenced, (2) the availability of incentives would be limited to only 5 years from the date of commencement of production.

Mr. Ganesh who was appearing for the assessee i.e. Sahney Steel Works contented that these incentives were given for rapid industrialisation in the State and the main objective of the incentives were to encourage industrialisation. There they must not be subjected to tax.

The Supreme Court finally held, that the incentives were granted after the company started the production and that the incentives provided were also subject to a time limit. These grants were not just given for setting up of an industry but were provided for conducting smooth production and granting relaxations such as reduced water and electricity bill and reduced  rate of sales tax which could ultimately result in increase in the profits of the company. By observing these points Supreme Court concluded that   these aspects must be treated as revenue receipts and shall be subjected to tax. Hence making it clear that the subsidies provided by the Government would be subjected to tax.

Authors of this post:

1.    Lakshay Parmar

2.    Dilpreet Singh 


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