The assessee-company derived income from the manufacture of yarn, synthetic fabrics, etc. In the earlier assessment year, it had also commenced manufacture of polyester staple fibre in its unit in Patalganga. In the return of income filed by the assessee for the A.Y. 1986-87 in computing the total income a sum of Rs.14,70,40,220 was reduced from the net profit of Rs.71,33,74,748 being subsidy (notional sales tax liability) in the nature of capital receipt. According to the assessee, to encourage setting of new industrial units in backward areas of Maharashtra, the State Government instead of giving cash subsidy, allowed the assessee to retain sales tax payable to the State Government. The Assessing Officer disallowed the claim for the reasons given in the assessment order and first Appellate order for A.Y. 1984-85, in which it was held that the assessee had already got remission by way of exemption of sales tax and there was no ground for taking notional sales tax liability as notional receipt. On appeal, the Commissioner (Appeals) following his earlier order rejected the ground of appeal on the above issue. The Tribunal referred the matter to the Special Bench, since the Tribunal in the earlier orders in the assessee’s own case for the A.Ys. 1984-85 and 1985-86 had held that the sales tax incentive was a capital receipt, but thereafter after considering the above judgments, the Bombay Bench of the Tribunal, in the case of Bajaj Auto Ltd. (ITA Nos. 49 and 1101 of 1991, dated 31-12-2002) had rejected the assessee’s claim that the incentive was a capital receipt on various grounds. The Special Bench of the Tribunal held as under:
“The Scheme framed by the Government of Maharashtra in 1979 and formulated by its Resolution dated 5-1-1980 has been analysed in detail by the Tribunal in its order in RIL for the A.Y. 1985-86 which we have already referred to the extenso. On an analysis of the Scheme, The Tribunal has come to the conclusion that the thrust of the Scheme is that the assessee would become entitled for the sales tax incentive even before the commencement of the production, which implies that the object of the incentive is to fund a part of the cost of the setting up of the factory in the notified backward area. The Tribunal has at more than one place, stated that the thrust of the Maharashtra Scheme was the industrial development of the backward districts as well as generation of employment, thus establishing a direct nexus with the investment in fixed capital assets. It has been found that the entitlement of the industrial unit to claim eligibility for the incentive arose even while the industry was in the process of being set up. According to the Tribunal, the Scheme was oriented towards and was subservient to the investment in fixed capital assets. The sale tax incentive was envisaged only as an alternative to the cash disbursement and by its very nature was to be available only after production commenced. Thus, in effect, it was held by the Tribunal that the subsidy in the form of sales tax incentive was not given to the assessee for assisting it in carrying out the business operations. The object of the subsidy was to encourage the setting up of industries in the backward area.”
On appeal, the High Court noting the above held that a finding has been recorded that the object of the subsidy was to encourage the setting up of industries in the backward area by generating employment therein. In our opinion, in answering the issue, the test as laid down by the Supreme Court in Commissioner of Income-tax v. Ponni Sugars and Chemicals Ltd., (2008) 306 ITR 392 (SC) will have to be considered. The Supreme Court has held that the test of the character of the receipt of a subsidy in the hands of the assessee under a scheme has to be determined with respect of the purpose for which the subsidy is granted. The Supreme Court further observed that in such cases, what has to be applied is the purpose test. The point of time at which the subsidy is paid is not relevant. The source is immaterial. Form of subsidy is material. The Supreme Court then proceeded to observe as under:
“The main eligibility condition in the Scheme with which we are concerned in this case is that the incentive must be utilised for repayment of loans taken by the assessee to set up new units or for substantial expansion of existing units. On these aspects there is no dispute. If the object of the subsidy Scheme was to enable the assessee to run the business more profitably than the receipt is on revenue account. On the other hand, if the object of the assistance under the subsidy Scheme was to enable the assessee to set up a new unit or to expand the existing unit than the receipt of the subsidy was on capital account.”
The High Court applying the purpose test based on the findings recorded by the Special Bench observed that the object of the subsidy was to set up a new unit in a backward area to generate employment. The High Court therefore held that the subsidy was clearly on capital account.
On an appeal by the Revenue, the Supreme Court held that the High Court ought not to have dismissed the appeal without inter alia considering the following question, which did arise for consideration:
“Whether on the facts and in the circumstances of the case and in law the Hon’ble Tribunal was right in holding that sales tax incentive is a capital receipt?”
The Supreme Court allowed the civil appeals and set aside the impugned order of the High Court and remitted the matter back to the High Court to decide the question, formulated above, in accordance with the law.
