Concept of Capital Subsidy vs Revenue Subsidy under Income Tax Act

Time and again through various judgments courts have tried to demarcate between Capital and Revenue subsidy for taxability purpose. It is the purpose of the incentive or the subsidy which decides its nature and not the modality or the source thereof. It is the object for which the subsidy/assistance is given which determines the nature of the incentive subsidy

Hon'ble Apex Court in the case of CIT - vs.- Ponni Sugars & Chemicals Ltd. reported in (2008) 306 ITR 392 (SC) wherein it has been held that it is the purpose of the incentive which decides its nature and not the modality or the source thereof. In other words, in such cases, one has to apply the purpose test. The point of time at which the subsidy is paid is not relevant. The source is immaterial. The form of subsidy is immaterial.. On this aspect there is no dispute. If the object of the subsidy scheme was to enable the assessee to run the business more profitably then 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 then the receipt of the subsidy was on capital account.

For example, if the scheme was that the assessee will be given refund of sales tax on purchase of machinery as well as on raw materials to enable the assessee to acquire new plants and machinery for further expansion of its manufacturing capacity in a backward area, the entire subsidy must be held to be a capital receipts in the hands of the assessee. It will not be open to the Revenue to contended that the refund of sales tax paid on raw materials or finished products must be treated as revenue receipts in the hand of the assessee. In both the cases , the Government is paying out of public funds to the assessee for definite purpose.

Recently Sundaram Finance Limited Vs. Assistant Commissioner of Income Tax Subsidy / remittance received for any business link or services rendered by the Assessee to the UK based company towards subscribing the share capital of the joint venture to be capital receipt in the hands of the Assessee and it cannot be brought to tax as Revenue Receipt

Therefore, in order to determine the nature of subsidy we must see its object for which the subsidy/assistance is given. The form of the mechanism through which the subsidy is given is irrelevant