Taxation of Subsidy, Grant & Incentives

To promote economic and social policy, Government do offers incentives in various forms like capital investment subsidy, sales tax/SGST subsidy, Stamp duty waiver, production subsidy, cash assistance, Electricity duty concessions, Octroi reimbursement, export subsidy, duty drawback, etc. All this are nothing but the financial aids given to specified institution, business, or individuals with an aim to stimulate the process of setting up, expanding or promoting industrial units in the region. A common question emerges, whether receipt of subsidy is taxable or tax free in the hands of the recipient. Whether it is income within the purview of income tax? The issue has been subject to judicial scrutiny in plethora of cases by courts & finally the disputes was put to rest by the Finance Act-2015.

Taxability prior to 2015:

1. Prior to 2015, there was no provision in the Income-tax Act, 1961 which explicitly dealt with taxability of subsidies & the issue was full of divergent views, litigation & judicial pronouncements.

2. Courts have almost settled the law by distinguishing the subsidy of a capital nature from subsidy of revenue nature. Primarily, the taxability of subsidy was dependent by its categorization i.e., whether the subsidy is a capital receipt or revenue receipt

3. Supreme Court in the case of Sahney Steel & Pressworks Limited & Ponni Sugars & Chemicals Limited has applied the ‘motive’ or ‘purposive’ test to determine the nature of subsidy.

   i) If the object of the incentive scheme was 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 revenue receipt and was considered as taxable.

   ii) On the other hand, if the object of the assistance was under the subsidy scheme to enable the taxpayers to set up a new unit or to expand the existing unit then the subsidy was reckoned as capital receipt. Such capital subsidies were held as not taxable. However, such capital subsidy was required to be reduced from ‘actual cost’ of asset in case of depreciable assets.

Provision after amendment by the Finance Act – 2015

1. Finance Act,2015 has inserted sub clause (xviii) in section 2(24) of the Income Tax 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.

2. 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.

3. 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 short, 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.

4. Taxability even if subsidy is subject to terms, conditions & other stipulations:
   As per Section 145B(3), income by way of subsidy, grant etc is deemed to be the income of the year in which it is received, if it is not charged to income tax in any earlier previous year. In short, Section 145B(3) of the Act specifically provides that subsidy should be deemed to be the income of the previous year in which it is received, even though it has not de facto accrued.

LPG Subsidy:

Clarification was issued by the Central-Government that above definition of stretched definition of income will not affect the domestic LPG subsidy and other welfare subsidies received by individuals.

Relevant part of Income Tax Act:

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.

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