Electricity subsidy quantified on power bills is revenue, whatever the scheme's stated object
Justices Prashant Kumar Mishra and Shree Chandrashekhar dismissed Mepco Industries' fourteen-year-old appeal, holding that the purpose test reads a subsidy scheme whole and not through its general object clause.
A power subsidy of Rs 16,20,745 received by a potassium chlorate manufacturer from the Government of Pondicherry is a revenue receipt and taxable, the Supreme Court has held, dismissing an appeal that had been pending since 2012. A Division Bench of Justice Prashant Kumar Mishra and Justice Shree Chandrashekhar accepted that the purpose for which a subsidy is granted decides its character, but held that the purpose must be drawn from the operative provisions of the scheme and not from a general object clause about fostering industry. The judgment also fixes the limits of Sahney Steel, the 1997 decision all four authorities below had relied on: that case does not say every subsidy linked to production or electricity consumption is revenue in nature.
A Rs 16.2 lakh subsidy, four forums, and the same answer each time
Mepco Industries Ltd. manufactures potassium chlorate. For assessment year 1997-98 it received Rs 16,20,745 as electricity subsidy from the Government of Pondicherry and treated the amount as a capital receipt not liable to tax, filing its return on 27 November 1997.
The subsidy came from a Scheme of Power Subsidy that had been in operation since 27 November 1975, framed with the object of fostering industrial growth in the Union Territory. Under the relevant pattern it provided subsidy on power charges for a specified period after production commenced: 33 and one-third per cent of power charges for the first three years, 20 per cent for the fourth year and 10 per cent for the fifth, subject to a ceiling.
The assessment was taken up for scrutiny and completed under Section 143(3) by the Joint Commissioner of Income Tax, Special Range-II, Madurai, by order dated 31 March 2000. The Assessing Officer treated the subsidy as a revenue receipt and added it to taxable income, holding it was given towards revenue expenditure and relying on Sahney Steel and Press Works Ltd., Hyderabad vs Commissioner of Income Tax, A.P.-I, Hyderabad, (1997) 7 SCC 764.
The Commissioner of Income Tax (Appeals), Madurai dismissed the appeal on 12 March 2002. Examining the terms of the subsidy, that authority noted the amount was calculated with reference to power charges, and concluded that its effect was to reduce the cost of power consumed and so assist the profitability of the business.
The Income Tax Appellate Tribunal, Chennai dismissed ITA No. 857 (MDS)/2002 on 28 July 2005. It proceeded on the basis that the subsidy was available only after the unit had been set up and production had commenced, and was granted with reference to the cost of electricity. On Sahney Steel it regarded the subsidy as assistance in carrying on the business rather than a contribution towards the capital outlay of the undertaking, and recorded that there was no case that the subsidy was granted for bringing any new asset into existence.
The Madras High Court dismissed Tax Case (Appeal) No. 1614 of 2005 on 9 July 2012, following its own earlier decision in Commissioner of Income-tax vs Karaikal Chlorates Ltd., 2011 SCC OnLine Mad 2604, which had concerned the power subsidy under the same scheme. Against those concurrent findings Mepco came to the Supreme Court. The Court heard counsel for the appellant and the Additional Solicitor General for the Revenue.
The dispute had been framed in those terms from the start. Mepco's case was that the scheme was meant to encourage the establishment of new industries in backward areas; the Revenue treated the subsidy as assistance towards the cost of power consumed in the course of an existing business. The Bench recorded that the answer must depend on the true character and purpose of the scheme under which the amount was granted, which is why it went to the scheme documents rather than to the arithmetic of the assessment.
What Sahney Steel actually decided, and what it did not
Because every authority below had rested on Sahney Steel, the Bench went back to it. That case examined incentives under an Andhra Pradesh scheme, including relief in electricity and water charges and other concessions for new industries. The Court there noticed that the subsidies were available only after the industry had been set up and production had commenced, and were intended to assist the assessee in carrying on its business; they were not granted for bringing into existence any new capital asset or as a contribution towards capital outlay. It characterised them as operational assistance and held them to be revenue receipts, concluding that “The subsidies are operational subsidies and not capital subsidies.”
Two strands of that reasoning deserve attention because they go directly to Mepco's facts. The first is that Sahney Steel had itself dealt with relief in electricity charges, and said in terms that subsidies by way of refund of sales tax or relief of electricity or water charges could not by any stretch be treated as an aid to setting up the industry; payments were to be made only if and when the assessee commenced production, and then for five years from that date. The second is the rationale the Court offered for calling such payments revenue: the package of incentives was given so that industries could run more profitably for five years from the commencement of production, a helping hand during the early days to bring them to a competitive level with established industries. The object, in other words, was profitability of an existing operation, not the creation of one.
Then comes the part of the present judgment that will be cited. Sahney Steel, the Bench said, examines the substance of the assistance and draws a distinction between a subsidy which helps an assessee set up or complete its capital structure and one which helps it carry on a business already established, the latter bearing the character of a revenue receipt. So understood, Sahney Steel does not lay down that every subsidy linked to production or electricity consumption is invariably revenue in nature. It requires the character of the particular assistance to be determined in the light of the scheme under which it is granted.
The purpose test, and the things it treats as irrelevant
That understanding, the Court said, was reaffirmed in Commissioner of Income Tax, Madras vs Ponni Sugars and Chemicals Limited, (2008) 9 SCC 337, which described Sahney Steel as having laid down the basic test for judging the character of a subsidy: the character of the receipt in the assessee's hands is determined with respect to the purpose for which the subsidy is given. Ponni Sugars named this the purpose test and stripped out three factors as non-decisive — “The point of time at which the subsidy is paid is not relevant.” The source is immaterial. The form is immaterial. What governs is the object the scheme seeks to achieve. If the object is to let the assessee run the business more profitably, the receipt is on revenue account; if it is to let the assessee set up a new unit or substantially expand an existing one, the receipt is on capital account.
What made the Ponni Sugars receipt capital is instructive for the test's practical working. The main eligibility condition in the scheme there was that the incentive be utilised for repayment of loans taken to set up new units or for substantial expansion of existing ones — a condition on the use of the money, written into the scheme itself, tying it to the capital structure. That is the kind of operative provision the purpose test looks for, and it is precisely what the Pondicherry scheme lacks.
Commissioner of Income Tax-I, Kolhapur vs Chaphalkar Brothers, Pune, (2018) 13 SCC 358, showed the test working the other way. The subsidy there took the form of an exemption from entertainment duty, but the Court looked past the form of the incentive and found that the object of the scheme was to encourage the setting up of highly capital-intensive multiplex theatre complexes. The subsidy was held to be capital in nature, with the Court repeating that time of payment, source and form are not determinative and that there is no straightjacket formula for deciding whether an incentive is capital or revenue.
From that line of authority the Bench drew its own proposition, and it is the real holding of the case. The purpose test governs, but the purpose has to be ascertained from the scheme as a whole, and not merely from a general statement of policy or from the nomenclature the Government has used. That a subsidy scheme is intended to encourage industrial growth, employment or the development of a backward area cannot by itself settle the character of the receipt. The court must examine the manner in which the incentive actually operates and the benefit it is designed to confer on the recipient.
Reading the Pondicherry scheme from its operative clauses
Tested that way, the scheme decided the case. The original scheme, published in the Gazette of 27 November 1975, provided power subsidy to new industries, both low tension and high tension consumers, with the stated object of fostering industrial growth in the Union Territory. But the subsidy itself was tied to power charges: the scheme contemplated that the consumer would pay the electricity charges and then claim subsidy with reference to the electricity consumed for the manufacturing process.
The revised pattern approved on 9 December 1985 made the operational character plainer still. Subsidy was to be paid for five years from the date the unit went into production, quantified at 33 and one-third per cent of the actual energy charges paid during the first three years, 20 per cent during the fourth year and 10 per cent during the fifth. By G.O.Ms. No. 47/87 dated 12 August 1987 the Government of Pondicherry described the measure as a power subsidy to industrial units on a tapering basis from the date of commencement of production.
The mechanics pointed the same way. The scheme required the industrial consumer to establish the electricity consumed for the manufacturing process and the charges paid, and quantified the subsidy on that basis; a later arrangement authorised deductions from the current consumption bills of eligible units towards the power subsidy. The subsidy was therefore not an independent grant calculated with reference to capital invested in the undertaking. Its quantum moved directly with the electricity charges incurred in the course of production.
The Bench set out what the scheme does not do, which is the mirror image of the same finding. It does not require the subsidy to be applied towards acquisition of plant or machinery, construction of the factory, repayment of a capital borrowing, or the creation of any other capital asset. The record did not disclose that the amount Mepco received was earmarked for any such capital purpose. The very basis of quantification was expenditure on power consumed in production.
Three arguments the Court rejected
Mepco's main argument was that the broader object of the scheme was to encourage industrial growth and the establishment of industries in a backward area. The Court held that this object cannot be viewed in isolation. An industrial incentive may well carry the broad economic objective of encouraging industrialisation, employment or regional development, while the particular financial assistance it grants is nevertheless intended to meet an operational cost of an industry that has already commenced production. The relevant inquiry is not what the scheme seeks at a high level of generality, but what the particular subsidy is intended to achieve in the hands of the recipient.
The second argument fastened on the scheme's own words, “to foster the growth of industries”. The Bench declined to let one general object clause decide the question while the operative provisions were disregarded. Read as a whole, the scheme implements a general object of industrial development through a specific subsidy on power charges, calculated on actual energy charges and available only for a defined period after production commences. It is that immediate and operative purpose which fixes the character of the receipt.
The third was an argument from business economics: that reducing electricity expenditure leaves more funds with the assessee for its business. The Court held that a subsidy does not lose its revenue character for that reason. The question is whether the Government intended a contribution towards the capital structure or capital assets of the undertaking, and the record disclosed no such feature. The subsidy substitutes for, or reduces, part of an expense the assessee incurs in the ordinary course of manufacturing — the very distinction Sahney Steel draws between an operational subsidy and assistance towards capital outlay.
Two narrower points were dealt with in passing. That Mepco may have taken steps towards establishing the unit before production commenced did not alter the conclusion, because the scheme makes commencement of production the point from which the five-year period runs and the amount thereafter depends on actual energy charges. And the fact that the subsidy was released only after production commenced could not be the sole reason for calling it revenue, since Ponni Sugars holds the time of payment not to be determinative; once the purpose and mechanism of the scheme are examined, however, the commencement-of-production condition takes on significance as one part of the overall scheme.
Order
The Bench found that the Assessing Officer, the Commissioner of Income Tax (Appeals) and the Tribunal had correctly appreciated the nature of the subsidy: given after the unit was established and production had commenced, calculated with reference to power charges, operating to reduce the cost of electricity consumed, and not shown to be a contribution towards bringing any new capital asset into existence. The Madras High Court was equally correct in affirming that conclusion. No interference was called for and the appeal was dismissed.