Commnr. Of Income Tax, Madras vs M/S. Ponni Sugars & Chemicals Ltd

Commissioner of Income Tax, Madras ... Appellant(s)

versus

Ponni Sugars & Chemicals Ltd. ... Respondent(s)

with

Civil Appeal No. 5695/08 (arising out of S.L.P.(C) No. 12355/06), Civil Appeal No. 5696/08 (arising out of S.L.P.(C) No. 21064/06), Civil Appeal No. 5697/08 (arising out of S.L.P.(C) No. 6557/08), Civil Appeal No. 5698/08 (arising out of S.L.P.(C) No. 9823/08), Civil Appeal No. 5699/08 (arising out of S.L.P.(C) No. 18442/04), Civil Appeal No. 5700/08 (arising out of S.L.P.(C) No. 11787/06), Civil Appeal No. 5701/08 (arising out of S.L.P.(C) No. 12778/06), Civil Appeal No. 5702/08 (arising out of S.L.P.(C) No. 12958/06), Civil Appeal No. 5703/08 (arising out of S.L.P.(C) No. 15099/06), Civil Appeal No. 5704/08 (arising out of S.L.P.(C) No. 573/07), Civil Appeal No. 5705/08 (arising out of S.L.P.(C) No. 3948/07), Civil Appeal No. 5706/08 (arising out of S.L.P.(C) No. 6658/07), Civil Appeal No. 5707/08 (arising out of S.L.P.(C) No. 3112/06), Civil Appeal No. 5708/08 (arising out of S.L.P.(C) No. 11963/07), Civil Appeal No. 5709/08 (arising out of S.L.P.(C) No. 14407/07), Civil Appeal No. 5710/08 (arising out of S.L.P.(C) No. 14050/07), Civil Appeal No. 5711/08 (arising out of S.L.P.(C) No. 8290/07), Civil Appeal No. 5712/08 (arising out of S.L.P.(C) No. 6686/08), Civil Appeal No. 5713/08 (arising out of S.L.P.(C) No. 7643/08), Civil Appeal No. 5714/08 (arising out of S.L.P.(C) No. 9584/08) and Civil Appeal No. 5715/08 (arising out of S.L.P.(C) No. 17149/08) 2

JUDGMENT

S. H. KAPADIA, J.

Leave granted.

2. In the above batch of civil appeals, based on the arguments addressed

before us, we are mainly concerned with the following two questions,

namely:

(i) Whether the incentive subsidy received by the assessee is a capital receipt not includible in the total income?

(ii) Whether the assessee was entitled to exemption under Section 80 P(2)(a)(i) of the Income Tax Act, 1961 in respect of interest received from the members of the society?

3. At the outset, it may be noted that this batch of civil appeals covers

four incentive subsidy Schemes of 1980, 1987, 1988 and 1993. All the four

schemes are almost identical. They are different in matter of details.

However, in 1980 and 1987 Schemes there is an additional benefit by way

of rebate in respect of payment of excise duty which is not there in the

remaining two Schemes of 1988 and 1993.

3

4. With the above preface, we refer to the facts in the case of Salem

Cooperative Sugar Mills Ltd (civil appeal arising out of SLP (C) No.

12355/06).

5. That matter concerns the 1980 Scheme. The dispute pertains to

Assessment Year 1986-87. In this matter both the above questions arises for

determination. The incentives conferred under that Scheme were twofold.

First, in the nature of a higher free sale sugar quota and second, in allowing

the manufacturer to collect excise duty on the sale price of the free sale

sugar in excess of the normal quota, but pay to the Government only the

excise duty payable on the price of levy sugar. In that connection, we quote

clause 7 of the Scheme, which reads as under:

"The beneficiaries of the incentive scheme shall ensure that the surplus funds generated through sale of the incentive sugar are utilized for the repayment of term loans, if any, outstanding from the Central Financial institutions. The sugar factories should submit utilization certificates annually from Chartered/Cost Accountant, holding certificate of practice. Utilisation certificate in respect of each sugar season during the incentive period should be furnished on or before the 31st December of the succeeding year. Failure to submit utilization certificate within the stipulated time may result not only in the termination of release of incentive free sale quota, but also in the recovery of the incentive free sale releases 4

already made, by resorting to adjustment from the free sale releases of future years."

6. At this stage, we may again note that the 1980 and 1987 Schemes are

similar to each other. In the case of Salem Cooperative Sugar Mills Ltd. we

are concerned with the Scheme of 1980.

7. On the first question, namely, whether the incentive subsidy received

by the assessee is a capital receipt, Shri P.V. Shetty, learned senior counsel

appearing on behalf of the Department (appellant) submitted that the

additional revenue generated by higher free sale sugar quota cannot be

considered to be a capital receipt in the hands of the assessee (respondent

herein) as held by the High Court. He further contended that similarly

retention of the collective excise duty on the sale price of free sale sugar in

excess of the normal quota and paying to the Government only the excise

duty payable on the price of levy sugar resulted in revenue generation in the

hands of the assessee which contention of the Department has been

erroneously rejected by the High Court. According to the learned counsel,

under the Scheme, there were two distinct concepts, namely, the concept of

accrual of income in the hands of the assessee and the concept of

application of additional funds generated thereunder. According to the

learned counsel, application of additional funds is neither material nor 5

relevant for deciding the character of the incentive subsidy. In this

connection, learned counsel placed reliance on the judgment of this Court in

the case of Sahney Steel and Press Works Ltd. and Ors. v. CIT

reported in (1997) 228 ITR 253.

8. Shri Ganesh, learned senior counsel appearing on behalf of the

assessee submitted that the benefits were conferred on the assessee under

the 1980 and 1987 Schemes, namely, additional price by reason of

enhancement of free sale sugar quota, which resulted in the benefit of

additional price, which price had to be utilized only for repayment of loans

taken by the assessee to establish a new unit or for expanding the existing

unit. The said Schemes were not meant for a running unit. The second

benefit, according to the learned counsel, lay in the rebate of excise duty

under which the assessee was required to pay excise duty on the

manufacture of additional quota of free sale sugar. According to the learned

counsel, in judging the character of the incentive, the "purpose test" is

applicable. In other words, according to the learned counsel, the character of

the receipt in the hands of the assessee had to be determined with respect to

the purpose for which the subsidy was given and that the point of time at

which it is paid or its source or its form was irrelevant. In this connection, 6

learned counsel also places reliance on the same judgment of this Court in

the case of Sahney Steel and Press Works Ltd. (supra).

9. The key question which arises for determination is: what is the

character of the incentive subsidy under the said Schemes?

10. At the outset, it may be stated that during the relevant year in

question, on account of economic factors, namely, high cost, the new sugar

factories could not come up as it was not economically viable. Due to high

cost, the financial institutions did not come forward to advance loans to the

entrepreneurs of new sugar factories. Secondly, the tempo of establishing

new sugar factories received a serious set back, therefore, the Government

appointed a Committee known as Sampat Committee to examine the

question relating to economic viability of new sugar factories. One of the

terms of reference suggested was to work out various incentives for making

new sugar factories economically viable units. The increase of the cost of

the project during the relevant years was on account of the increase in the

cost of Plant and Machinery. The said Committee gave its Report in which

the Committee recommended that the economic viability of a factory would

mean that the unit should not break even after meeting the working 7

expenses, interest on borrowings, depreciation on Plant and Machinery, but

it should also be able to declare a reasonable dividend on the equity capital.

According to the Committee, the factory should be able to generate

sufficient funds to repay the instalments of the term loans. Under Para 21.0

the said Committee stated that five possible incentives for making a sugar

plant economically viable unit could be provided for, namely, capital

subsidy, allowing a larger percentage of free sale sugar, high levy sugar

price, allowing rebate on excise duty and remission of purchase tax. In this

case, we are concerned with allowability of a larger percentage of free sale

sugar and rebate on excise duty. Following the said Report of the Sampat

Committee, the above Schemes came to be formulated.

11. We have examined in this case the 1980 and 1987 Schemes.

Essentially all the four schemes are similar except in the matter of details.

Four factors exist in the said Schemes, which are as follows:

(i) Benefit of the incentive subsidy was available only to new units and to substantially expanded units, not to supplement the trade receipts.

(ii) The minimum investment specified was Rs. 4 crores for new units and Rs. 2 crores for expansion units.

8 (iii) Increase in the free sale sugar quota depended upon increase in the production capacity. In other words, the extent of the increase of free sale sugar quota depended upon the increase in the production capacity.

(iv) The benefit of the scheme had to be utilized only for repayment of term loans.

12. One important aspect may also be noted that in the case of Salem

Cooperative Sugar Mills Ltd. we are concerned with Notification dated

15.11.1980. It indicates the above factors of the Scheme. The important

point to be noted is that Government of India, financial institutions as well

as the sugar industries are parties to the scheme in the sense that but for the

scheme the financial institutions would not have given term loans to set up

new units/expansion of the existing units.

13. The main controversy arises in these cases because of the reason that

the incentives were given through the mechanism of price differential and

the duty differential. According to the Department, price and costs are

essential items that are basic to the profit making process and that any price

related mechanism would normally be presumed to be revenue in nature. In

other words, according to the Department, since incentives were given

through price and duty differentials, the character of the impugned incentive 9

in this case was revenue and not capital in nature. On the other hand,

according to the assessee, what was relevant to decide the character of the

incentive is the purpose test and not the mechanism of payment.

14. In our view, the controversy in hand can be resolved if we apply the

test laid down in the judgment of this Court in the case of Sahney Steel and

Press Works Ltd. (supra). In that case, on behalf of the assessee, it was

contended that the subsidy given was up to 10% of the capital investment

calculated on the basis of the quantum of investment in capital and,

therefore, receipt of such subsidy was on capital account and not on revenue

account. It was also urged in that case that subsidy granted on the basis of

refund of sales tax on raw materials, machinery and finished goods were

also of capital nature as the object of granting refund of sales tax was that

the assessee could set up new business or expand his existing business. The

contention of the assessee in that case was dismissed by the Tribunal and,

therefore, the assessee had come to this Court by way of a special leave

petition. It was held by this Court on the facts of that case and on the basis

of the analyses of the Scheme therein that the subsidy given was on revenue

account because it was given by way of assistance in carrying on of trade or

business. On the facts of that case, it was held that the subsidy given was to 10

meet recurring expenses. It was not for acquiring the capital asset. It was not

to meet part of the cost. It was not granted for production of or bringing into

existence any new asset. The subsidies in that case were granted year after

year only after setting up of the new industry and only after commencement

of production and, therefore, such a subsidy could only be treated as

assistance given for the purpose of carrying on the business of the assessee.

Consequently, the contentions raised on behalf of the assessee on the facts

of that case stood rejected and it was held that the subsidy received by

Sahney Steel could not be regarded as anything but a revenue receipt.

Accordingly the matter was decided against the assessee. The importance of

the judgment of this Court in Sahney Steel case lies in the fact that it has

discussed and analysed the entire case law and it has laid down the basic

test to be applied in judging the character of a subsidy. That test is that the

character of the receipt in the hands of the assessee has to be determined

with respect to the purpose for which the subsidy is given. 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. The main eligibility condition in the scheme with

which we are concerned in this case is that the incentive must be utilized for

repayment of loans taken by the assessee to set up new units or for 11

substantial expansion of existing units. 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. Therefore, it is the object

for which the subsidy/assistance is given which determines the nature of the

incentive subsidy. The form of the mechanism through which the subsidy is

given is irrelevant.

15. In the decision of House of Lords in the case of Seaham Harbour

Dock Co. v. Crook (1931) 16 TC 333 the Harbour Dock Co. had applied

for grants from the Unemployment Grants Committee from funds

appropriated by Parliament. The said grants were paid as the work

progressed the payments were made several times for some years. The Dock

Co. had undertaken the work of extension of its docks. The extended dock

was for relieving the unemployment. The main purpose was relief from

unemployment. Therefore, the House of Lords held that the financial

assistance given to the company for dock extension cannot be regarded as a

trade receipt. It was found by the House of Lords that the assistance had

nothing to do with the trading of the company because the work undertaken 12

was dock extension. According to the House of Lords, the assistance in the

form of a grant was made by the Government with the object that by its use

men might be kept in employment and, therefore, its receipt was capital in

nature. The importance of the judgment lies in the fact that the company had

applied for financial assistance to the Unemployment Grants Committee.

The Committee gave financial assistance from time to time as the work

progressed and the payments were equivalent to half the interest for two

years on approved expenditure met out of loans. Even though the payment

was equivalent to half the interest amount payable on the loan (interest

subsidy) still the House of Lords held that money received by the company

was not in the course of trade but was of capital nature. The judgment of

House of Lords shows that the source of payment or the form in which the

subsidy is paid or the mechanism through which it is paid is immaterial and

that what is relevant is the purpose for payment of assistance. Ordinarily

such payments would have been on revenue account but since the purpose

of the payment was to curtail/obliterate unemployment and since the

purpose was dock extension, the House of Lords held that the payment

made was of capital nature.

16. One more aspect needs to be mentioned. In Sahney Steel and Press

Works Ltd. (supra) this Court found that the assessee was free to use the 13

money in its business entirely as it liked. It was not obliged to spend the

money for a particular purpose. In the case of Seaham Harbour Dock Co.

(supra) assessee was obliged to spend the money for extension of its docks.

This aspect is very important. In the present case also, receipt of the subsidy

was capital in nature as the assessee was obliged to utilize the subsidy only

for repayment of term loans undertaken by the assessee for setting up new

units/expansion of existing business.

17. Applying the above tests to the facts of the present case and keeping

in mind the object behind the payment of the incentive subsidy we are

satisfied that such payment received by the assessee under the Scheme was

not in the course of a trade but was of capital nature. Accordingly the first

question is answered in favour of the assessee and against the Department.

18. Coming to the second question, namely, whether the assessee was

entitled to exemption under Section 80 P(2)(a)(i) of the Income Tax Act,

1961 ("1961 Act") in respect of interest received from the members of the

society, we find that none of the authorities below, including the High

Court, have examined the Memorandum of Association filed by Salem

Co-operative Sugar Mills Ltd., Madurantakam Co-operative Sugar Mills

Ltd., Ambur Co-operative Sugar Mills Ltd., Dharampuri District 14

Co-operative Sugar Mills Ltd., Vellore Co-operative Sugar Mills Ltd., Attur

Agricultural. Producers Co-operative Society Ltd. and Modern Engineers

Construction Co-operative Society Ltd.. Under Section 80 P(1) deduction

in respect of income of co-operative societies is provided for. Under Section

80 P(1), where the gross total income of a co-operative society includes any

income referred to in sub-section (2) then the sums specified in sub-section

(2) shall be deducted from the gross total income to arrive at the total

income of the assessee-society. In order to earn exemption under Section 80

P(2) a co-operative society must prove that it had engaged itself in carrying

on any of the several businesses referred to in sub-section (2). In that

connection, it is important to note that under sub-section (2), in the context

of co-operative society, Parliament has stipulated that the society must be

engaged in carrying on the business of banking or providing credit facilities

to its members. Therefore, in each case, the Tribunal was required to

examine the Memorandum of Association, the Articles of Association, the

Return of Income filed with the Department, the status of business indicated

in such Returns etc.. This exercise had not been undertaken at all.

19. For the aforestated reasons, we set aside the impugned judgments of

the High Court and remit the matters to the Tribunal for de novo 15

consideration in accordance with law. All the contentions on both sides are

expressly kept open.

20. In addition to the above two questions, one more question arises for

consideration in the civil appeal arising out of SLP (C) No. 573/07

[CIT, Salem v. Dharampuri District Co-operative Sugar Mills Ltd.] filed

by the Department is: whether the area development funds collection by

sugar mills would be trading receipt?

21. In view of the judgment of the Bombay High Court in CIT v.

Chhatrapati Sahakari Sakhar Karkhana Ltd. reported in

(2000) 245 ITR 498 the matter is remitted to the Tribunal for de novo

consideration in accordance with law and in accordance with the directions

given therein.

22. Accordingly, the appeals filed by the Department are partly allowed

with no order as to costs.

.................................J. (S.H. Kapadia) 16

.................................J. (B. Sudershan Reddy) New Delhi;

September 16, 2008.