2025 (4) TMI 1081 - AT - Income Tax

Sales tax subsidies from state governments are capital receipts that must reduce fixed asset costs for depreciation under Section 43(1) Explanation 10

M/s. Munjal Auto Industries Ltd. Versus The Income Tax Officer Ward-4 (1), Baroda

ITAT Ahmedabad held that sales tax subsidies received from Punjab and Haryana state governments constituted capital receipts, as affirmed by SC dismissal ... Nature of receipt - tax treatment of sales tax subsidies received from the State Governments of Punjab and Haryana - whether the sales tax subsidy should be treated as a capital or revenue receipt? - subsequent impact on depreciation computation and Minimum Alternate Tax (MAT) liability u/s 115JB - HELD THAT:- Vide [2018 (5) TMI 1738 - SC ORDER] the Hon’ble Supreme Court dismissed the Revenue’s appeal, thereby affirming the classification of the sales tax subsidy as capital in nature.In light of the Apex Court’s ruling, the characterisation of the subsidy stands conclusively determined. Treatment of the subsidy in relation to the cost of fixed assets, its impact on depreciation computation u/s 43(1) of the Act, and its implications for the determination of book profits under Section 115JB - The fact that the incentive was structured as a deferment of statutory liability, later converted into a capital reserve, does not alter its fundamental nature. Non-payment of a statutory liability is functionally equivalent to a direct inflow of funds, making the subsidy fall squarely within the ambit of Explanation 10 to Section 43(1) of the Act. Consequently, the subsidy must be deducted from the cost of fixed assets for the purpose of depreciation computation. We also take note of the ruling in Kinfra Export Promotion Industrial Parks Ltd. [2022 (4) TMI 809 - KERALA HIGH COURT] where it was held that even financial assistance without reference to a specific asset must be apportioned and deducted from the cost of the assets under Explanation 10 to section 43(1) of the Act. Thus, we hold that the sales tax deferment incentive received by the assessee qualifies for reduction from the actual cost of assets under Explanation 10 to Section 43(1) of the Act. The fact that the subsidy was received after the commencement of production does not alter its fundamental character, as its eligibility was directly tied to the assessee’s fixed capital investment. We reject the assessee’s contention that the mode of receipt determines the applicability of Explanation 10. The statutory liability retained by the assessee is equivalent to an inflow of funds, and thus, the benefit derived from it must be adjusted against the asset cost. Once the asset is merged into the block of assets, its individual character is lost, making the proportionate reduction of subsidy from the block cost mandatory. Thus, as the capital nature of the subsidy is undisputed, and once classified as such, its reduction from the cost of fixed assets follows as a natural consequence under Explanation 10 to section 43(1) of the Act. We direct the AO to recalculate depreciation in accordance with Explanation 10 to Section 43(1). The AO shall reduce the proportionate amount of subsidy from the actual cost of fixed assets, in line with the findings of the Co-ordinate Bench and re- compute depreciation on the revised cost of assets, following the provisions of Section 32 of the Act. Appeals filed by the Revenue are dismissed, and the directions issued to the AO by the Co-ordinate Bench for re-computation of depreciation are upheld. Computation of book profit u/s 115JB - We find merit in the argument of the AR that the AO has no power to tinker with the book profits unless the accounts are not prepared in accordance with Part II & III of Schedule VI of the Companies Act, 1956. The Hon’ble Supreme Court in Apollo Tyers Ltd [2002 (5) TMI 5 - SUPREME COURT] has categorically held that the AO has no authority to alter the book profit unless there is a violation of accounting standards or provisions of the Companies Act. The assessee's treatment of the subsidy is, therefore, in compliance with AS-12 and the Companies Act, 1956. The contention of the DR that the subsidy should be included in book profit due to its impact on depreciation is not supported by any express provision in Explanation 1 to Section 115JB. Since the sales tax subsidy was directly credited to the capital reserve and was never debited to the Profit & Loss Account, the AO was not justified in making an addition to book profit under Section 115JB. The AO’s adjustment in this regard is not justified. Accounts of the assessee were not prepared in accordance with Part II & III of Schedule VI of the Companies Act, 1956 because the subsidy was not appropriately accounted for in book profits and AO, based on this observation, sought to re-compute book profit under Section 115JB - Hon’ble Supreme Court in Apollo Tyers [2002 (5) TMI 5 - SUPREME COURT] has held that once the accounts are certified by the auditors and approved by shareholders, the AO cannot make adjustments unless there is fraud, misrepresentation, or non-compliance with Schedule VI of the Companies Act. There is no finding in the CIT(A)’s order that the accounts were not in accordance with the Companies Act, apart from the difference in accounting treatment of the subsidy. A mere difference in accounting interpretation cannot be a reason to modify book profits under Section 115JB. Therefore, we hold that the accounts of the assessee were correctly prepared, and the AO’s adjustment was beyond his jurisdiction. The principal legal questions considered in these appeals concern the tax treatment of sales tax subsidies received by the assessee from State Governments, specifically:Whether the sales tax subsidy constitutes a capital receipt or a revenue receipt for income tax purposes.Whether, once classified as a capital receipt, the subsidy must be reduced from the actual cost of fixed assets for the purpose of computing depreciation under Section 43(1) of the Income Tax Act, 1961.The applicability and interpretation of Explanation 10 to Section 43(1) regarding the reduction of subsidies from asset cost.The impact of the subsidy on the computation of book profits under Section 115JB of the Act, particularly whether the subsidy credited to capital reserves should be added back to book profits.Whether the Assessing Officer (AO) has jurisdiction to alter the book profits where accounts are prepared in accordance with the Companies Act, 1956 and relevant Accounting Standards.Issue 1: Nature of the Sales Tax Subsidy - Capital or Revenue ReceiptThe legal framework involved the classification of receipts as capital or revenue in nature, a fundamental distinction affecting taxability. The Tribunal and the Hon'ble Gujarat High Court had earlier held the subsidy to be capital in nature. The Hon'ble Supreme Court affirmed this classification, dismissing the Revenue's appeal, thus conclusively determining the subsidy as a capital receipt.The Court reasoned that the subsidy was linked to fixed capital investment and industrial development, even though the quantum was determined post-commencement of production. The subsidy was conditional and could be forfeited if conditions were not met, reinforcing its capital character. The Revenue's argument that the subsidy was to augment normal business operations was rejected in light of the subsidy's conditionality and nexus to fixed capital investment.Issue 2: Applicability of Explanation 10 to Section 43(1) - Reduction of Subsidy from Cost of Fixed AssetsExplanation 10 to Section 43(1), introduced w.e.f. 01.04.1999, mandates that if a portion of the cost of an asset is met directly or indirectly by the Government in the form of subsidy, grant, or reimbursement, such portion must be excluded from the actual cost of the asset for depreciation purposes. The proviso requires apportionment if the subsidy is not directly linked to a specific asset.The Revenue contended that the sales tax subsidy, although received post-commencement, was inherently linked to fixed capital investment and thus must be reduced from the cost of fixed assets. The Assessing Officer's show cause notice and submissions during assessment confirmed the subsidy's nexus to fixed assets. The Revenue relied on Explanation 10 and judicial precedents supporting this interpretation.The assessee argued that the subsidy was not a direct financial assistance for acquiring fixed assets but a post-commencement incentive linked to sales, without a direct nexus to asset acquisition. It relied on the Hon'ble Bombay High Court's decision in Pr. CIT vs. Welspun Steel Ltd., which held that subsidies without direct linkage to fixed assets should not be deducted from asset cost. The assessee also cited Accounting Standard (AS) 12 and decisions emphasizing that only subsidies related to specific fixed assets should reduce asset cost.The Court rejected the assessee's contention, holding that Explanation 10 is a statutory provision overriding earlier judicial interpretations predating its insertion. The mode of receipt-whether direct payment or retention of statutory liability-does not affect the subsidy's treatment. Non-payment of statutory liability equates to an inflow of funds, falling within Explanation 10's ambit. The subsidy's conditionality and linkage to fixed capital investment confirmed its capital nature and eligibility for reduction from asset cost.The Court relied on the Co-ordinate Bench's earlier order directing the AO to recalculate depreciation after reducing the subsidy from fixed asset cost and on the Kerala High Court's ruling in Kinfra Export Promotion Industrial Parks Ltd., which upheld proportional reduction even when subsidy was not linked to specific assets.Issue 3: Treatment of Sales Tax Subsidy in Computation of Book Profits under Section 115JBThe assessee challenged the AO's addition of the subsidy amount to book profits under Section 115JB, contending that the subsidy was a capital receipt credited to capital reserves and not routed through the Profit & Loss Account. The assessee argued that the accounts were prepared in accordance with the Companies Act, 1956 and AS-12, which mandates capital grants be credited to capital reserves, not income.The Revenue contended that the creation of a Sales Tax Capital Reserve represented an amount carried to reserves, which under Explanation 1 to Section 115JB, must be added back to book profits. It argued that the subsidy impacted depreciation and net profit, justifying adjustment.The Court held that the AO cannot alter book profits if accounts are prepared as per the Companies Act and Accounting Standards, absent fraud or misrepresentation, citing the Supreme Court's ruling in Apollo Tyres Ltd. The Court found the assessee's treatment consistent with AS-12, which distinguishes capital grants credited to reserves from income recognized in Profit & Loss. The Court rejected the Revenue's contention that the subsidy should be added back due to its impact on depreciation, noting no express provision in Explanation 1 to Section 115JB supports this.Therefore, the AO's addition to book profits was unjustified, and the assessee's ground on this issue was allowed.Issue 4: Jurisdiction of AO to Alter Book Profits Where Accounts Are Prepared in Accordance with Companies ActThe Court emphasized that the AO's power to alter book profits under Section 115JB is circumscribed by the statutory requirement that accounts must be prepared in compliance with the Companies Act and Accounting Standards. The Supreme Court's precedent in Apollo Tyres Ltd. was reiterated, holding that absent non-compliance, misrepresentation, or fraud, the AO cannot modify book profits. The Court found no such violation here and held that the accounts were correctly prepared and approved.Conclusions and DirectionsThe Court concluded that:The sales tax subsidy is a capital receipt as conclusively determined by the Supreme Court.Explanation 10 to Section 43(1) applies mandatorily, requiring the subsidy to be reduced from the actual cost of fixed assets for depreciation computation.The mode of receipt or timing of subsidy does not alter its capital character or the applicability of Explanation 10.The AO must recalculate depreciation after reducing the subsidy from asset cost, providing the assessee an opportunity of hearing.The AO cannot add back the subsidy to book profits under Section 115JB where the accounts are prepared in accordance with the Companies Act and AS-12, and no fraud or misrepresentation is alleged.The assessee's accounts were properly prepared, and the AO's adjustment to book profits was beyond jurisdiction.Accordingly, the appeals filed by the Revenue were dismissed, except for the direction to recalculate depreciation after reducing the subsidy from asset cost. The assessee's appeal was partly allowed by setting aside the addition to book profits and upholding the treatment of subsidy as capital receipt credited to reserves.Significant holdings include the following verbatim excerpts:'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.''Non-payment of a government-mandated liability is tantamount to an additional inflow of funds, and therefore, such incentives fall squarely within the ambit of Explanation 10 to section 43(1) of the Act.''The Hon'ble Supreme Court in Apollo Tyres Ltd. v. CIT (2002) 255 ITR 273 (SC) has categorically held that the AO has no authority to alter the book profit unless there is a violation of accounting standards or provisions of the Companies Act.''The mere credit to reserves does not fall under the specific additions required under Explanation 1 to Section 115JB. The statutory language is clear that amounts specified in clauses (a) to (i) are to be added only if they are debited to the statement of profit and loss.'These principles establish that capital subsidies must be deducted from asset cost for depreciation, and that book profits computed as per statutory accounting standards cannot be arbitrarily altered by the tax authorities without statutory basis or evidence of non-compliance.