2025 (9) TMI 1200 - HC - Income Tax

State incentives for building new multiplex complexes are capital receipts; Rule 8D applies prospectively from AY 2008-09

HC held that state incentives/subsidies for development of new multiplex complexes are capital receipts, aligning with precedent in favour of the ... Nature of receipt - incentive/ subsidy given by state Governments on account of development of new Multiplexes in the state - capital or revenue receipt - HELD THAT:- Undisputedly, the purpose of the Scheme in the present case is also to encourage the development of the multiplex theatre complexes, which are capital intensive in nature. Thus, the questions sought to be raised are squarely covered in favour of the Assessee by the decision of M/s Chaphalkar Brothers Pune [2017 (12) TMI 816 - SUPREME COURT] Disallowance u/s 14A - prospectivity or retrospectivity of the amendment has concluded that Rule 8D - HELD THAT:- Rule 8D is prospective in operation and could not have been applied to any assessment year priord to Assessment Year 2008-09. ISSUES PRESENTED AND CONSIDERED 1. Whether entertainment tax collected and retained by an assessee as an incentive/subsidy given by State Governments for development of new multiplexes is capital or revenue in nature. 2. Whether expenditure in respect of Employee Stock Option Plans (ESOP) and Employee Stock Purchase Schemes (ESPS), being difference between grant price and market price at grant, is allowable as revenue expenditure under section 37(1). 3. Whether Rule 8D (relating to disallowance under section 14A read with Rule 8D) is applicable to the assessment year in question (i.e., whether Rule 8D operates prospectively) and whether the Assessing Officer's disallowance under section 14A read with Rule 8D was correctly made. 4. Whether disallowances (depreciation under section 43(1), ESOP/ESPS expenditure, and section 14A disallowance) are to be considered in computing book profit under section 115JB. 5. Whether the Tribunal's order on the above items is perverse in law or on facts. ISSUE-WISE DETAILED ANALYSIS Issue 1 - Nature of entertainment tax retained as incentive/subsidy: legal framework - The central test applied is whether a receipt is capital or revenue in nature determined by the purpose/object of the receipt; payments or concessions given to encourage capital formation or construction of capital-intensive projects are to be treated as capital receipts. Precedent Treatment - The Court followed and applied binding higher court authority which applied the 'purpose test' (as articulated in earlier apex decisions) to hold entertainment-tax concessions granted to encourage construction of multiplex complexes are capital in nature. That line of precedent emphasizes that timing, source or form of the subsidy is immaterial; what matters is the object/purpose of the scheme. Interpretation and reasoning - The Tribunal's finding that the entertainment tax retained by the assessee is a capital receipt was examined against the stated object of the State scheme: to promote construction of multiplex theatre complexes which are capital intensive and require gestation support. The Court accepted that the scheme's object is unequivocally to assist establishment of capital assets and that the concession, even if operative post-construction, aims at facilitating capital formation. Therefore, the receipt functions as an incentive toward capital expenditure rather than a revenue stream. Ratio vs. Obiter - Ratio: A governmental concession in the form of retained entertainment tax given to promote construction of capital-intensive multiplexes is capital in nature because the dominant purpose is to support capital formation. Obiter: Observations on immateriality of the source, timing and form of subsidy reiterate settled principles from higher authority but serve as explanatory amplification. Conclusions - The Tribunal was justified in treating the entertainment tax retained pursuant to the incentive scheme as capital receipt; no substantial question of law arises for reconsideration on this issue. Issue 2 - Allowability of ESOP/ESPS-related expenditure under section 37(1): legal framework - Section 37(1) permits deduction of revenue expenses laid out 'wholly and exclusively' for the purposes of business. The question is whether the difference between grant price and market price at grant (a contingent/notional figure) constitutes an allowable revenue expense. Precedent Treatment - The Tribunal's approach was assessed in light of High Court authority favorable to the assessee which treated such ESOP/ESPS costs as allowable revenue expenditure, and that authority was followed by the Court in an earlier judgment concerning the same assessee. Interpretation and reasoning - Applying the precedents, the Court found that the ESOP/ESPS cost as quantified (difference between grant and market price) represents an expense incurred for the purposes of business (employee incentivisation) and falls within the ambit of section 37(1). The Tribunal's contrary conclusion was held to be erroneous in law as it failed to give effect to binding judicial interpretation treating the notional/contingent ESOP/ESPS charge as deductible. Ratio vs. Obiter - Ratio: The ESOP/ESPS differential (grant price vs. market price at grant) is allowable as revenue expenditure under section 37(1) where established by binding precedent. Obiter: Discussion on contingent or notional character clarifies that notional nature does not preclude allowability when consistent with judicial interpretation. Conclusions - The Tribunal erred in disallowing the ESOP/ESPS expenditure; following precedent, such expenditure is allowable under section 37(1), and the Tribunal's contrary view is set aside. Issue 3 - Applicability/retrospectivity of Rule 8D and section 14A disallowance for the assessment year: legal framework - Section 14A and Rule 8D govern disallowance of expenditure in relation to tax-free income. The key legal question is whether Rule 8D applies to assessment years prior to its prospective operation. Precedent Treatment - The Court relied on binding supreme judicial pronouncements concluding that Rule 8D is prospective in nature and cannot be applied to assessment years earlier than its effective operation; thus disallowances under Rule 8D cannot be made for such prior years. Interpretation and reasoning - The Tribunal's conclusion that Rule 8D did not apply to the assessment year under consideration was upheld. The Court accepted that the rule's retrospective operation was rejected by higher authority and that applying Rule 8D to pre-effective assessment years would be impermissible. Consequently, any disallowance made solely by applying Rule 8D for the year in question is not sustainable. Ratio vs. Obiter - Ratio: Rule 8D operates prospectively and cannot be applied to assessment years prior to its operative commencement; therefore section 14A disallowances computed solely by Rule 8D are not permissible for such earlier years. Obiter: Commentary on reliance upon specific appellate decisions elucidates the treatment but does not extend beyond the prospective application principle. Conclusions - The Tribunal was correct to hold Rule 8D inapplicable for the assessment year in question; the AO's disallowance under section 14A read with Rule 8D is rejected. Issue 4 - Treatment of specified disallowances in computation of book profit under section 115JB - The computation of book profit under the minimum alternate tax regime requires reconciliation between book profit and certain tax disallowances. Precedent Treatment - The Court treated this issue as consequential to the conclusions on Issues 1-3: where an item is held capital in nature or a disallowance is held inapplicable, it should not be taken into account in computing book profit under section 115JB. Interpretation and reasoning - Since (a) entertainment tax retained was held capital, (b) ESOP/ESPS expenditure was allowable as revenue under section 37(1), and (c) Rule 8D-based disallowance under section 14A did not apply for the year in question, these items cannot be part of book profit adjustments under section 115JB. The Court accordingly treated question 2.4 as consequential and rejected the Revenue's contentions. Ratio vs. Obiter - Ratio: Adjustments to book profit under section 115JB must respect substantive determinations on the nature/allowability of receipts and expenditures; items held capital or allowable, or disallowable only by inapplicable provisions, are excluded from adverse adjustments. Obiter: No extended propositions beyond the consequential application of earlier findings. Conclusions - Disallowances relating to depreciation under section 43(1), ESOP/ESPS expenses and section 14A (as computed by Rule 8D for the year) are not to be considered for computing book profit under section 115JB in the facts of the present assessment year. Issue 5 - Allegation of perversity of the Tribunal's order - The contention that the Tribunal's order is perverse in law or on facts is evaluated in light of the foregoing issues. Interpretation and reasoning - Given that the Tribunal's conclusions on the capital nature of the entertainment-tax incentive, the allowability of ESOP/ESPS expenditure (as per binding judicial interpretation), and the non-applicability of Rule 8D to the assessment year are supported by higher court authority and coherent legal reasoning, the allegation of perversity was rejected. Conclusions - The Tribunal's order is not perverse; no substantial question of law arises for reconsideration and the appeal by the Revenue is dismissed.