State capital subsidy for small hydro power project-whether it reduces depreciable asset cost; depreciation disallowance overturned.

The dominant issue was whether a State capital subsidy received for setting up a small hydro power project constituted a receipt toward the cost of depreciable assets warranting reduction of actual cost and consequent restriction of depreciation. Applying the "purpose test," the Tribunal held the subsidy scheme's conditions showed the support was to encourage entrepreneurs, not to meet asset cost, as release could be deferred until successful commissioning and generation. It further held that s. 2(24)(xviii) had only prospective operation and did not govern the relevant AY. Consequently, the AO's reduction of asset cost and disallowance of depreciation (affirmed by CIT(A)) was set aside and the depreciation disallowance was deleted.

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1. ISSUES PRESENTED AND CONSIDERED

(i) Whether the financial support/subsidy received under the Small Hydro Power policy scheme was required to be reduced from the "actual cost" of depreciable assets, thereby warranting withdrawal of depreciation claimed, on the footing that the subsidy met the cost of plant and machinery.

(ii) Whether the insertion of section 2(24)(xviii) (introduced w.e.f. 01.04.2016) could be applied to the relevant assessment year to justify treating the subsidy as "income" or otherwise support reduction from actual cost and consequent depreciation disallowance.

2. ISSUE-WISE DETAILED ANALYSIS

Issue (i): Reduction of subsidy from actual cost and withdrawal of depreciation

Legal framework (as discussed by the Tribunal): The Tribunal examined the principle governing when a subsidy is considered as having met the cost of an asset for purposes of reducing the "actual cost", and applied the approach that only a subsidy intended to offset the cost of acquiring/installing the asset warrants such reduction; a subsidy intended to encourage industrial development or setting up of projects, though quantified with reference to capacity/investment, does not ipso facto meet the asset cost.

Interpretation and reasoning: The Tribunal analysed the subsidy scheme features relied upon by the tax authority (release linked to placement of orders for equipment, disbursement of loans, commissioning, performance tests, and routing through financial institutions to reduce term loan). The Tribunal held these clauses reflected a mechanism for release and monitoring of financial support, not a purpose to reimburse or directly meet the cost of specific depreciable assets. The Tribunal emphasised that (a) the second instalment could be released after successful commissioning/commercial generation/performance testing, and (b) the first instalment was optional and the entire support could be released after commissioning, indicating the support was not intrinsically tied to meeting the purchase cost of any particular asset. On this construction, the Tribunal accepted the assessee's explanation that the subsidy was granted to encourage entrepreneurs to set up small hydro power projects in the concerned States rather than to meet the asset cost.

Conclusions: The Tribunal conclusively held that the subsidy was not towards meeting the cost of the assets on which depreciation was claimed, and therefore the tax authority was not justified in reducing the cost of fixed assets by the subsidy amount and withdrawing depreciation. The depreciation disallowance (computed by withdrawing depreciation attributable to the subsidy amount) was deleted.

Issue (ii): Applicability of section 2(24)(xviii) (w.e.f. 01.04.2016) to the relevant assessment year

Legal framework (as discussed by the Tribunal): The Tribunal addressed the statutory amendment inserting section 2(24)(xviii) with effect from 01.04.2016 and considered its temporal operation as relevant to the assessment year in question.

Interpretation and reasoning: The Tribunal relied on a coordinate bench determination in the assessee's own matters for earlier years that the insertion of section 2(24)(xviii) is prospective and does not affect the law applicable to assessment years prior to 01.04.2016. The Tribunal applied the same reasoning to the present assessment year, rejecting the approach of using the post-01.04.2016 amendment to justify the impugned adjustment/disallowance for the relevant year.

Conclusions: The Tribunal held that section 2(24)(xviii), being prospective from 01.04.2016, could not be applied to the assessment year under consideration to support taxing treatment or reduction of subsidy from asset cost. Consequently, the basis adopted by the tax authority and affirmed in appeal on this point was not sustainable.

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