2025 (6) TMI 1903 - AT - Income Tax

Nature and character of subsidy/incentive received under The New Sugar Promotion Policy 2004 of the Government of Uttar Pradesh - whether capital or revenue receipt? - assessee is a resident corporate entity engaged in manufacturing and sale of sugar - HELD THAT - On perusal of the facts and materials on record it is noticed that it is a legacy issue recuring from A.Y. 2007-08 onwards. While deciding the issue for the first time in A.Y. 2007-08 the Tribunal 2023 (1) TMI 1482 - ITAT MUMBAI has decided the issue in favour of the assessee holding that the subsidy/incentives received under New Sugar Promotion Policy issued by Government of Uttar Pradesh is capital in nature . Thus we hold that the subsidy/incentive received under The New Sugar Promotion Policy 2004 of the Government of Uttar Pradesh being in the nature of capital receipt is not taxable. Hence this ground is decided in favour of the assessee. Addition of an amount on account of non-reconciliation of ITS details - HELD THAT - Once the assessee denies its involvement in the transactions duty is cast upon the AO to make thorough enquiry and ascertain the veracity of assessee s claim. Departmental authorities in our view have failed to do so. Insofar as the alleged transaction with Rauzagaon Chini Mills (A unit of Balrampur Chini Mills Ltd.) Faizabad is concerned the assessee has submitted before us that the concerned party has uploaded revised Form 26AS wherein the particular transaction does not appear in the name of the assessee. A.O. is directed to factually verify this fact and delete the addition. Insofar as the rest of the transactions alleged to have been entered into with Standard Chartered Bank Fort Mumbai and American Express Bank Ltd. it is the duty of the A.O. to make proper enquiry to ascertain whether the transactions actually relate to the assessee or not. In case the transactions do not relate to the assessee the additions made have to be deleted. This ground is allowed for statistical purpose. Incentives received under the New Sugar Industry Promotion Policy ought to be reduced while computing the book profit u/s 115JB - As adjudicated the ground no. 2 of the assessee holding that incentive received under the New Sugar Industry Promotion Policy 2004 of Uttar Pradesh Government are of the nature of capital receipt therefore we direct the assessing officer to reduce the same while computing the book profit u/s 115JB of the Act. Disallowance u/s.14A read with Rule 8D(2) - suo motu the assessee has disallowed an amount based on proportionate salary cost of employees engaged in investment activity rent office administration electricity etc. - HELD THAT - Factual matrix reveals that the suo motu disallowance of expenses u/s. 14A of the Act was made by the assessee adopting a consistently followed method. While computing the disallowance the assessee has taken into account proportionate salary cost of persons engaged in investment activity office administration electricity office equipment and depreciation and miscellaneous expenses. A reading of the assessment order clearly reveals that before rejecting assessee s computation of suo motu disallowance and applying Rule 8D the A.O. has not recorded any positive satisfaction to establish that the suo motu disallowance made by the assessee is incorrect having regard to its accounts. Further the fact that the assessee has surplus interest free fund could not be controverted by the Revenue. As in assessee s case in A.Y. 2008-09 2024 (5) TMI 1586 - ITAT MUMBAI wherein under identical facts and circumstances disallowance made u/s. 14A read with Rule 8D was deleted by the Tribunal. In view of the aforesaid we uphold the decision of learned first appellate authority by dismissing the grounds. Addition on account of gain on foreign exchange fluctuation in respect of foreign currency convertible bonds (FCCB) - Before us the parties have agreed that while deciding identical issue in assessee s case in A.Ys. 2007-08 2008-09 and 2009-10 the co-ordinate bench has restored the issue to the A.O. for fresh adjudication after verifying the materials on record. Addition towards alleged gain on sale of shares of closed business subsidiary in Brazil - As rightly observed by learned first appellate authority the value of shares held in Brazil in foreign currency represented capital asset of the assessee. Therefore when the shares were sold the amount realized through transfer of such capital asset has to be treated as capital receipt as the transaction is on capital account. That being the factual position emerging on record the receipts have to be treated as capital in receipt and not income from other sources as held by A.O. Learned first appellate authority having decided the issue in accordance with settled legal principles we uphold the same. Grounds are dismissed.

Summary

1. ISSUES PRESENTED and CONSIDERED

The core legal questions considered by the Tribunal in these appeals relate primarily to the tax treatment of various receipts and adjustments in the hands of a corporate assessee engaged in sugar manufacturing. The issues include:

(a) Whether the subsidy/incentive received under The New Sugar Promotion Policy, 2004 of the Government of Uttar Pradesh is to be treated as capital receipt or revenue receipt for income tax purposes.

(b) Whether the subsidy/incentives characterized as capital receipts should be reduced while computing book profits under section 115JB of the Income Tax Act.

(c) The validity of additions made on account of non-reconciliation of certain transactions appearing in the Income Tax Statement (ITS) details.

(d) The correctness of disallowance made under section 14A read with Rule 8D(2) of the Income Tax Rules relating to expenditure incurred in relation to exempt income.

(e) The taxability and nature (capital or revenue) of gains arising from foreign exchange fluctuations on Foreign Currency Convertible Bonds (FCCBs).

(f) The tax treatment of gains arising on discount on buy-back of FCCBs.

(g) The taxability of gains on sale of shares of a closed business subsidiary located abroad, specifically whether gains due to foreign exchange fluctuations on repatriation of capital are capital receipts or income from other sources.

2. ISSUE-WISE DETAILED ANALYSIS

(a) Nature and Character of Subsidy/Incentive under New Sugar Promotion Policy, 2004

Legal Framework and Precedents: The Tribunal applied the "purpose test" as enunciated in CIT vs. Ponni Sugar & Chemical Ltd. (2008), which holds that the character of subsidy must be determined with reference to the purpose for which it is granted, irrespective of the timing or form of subsidy. The Tribunal also relied on various authoritative decisions including Everest Industries Ltd. vs. Joint CIT, CIT vs. Shri Balaji Alloys, CIT Kolhapur vs. Chaphlekar Brothers Pvt. Ltd., ACIT vs. Gems Electrotech Ltd., and PCIT vs. Capgemini India Pvt. Ltd., all of which support the proposition that subsidies granted for industrial promotion or capital investment are capital receipts.

Court's Interpretation and Reasoning: The Tribunal examined the New Sugar Promotion Policy, 2004 issued by the Government of Uttar Pradesh, which aimed at promoting private investment in the sugar industry for industrial development, rural welfare, and increased sugar production. The policy provided various incentives such as capital subsidies, exemptions from stamp duty and registration fees, exemption from VAT and CST on molasses, reimbursement of transportation costs, and purchase tax exemptions. The Tribunal noted that these incentives were linked to capital investment and were intended to encourage setting up new sugar mills, thus serving the purpose of capital formation.

Key Evidence and Findings: The assessee had invested substantial capital (over Rs. 500 crores) and had been granted eligibility certificates for availing benefits under the policy. The Tribunal reviewed the detailed scheme of incentives and found them to be integrally connected with capital expenditure and industrial development. Earlier decisions of the Tribunal in the assessee's own case for assessment years 2007-08, 2008-09, and 2009-10 had consistently held these incentives to be capital receipts.

Application of Law to Facts: Applying the purpose test and considering the nature of the incentives, the Tribunal concluded that the subsidy/incentives received under the New Sugar Promotion Policy are capital receipts and not taxable as income. Furthermore, the incentives were not to be reduced from the cost of assets for depreciation purposes.

Treatment of Competing Arguments: The Revenue's contention that the subsidy should be treated as revenue receipt was rejected, especially since the Revenue did not dispute the earlier Tribunal decisions. The Departmental Representative conceded that the issue had been decided in favour of the assessee in earlier years.

Conclusions: The Tribunal held that the subsidy/incentives under the New Sugar Promotion Policy, 2004 are capital receipts and not taxable under the Income Tax Act.

(b) Treatment of Capital Subsidy in Computation of Book Profit under Section 115JB

Legal Framework and Precedents: Section 115JB mandates computation of book profits for Minimum Alternate Tax (MAT). The issue was whether capital subsidies should be added back to book profits.

Court's Interpretation and Reasoning: The Tribunal, following its own earlier decision for A.Y. 2009-10, held that if the subsidy/incentives are capital receipts, they should be reduced while computing book profits under section 115JB, ensuring consistency in tax treatment.

Conclusions: The Tribunal allowed the assessee's claim that capital subsidy/incentives be reduced in computing book profits under section 115JB.

(c) Addition on Account of Non-Reconciliation of ITS Details

Legal Framework and Precedents: The burden of proof lies on the Assessing Officer to establish that transactions pertain to the assessee if the assessee denies them. The Tribunal referred to the decision in M/s. Pfizer Limited vs. JCIT.

Court's Interpretation and Reasoning: The assessee denied involvement in the disputed transactions totaling Rs. 7,18,682/-. The Tribunal noted that the Assessing Officer failed to conduct a thorough enquiry to verify the transactions. Also, the assessee demonstrated that one transaction was removed from its Form 26AS by the concerned party.

Conclusions: The Tribunal directed the Assessing Officer to verify the facts and delete the addition if the transactions do not relate to the assessee. The ground was allowed for statistical purposes.

(d) Disallowance under Section 14A read with Rule 8D(2)

Legal Framework and Precedents: Section 14A disallows expenditure incurred to earn exempt income. Rule 8D prescribes the method for computation of such disallowance. The Assessing Officer must record satisfaction before making disallowance.

Court's Interpretation and Reasoning: The assessee made suo motu disallowance based on proportionate expenses. The Assessing Officer rejected this and computed disallowance under Rule 8D(2). However, the Assessing Officer did not record any positive satisfaction under section 14A(2) that the assessee's method was incorrect. The Tribunal also noted that the assessee had surplus interest-free funds, negating the Revenue's claim.

Conclusions: The Tribunal upheld the deletion of disallowance by the first appellate authority, dismissing the Revenue's grounds.

(e) Gain on Foreign Exchange Fluctuation on FCCBs

Legal Framework and Precedents: The nature of foreign exchange gain depends on whether the underlying asset is capital or revenue in nature. The Tribunal referred to its own earlier decisions and the principle that gains related to capital expenditure are capital receipts.

Court's Interpretation and Reasoning: The Assessing Officer treated the gain as revenue income. However, the first appellate authority and the Tribunal noted that the gain arose on capital expenditure and thus was capital in nature. The Tribunal restored the issue to the Assessing Officer for fresh adjudication after verifying the material, following earlier precedents.

Conclusions: The issue was restored to the Assessing Officer for fresh consideration consistent with earlier decisions.

(f) Discount on Buy-Back of FCCBs

Court's Interpretation and Reasoning: Since this issue is consequential to the nature of foreign exchange gain on FCCBs, the Tribunal restored it to the Assessing Officer for fresh adjudication.

(g) Gain on Sale of Shares of Closed Business Subsidiary in Brazil

Legal Framework and Precedents: The Tribunal applied the principle from Sutlej Cotton Mills Ltd. v. CIT and other decisions that gains or losses on foreign exchange fluctuations on capital assets are capital in nature.

Court's Interpretation and Reasoning: The shares held in the Brazilian subsidiary represented capital assets. The gain on sale, including the component due to foreign exchange fluctuation, was integral to the capital receipt on transfer of the asset. The Assessing Officer's treatment of the exchange gain as income from other sources was incorrect.

Conclusions: The Tribunal upheld the first appellate authority's deletion of the addition and held the gain as capital receipt, dismissing the Revenue's appeal.

3. SIGNIFICANT HOLDINGS

"The test is that the character of receipt in the hands of the assessee has to be determined with respect to the purpose for which the subsidy is given. The point of time at which the subsidy is paid is not relevant. The form of subsidy is immaterial."

"The various incentives given under the New Sugar Industry Promotion Policy, 2004 are in the nature of capital receipts and accordingly not liable to tax."

"Where profit or loss arises to an assessee on account of appreciation or depreciation in the value of foreign currency held by it on conversion into another currency, such profit or loss would ordinarily be trading profit or loss if the foreign currency is held on revenue account. But if the foreign currency is held as a capital asset, such profit or loss would be of capital nature."

"The Assessing Officer must record a positive satisfaction under section 14A(2) before making disallowance of expenditure incurred in relation to exempt income. Without such satisfaction, disallowance cannot be sustained."

Final determinations include:

• The subsidy/incentives under the New Sugar Promotion Policy, 2004 are capital receipts and not taxable as income.
• Such capital subsidies should be reduced while computing book profits under section 115JB.
• Additions on account of non-reconciliation of ITS transactions are to be deleted if the transactions do not relate to the assessee.
• Disallowance under section 14A read with Rule 8D(2) is not sustainable without recorded satisfaction and proper enquiry.
• Gains on foreign exchange fluctuations on FCCBs require fresh adjudication consistent with earlier decisions.
• Gains on sale of shares of foreign subsidiaries, including exchange fluctuation components, are capital receipts.