Holding

The nature of a subsidy is determined by the purpose for which it is granted; where the purpose is to facilitate the setting up or expansion of units and repayment of term loans, the subsidy is a capital receipt not includible in total income.

Summary

The Supreme Court examined whether incentive subsidies received by Ponni Sugars & Chemicals Ltd. under various government schemes were capital or revenue receipts, whether the company could claim exemption under Section 80P(2)(a)(i) for interest earned from cooperative society members, and whether area development funds collected by sugar mills constituted trading receipts. Applying the "purpose test", the Court held that the subsidies were granted to enable the assessee to set up new units or expand existing ones and to repay term loans, making them capital receipts not includible in total income. The Court found that the Tribunal had not examined the cooperative societies' Memorandum and Articles of Association, which is essential to determine eligibility for exemption under Section 80P(2), and therefore remitted that issue for fresh consideration. Similarly, the question of whether area development funds are trading receipts was remitted to the Tribunal following a precedent from the Bombay High Court. Consequently, the appeals filed by the Revenue were partly allowed.

Issues considered

Whether the incentive subsidy received by the assessee is a capital receipt not includible in total income
Whether the assessee is entitled to exemption under Section 80P(2)(a)(i) of the Income Tax Act, 1961 for interest received from members of a cooperative society
Whether area development funds collected by sugar mills constitute trading receipts

Legislation cited

Income Tax Act, 1961s. 80P(1), s. 80P(2), s. 80P(2)(a)(i)

Subjects

Income TaxSubsidyCapital receiptRevenue receiptPurpose testSection 80PCooperative societyTax exemptionArea development funds

Judgment

[2008] 13 S.C.R. 570
1- ~

A COMMISSIONER OF INCOME TAX, MADRAS
II.
PONNI SUGARS & CHEMICALS LTD.
(Civil Appeal No. 5694 of 2008 etc.)
SEPTEMBER 16, 2008 A ..,
B
[S.H. KAPADIA AND B. SUDERSHAN REDDY, JJ.]

Income Tax Act, 1961:
Subsidy receipt - Determination of nature - Whether in-
c cludible in total income Held: Character of such receipt has
to be determined applying the purpose test i.e. the purpose
for which the subsidy is given - In the instant case, the object
of the subsidy was capital in nature to utilize the same only for
repayment of term loan undertaken by the assessee for set-
D ting up new units/expansion of existing business- Hence such .,._ -
receipt was not includible in total income.
s. 80 P(2)(a)(i) - Exemption under - In respect of inter-
est received from the members of co-operative Society- Held:
In order to decide such question examination of Memoran-
E dum of Association, Articles of Association, the Return of In-
come, status of business etc., is required- In the present case,
since Tribunal failed to examine the same, matter remitted to
Tribunal for consideration of the question afresh.
Area development funds - Collected by sugar mills -
~-
F Whether trading receipt - Held: matter remitted to tribunal for
consideration of the question afresh.
The questions for consideration in the present ap-
peals are:

G (i) Whether the incentive subsidy received by the as-
sessee is a capital receipt not includible in the total income?
(ii) Whether the assessee was entitled to exemption y~

u/s 80 P(2) (a) (i) of Income Tax Act, 1961 in respect of
interest received from the members of the Society ? and
H 570
COMMISSIONER OF INCOME TAX, MADRAS v. PONNI 571
SUGARS & CHEMICALS LTD.

(iii) Whether the area development funds collected A
by sugar mills would be trading receipt ?
Partly allowing the appeals filed by the Revenue, the
Court
HELD: 1. The character of the receipt in the hands of B
... }
the assessee has to be determined with respect to the
purpose for which the subsidy is given. If the object of
the subsidy scheme was to enable the assessee to run
the business more profitably then the receipt is on rev-
enue account. On the other hand, if the object of the as- c
sistance 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 sub-
0
sidy. The form of the mechanism through which the sub-
sidy is given is irrelevant. In the present case, 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. Such payment re- E
ceived by the assessee under the Scheme was not in the
course of a trade but was of capital nature. [Paras 14, 16
and 17] [578 F & H] [579 AB, 580 C,D,E]
Sahney Steel and Press Works Ltd. and Ors. v. CIT F
(1997) 228 ITR 253 - relied on
Seaham Harbour Dock Co. v Crook (1931) 16 TC 333 -
referred to
2. In order to earn exemption u/s 80 P(2), a co-opera- G
tive society must prove that it had engaged itself in carry-
ing 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 so-
ciety, Parliament has stipulated that the society must be H
572 SUPREME COURT REPORTS [2008] 13 S.C.R.

A engaged in carrying on the business of banking or pro-
viding credit facilities to its members. Therefore, in each
case, the Tribunal was required to examine the Memoran-
dum of Association, the Articles of Association, the Re-
turn of Income filed with the Department, the status of
B business indicated in such Returns etc .. This exercise had
not been undertaken at all. Therefore, the matters are re- -" -r
mitted to the Tribunal for de nova consideration in accor-
dance with law. [Paras 18 and 19] [581 B-D & E]
3. In view of the judgment of the Bombay High Court
C in Chhatrapati Sahakari Sakhar Karkhana Ltd. case, the mat-
ter is remitted to the Tribunal for de novo consideration
of the question whether the area development funds col-
lection by sugar mills would be trading receipt, in accor-
dance with law and in accordance with the directions
D given therein. [Paras 20 and 21] [581 F G]
CIT v. Chhatrapati Sahakari Sakhar Karkhana Ltd. (2000)
245 ITR 498 - relied on
Case Law Reference
E (1997) 228 ITR 253 Relied on Para 14
(1931) 16 TC 333 Referred to Para 15
2000) 245 ITR 498 Relied on Para 21
CIVILAPPELLATE JURISDICTION: Civil Appeal No. 5694
F of 2008
From the final Judgment and Order dated 16.9.2002 of
the High Court of Judicature at Madras in T.C. 492of1996
P.V. Shetty, Harish Chandra, S. Ganesh, R.F. Nariman, P.H. ·
G Parekh, S.K. Bagaria, Rahul Kaushik, Sanjeev Bhardwaj, K. B.
Sandeep, B.V. Balaram Das, Radha Rangaswamy, Shashi M.
Kapila, Kush Chaturbedi, Vikas Mehta, E.R. Kumar, Arjun Garg,
Shakun Sharma, Rukmini Bobde (for Parekh &Co.), K.K. Mani,
C.K.R. Lenin Sekar, R.K. Pandey, C.N. Sree Kumar, Dushyant
H Parashar, P.R. Nayak Pankaj Gupta, Aarohi Bhalla, Shekhar
COMMISSIONER Of= INCOME TAX, MADRAS v. PONNI 573
SUGARS & CHEMICALS LTD.

Raj Sharma, Sujata Kurdukar, S.U.K. Sagar, Bina Madhavan, A
Manish, Ashima Chalia (for M/s. Lawyers Knit & Co.) and Manik
Karanjawala for the appearing parties.

. )
The Judgment of the Court was delivered by
S. H. KAPADIA, J. 1. Leave granted.

2. In the above batch of civil appeals, based on the argu-
ment$_ addressed before us, we are mainly concerned with the
B

following two questions, namely:
(i) Whether the incentive subsidy received by the c
a$sessee 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 D
•~ members of the society?
3. At the outset, it may be noted that this batch of civil ap-
peals covers four incentive subsidy Schemes of 1980, 1987,
1988 and 1993. All the four schemes are almost identical. They E
are different in matter of details. However, in 1980 and 1987
Schemes there is an additional benefit by way of rebate in re-
spect of payment of excise duty which is not there in the re-
maining two Schemes of 1988 and 1993.
4. With the above preface, we refer to the facts in the case F
-~ 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 con- G
ferred under that Scheme were twofold. First, in the nature of a
higher free sale sugar quota and second, in allowing the manu-
.. -. facturer 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 H
574 SUPREME COURT REPORTS [2008) 13 S.C.R.

A 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,
B 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
c furnished on or before the 31 51 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
D 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 Coop-
E erative Sugar Mills Ltd. we are concerned with the Scheme of
1980.
7. On the first question, namely, whether the incentive sub-
sidy received by the assessee is a capital receipt, Shri P.V.
Shetty, learned senior counsel appearing on behalf of the De-
F partment (appellant) submitted that the additional revenue gen-
erated 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
G 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 erro- •
neously rejected by the High Court. According to the learned
H counsel, under the Scheme, there were two distinct concepts,
COMMISSIONER OF INCOME TAX, MADRAS v. PONNI 575
·--+ SUGARS & CHEMICALS LTD. [S. H. KAPADIA, J.]

namely, the concept of accrual of income in the hands of the A
assessee and the concept of application of additional funds
generated thereunder. According to the learned counsel, appli-
cation of additional funds is neither material nor relevant for
deciding the character of the incentive subsidy. In this connec"
tion, learned counsel placed reliance on the judgment of this B
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 be-
half of the assessee submitted that the benefits were conferred
on the assessee under the 1980 and 1987 Schemes, namely, c
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
·---'t'
unit. The said Schemes were not meant for a running unit. The D
second benefit, according to the learned counsel, lay in the re-
bate 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 char-
acter of the incentive, the "purpose test" is applicable. In other E
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 poi~t of time at which it is paid or its source or its form was
~·'I! irrelevant. In this connection, learned counsel also places reli- F
ance 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? G

10. At the outset, it may be stated that during the relevant
•-y 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
H
576 SUPREME COURT REPORTS [2008] 13 S.C.R.
+- ..
A 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 Gov-
ernment appointed a Committee known as Sampat Commit-
tee to examine the question relating to economic viability of
B new sugar factories. One of the terms of reference suggested 1 .,,..
was to work out various incentives for making new sugar facto-
ries 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
c its Report in which the Committee recommended that the eco-
nomic viability of a factory would mean that the unit should not
break even after meeting the working 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
D
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 vi-
able unit could be provided for, namely, capital subsidy, allow-
ing a larger percentage of free sale sugar, high levy sugar price,
E allowing rebate on excise duty and remission of purchase tax.
In this case, we are concerned with allowability of a larger per-
centage of free sale sugar and rebate on excise duty. Follow-
ing the said Report of the Sampat Committee, the above
Schemes came to be formulated.
F .,
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:
G (i) Benefit of the incentive subsidy was available only to ,...
new units and to substantially expanded units, not to
supplement the trade receipts.
y ..
(ii) The minimum investment specified was Rs. 4 crores
for new units and Rs. 2 crores for expansion units.
H ,-
COMMISSIONER OF INCOME TAX, MADRAS v. PONNI 577
. --+ SUGARS & CHEMICALS LTD. [S. H. KAPADIA, J.]

(iii) Increase in the free sale sugar quota depended upon A
'
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 B
•
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 fac- c
tors of the Scheme. The important point to be noted is that Gov-
ernment of India, financial institutions as well as the sugar in-
dustries 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.
D
~--41
13. The main controversy arises in these cases because
of the reason that the incentives were given through the mecha-
nism 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 E
mechanism would normally be presumed to be revenue in na-
tu re. In other words, according to the Department, since incen-
tives were given through price and duty differentials, the char-
acter of the impugned incentive in this case was revenue and
not capital in nature. On the other hand, according to the asses- F
--:t see, 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 G
case, on behalf of the assessee, it was contended that the sub-

.. .,. sidy given was up to 10% of the capital investment calculated
on the basis of the quantum of investment in capital and, there-
fore, receipt of such subsidy was on capital account and not on
revenue account. It was also urged in that case that subsidy H
578 SUPREME COURT REPORTS [2008) 13 S.C.R.

A 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
B 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
c trade or business. On the facts of that case, it was held that the
subsidy given was to 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 com-
0
mencement 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
E 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
F judging the character of a subsidy. That test is that the charac-
ter of the receipt in the hands of the assessee has to be deter-
mined 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 rel-
G evant. The source is immaterial. The form of subsidy is imma-
terial. The main eligibility condition in the scheme with which
we are concerned in this case is that the incentive must be uti-
lized for repayment of loans taken by the assessee to set up
new units or for substantial expansion of existing units. On this
H aspect there is no dispute. If the object of the subsidy scheme
COMMISSIONER OF INCOME TAX, MADRAS v. PONNI 579
f -+ SUGARS & CHEMICALS LTD. [S. H. KAPADIA, J.]

was to enable the assessee to run the business more profitably A
then the receipt is on revenue account. On the other hand, ifthe
object of the assistance under the subsidy scheme was to en-
able the assessee to set up a new unit or to expand the existing
unit then the receipt of the subsidy was on capital account. There-
fore, it is the object for which the subsidy/assistance is given B
which determines the nature of the incentive subsidy. The form
of the mechanism through which the subsidy is given is irrel-
evant.

15. In the decision of House of Lords in the, case of
Seaham Harbour Dock Co. v. Crook (1931) 16 TC 333 the c
Harbour Dock Co. had applied for grants from the Unemploy-
ment Grants Committee from funds appropriated by Parliament.
The said grants were paid as the work progressed the pay-
ments were made several times for some years. The Dock Co.
I> A( had undertaken the work of extensi9n of its docks. The extended D
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 E
with the trading of the company because the work undertaken
was dock extension. According to the House of Lords, the as-
sistance in the form of a grant was made by the Government
with the object that by its use men might be kept in employment
~ -i and, therefore, its receipt was capital in nature. The importance F
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
G
loans. Even though the payment was equivalent to half the inter-
est 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
H
580 SUPREME COURT REPORTS [2008] 13 S.C.R.
+- <

A 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
-.(
B was dock extension, the House of Lords held that the payment 1
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 money in its business entirely as
c it liked. It was not obliged to spend the money for a particular
purpose. In the case of Seaham Harbour Dock Co. (supra) as-
sessee 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
D was obliged to utilize the subsidy only for repayment of term .....
loans undertaken by the assessee for setting up new units/ex-
pansion 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 incen-
E tive 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.

F 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
G
Sugar Mills Ltd., Madurantakam Co-operative Sugar Mills Ltd.,
Ambur Co-operative Sugar Mills Ltd., Dharampuri District Co-
operative Sugar Mills ltd., Vellore Co-operative Sugar Mills Ltd., ~~

Attur Agricultural. Producers Co-operative Society ltd. and Mod-
ern Engineers Construction Co-operative Society Ltd .. Under
H
COMMISSIONER OF INCOME TAX, MADRAS v. PONNI 581
SUGARS & CHEMICALS LTD. [S. H. KAPADIA, J.]

Section 80 P(1) deduction in respect of income of co-opera- A
tive 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-sec-
tion (2) shall be deducted from the gross total income to arrive at
the total income of the assessee-society. In order to earn ex- B
emption under Section 80 P(2) a co-operative society must prove
that it had engaged itself in carrying on any of the several busi-
nesses referred to in sub-section (2). In that connection, it is im-
portant to note that under sub-section (2), in the context of co-
operative society, Parliament has stipulated that the society must C
be engaged in carrying on the business of banking or providing
credit facilities to its members. Therefore, in each case, the Tri-
bunal was required to examine the Memorandum of Associa-
tion, the Articles of Association, the Return of Income filed with
the Department, the status of business indicated in such Returns
0
etc .. This exercise had not been undertaken at all.
19. For the aforestated reasons, we set aside the im-
pugned judgments of the High Court and remit the matters to
the Tribunal for de novo consideration in accordance with law.
All the contentions on both sides are expressly kept open. E
20. In addition to the above two questions, one more ques-
tion 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 de:-
velopment funds collection by sugar mills would be trading receipt? F
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 accor- G
dance with the directions given therein .
.. -¥. 22. Accordingly, the appeals filed bY the Department are
partly allowed with no order as to costs.
K.K.T Appeals partly allowed. H