REPORTABLE

IN THE SUPREME COURT OF INDIA

CIVIL APPELLATE JURISDICTION

CIVIL APPEAL No.  5694  of  2008 (arising out of S.L.P.(C) No. 7926/04)

Commissioner of Income Tax, Madras … Appellant(s)

              versus

Ponni Sugars & Chemicals Ltd. … Respondent(s)

with

Civil Appeal No. 5695/08 (arising out of S.L.P.(C) No. 12355/06), Civil Appeal No. 5696/08 (arising out of S.L.P.(C) No. 21064/06), Civil Appeal No. 5697/08 (arising out of S.L.P.(C) No. 6557/08), Civil Appeal No. 5698/08 (arising out of S.L.P.(C) No. 9823/08),

Civil Appeal No. 5699/08 (arising out of S.L.P.(C) No. 18442/04), Civil Appeal No. 5700/08 (arising out of S.L.P.(C) No. 11787/06), Civil Appeal No. 5701/08 (arising out of S.L.P.(C) No. 12778/06), Civil Appeal No. 5702/08 (arising out of S.L.P.(C) No. 12958/06), Civil Appeal No. 5703/08 (arising out of S.L.P.(C) No. 15099/06),

Civil Appeal No. 5704/08 (arising out of S.L.P.(C) No. 573/07), Civil Appeal No. 5705/08 (arising out of S.L.P.(C) No. 3948/07), Civil Appeal No. 5706/08 (arising out of S.L.P.(C) No. 6658/07), Civil Appeal No. 5707/08 (arising out of S.L.P.(C) No. 3112/06),

Civil Appeal No. 5708/08 (arising out of S.L.P.(C) No. 11963/07), Civil Appeal No. 5709/08 (arising out of S.L.P.(C) No. 14407/07), Civil Appeal No. 5710/08 (arising out of S.L.P.(C) No. 14050/07), Civil Appeal No. 5711/08 (arising out of S.L.P.(C) No. 8290/07), Civil Appeal No. 5712/08 (arising out of S.L.P.(C) No. 6686/08), Civil Appeal No. 5713/08 (arising out of S.L.P.(C) No. 7643/08),

Civil Appeal No. 5714/08 (arising out of S.L.P.(C) No.  9584/08) and Civil Appeal No. 5715/08 (arising out of S.L.P.(C) No. 17149/08)

J U D G M E N T

S. H. KAPADIA, J.

Leave granted.

2. In the above batch of civil appeals, based on the arguments addressed

before  us,  we  are  mainly  concerned  with  the  following  two  questions,

namely:

(i) Whether the incentive subsidy received by the assessee 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  members  of  the

society?  

3. At the outset, it may be noted that this batch of civil appeals covers

four incentive subsidy Schemes of 1980, 1987, 1988 and 1993. All the four

schemes  are  almost  identical.  They  are  different  in  matter  of  details.

However, in 1980 and 1987 Schemes there is an additional benefit by way

of  rebate  in  respect  of  payment of  excise  duty which  is  not  there in  the

remaining two Schemes of 1988 and 1993.

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4. With the above preface, we refer to the facts in the case 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 conferred under that Scheme were twofold.

First, in the nature of a higher free sale sugar quota and second,  in allowing

the manufacturer  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 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,  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 furnished on or before the 31st 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

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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 Cooperative Sugar Mills Ltd. we

are concerned with the Scheme of 1980.  

7. On the first question, namely, whether the incentive subsidy received

by the assessee is a capital receipt, Shri P.V. Shetty, learned senior counsel

appearing  on  behalf  of  the  Department  (appellant)  submitted  that  the

additional  revenue  generated  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 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

erroneously rejected by the High Court. According to the learned counsel,

under the Scheme, there were two distinct concepts, namely, the concept of

accrual  of  income  in  the  hands  of  the  assessee  and  the  concept  of

application  of  additional  funds  generated  thereunder.  According  to  the

learned  counsel,  application  of  additional  funds  is  neither  material  nor

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relevant  for  deciding  the  character  of  the  incentive  subsidy.  In  this

connection, learned counsel placed reliance on the judgment of this 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  behalf  of  the

assessee submitted that the benefits were conferred on the assessee under

the  1980  and  1987  Schemes,  namely,  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

unit.  The  said  Schemes  were  not  meant  for  a  running  unit.  The  second

benefit,  according to the learned counsel, lay in the rebate 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  character  of  the  incentive,  the  “purpose  test”  is

applicable. In other 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 point of time at

which it is paid or its source or its form was irrelevant. In this connection,

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learned counsel also places reliance 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?

10. At  the  outset,  it  may  be  stated  that  during  the  relevant  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 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 Government

appointed  a  Committee  known  as  Sampat  Committee  to  examine  the

question relating to economic viability of new sugar factories. One of the

terms of reference suggested was to work out various incentives for making

new sugar factories 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 its Report in which

the Committee recommended that the economic viability of a factory would

mean  that  the  unit  should  not  break  even  after  meeting  the  working

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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  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  viable  unit  could  be  provided  for,  namely,  capital

subsidy, allowing a larger  percentage of  free sale sugar,  high levy sugar

price, allowing rebate on excise duty and remission of purchase tax. In this

case, we are concerned with allowability of a larger percentage of free sale

sugar and rebate on excise duty. Following the said Report of the Sampat

Committee, the above Schemes came to be formulated.

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:

(i) Benefit of the incentive subsidy was available only to new units and to substantially expanded units, not to supplement the trade receipts.

(ii) The  minimum  investment  specified  was  Rs.  4 crores for new units and Rs. 2 crores for expansion units.

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(iii) Increase  in  the  free  sale  sugar  quota  depended upon 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 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 factors  of  the  Scheme.  The  important

point to be noted is that Government of India, financial institutions as well

as the sugar industries 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.

13. The main controversy arises in these cases because of the reason that

the incentives were given through the mechanism 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 mechanism would normally be presumed to be revenue in nature. In

other  words,  according  to  the  Department,  since  incentives  were  given

through price and duty differentials, the character of the impugned incentive

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in  this  case  was  revenue  and  not  capital  in  nature.  On  the  other  hand,

according to the assessee, 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 case, on behalf of the assessee, it was

contended that the subsidy given was up to 10% of the capital investment

calculated  on  the  basis  of  the  quantum  of  investment  in  capital  and,

therefore, receipt of such subsidy was on capital account and not on revenue

account. It was also urged in that case that subsidy 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 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 trade or

business. On the facts of that case, it was held that the subsidy given was to

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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 commencement

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  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 judging the character of a subsidy. That test is that the

character of the receipt in the hands of the assessee has to be determined

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 relevant. The source is immaterial. The form of

subsidy is  immaterial.  The main eligibility  condition  in  the scheme with

which we are concerned in this case is that the incentive must be utilized for

repayment  of  loans  taken  by  the  assessee  to  set  up  new  units  or  for

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substantial expansion of existing units. On this aspect there is no dispute. If

the  object  of  the  subsidy  scheme was  to  enable  the  assessee  to  run  the

business  more  profitably then  the  receipt  is  on  revenue  account.  On the

other hand, if the object of the assistance 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 subsidy. The form of the mechanism through which the subsidy is

given is irrelevant.  

15. In the decision of House of Lords in the case of  Seaham Harbour

Dock Co.  v.  Crook (1931) 16 TC 333 the Harbour Dock Co. had applied

for  grants  from  the  Unemployment  Grants  Committee  from  funds

appropriated   by  Parliament.  The  said  grants  were  paid  as  the  work

progressed the payments were made several times for some years. The Dock

Co. had undertaken the work of extension of its docks. The extended 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 with the trading of the company because the work undertaken

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was dock extension. According to the House of Lords, the assistance in the

form of a grant was made by the Government with the object that by its use

men might be kept in employment and, therefore, its receipt was capital in

nature. The importance 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 loans. Even though the payment

was  equivalent  to  half  the  interest  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 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  was  dock  extension,  the  House  of  Lords  held  that  the  payment

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

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money in its business entirely as it liked. It was not obliged to spend the

money for a particular purpose. In the case of Seaham Harbour Dock Co.

(supra) assessee 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 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.  

17. Applying the above tests to the facts of the present case and keeping

in  mind  the  object  behind  the  payment  of  the  incentive  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.  

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  Sugar  Mills  Ltd.,  Madurantakam Co-operative  Sugar  Mills

Ltd.,  Ambur  Co-operative  Sugar  Mills  Ltd.,  Dharampuri  District

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Co-operative Sugar Mills Ltd., Vellore Co-operative Sugar Mills Ltd., Attur

Agricultural.  Producers  Co-operative  Society Ltd.  and Modern  Engineers

Construction Co-operative Society Ltd..  Under Section 80 P(1) deduction

in respect of income of co-operative 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-section

(2)  shall  be  deducted  from the  gross  total  income to  arrive  at  the  total

income of the assessee-society. In order to earn exemption under Section 80

P(2) a co-operative society must prove that it had engaged itself in carrying

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 society, Parliament has stipulated that the society must be

engaged in carrying on the business of banking or providing credit facilities

to  its  members.  Therefore,  in  each  case,  the  Tribunal  was  required  to

examine the Memorandum of Association, the Articles of Association, the

Return of Income filed with the Department, the status of business indicated

in such Returns etc.. This exercise had not been undertaken at all.

19. For the aforestated reasons, we set aside the impugned judgments of

the  High  Court  and  remit  the  matters  to  the  Tribunal  for  de  novo

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consideration in accordance with law. All the contentions on both sides are

expressly kept open.

20. In addition to the above two questions, one more question 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  development  funds  collection  by

sugar mills would be trading receipt?

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 accordance with the directions

given therein.   

22. Accordingly, the appeals filed by the Department are partly allowed

with no order as to costs.

……………………………J.                                      (S.H. Kapadia)

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……………………………J.                                                 (B. Sudershan Reddy)

New Delhi; September 16, 2008.

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