Whether when Indian subsidiary turns its business losses into profit with financial aid coming from parent, such payment is to be treated as capital subsidy - YES: High Court

THE issues before the Bench are - Whether when the Indian subsidiary turns its business losses into profit with the financial subsidy coming from the parent, such payment is to be treated as capital subsidy; Whether in case assessee is obliged to utilize subsidy for repayment of term loan undertaken for setting up new units or expansion of existing business, it is capital in nature and Whether assistance granted in the early phase of setting up of a business concern, can be considered as an aid of capital nature. And the verdict goes against the assessee.

Facts of the case

The assessee, an Indian company, is engaged in the business of manufacturing Digital Electronic switching systems, computer software and also software services. it filed ROI for AYs 1999-2000, 2000-2001 and 2001-2002 declaring loss of Rs.9,08,30,417/- for the AY 1999-2000; Rs.7,29,68,898/- for 2000-01 and Rs.45,64,59,705/- for 2001-02. Insofar as the AY 1999-2000 was concerned, it was processed u/s 143(1)(a) accepting the returned loss and accordingly a refund of Rs.33,79,222/- including interest u/s 244A of Rs.7,13,155/- was granted. Subsequently, the case was selected for scrutiny by issue of notice u/s 143(2). In the statement of computation, assessee had shown a sum of Rs.21,28,40,000/- as monies received from Siemens AG Germany Company, which is the principal shareholder of the assessee's company. The assessee's representative in a letter had explained the said sum as "subvention payment" from the principal shareholder of the assessee, and that was paid to the assessee for two reasons, namely, the company was potentially sick company, and that its capacity to borrow had reduced substantially leading to shortage of working capital. In the letter issued by Siemens AG, and the assessee's letter, they explained that M/s Siemens AG being a parent company, had agreed to infuse further capital by reimbursing the accumulated loss. In short, case of the assessee was that the payment made by Siemens AG was to make good the loss incurred by them and payment/receipt of the subvention monies was capital receipt in nature and hence, cannot be treated as income or revenue receipt. During assessment, AO had rejected the contention of assessee. On appeal, CIT(A) had reversed the order of AO treating the said monies received from Siemens AG as capital receipt. On further appeal, Tribunal had confirmed the findings of CIT(A), who had observed that assessee company apparently paid the assessee or compensated the assessee in view of the continued lossess, and this in fact was to augment the capital base and to improve the net worth which had eroded due to losses suffered by the company. With a view to compensate the erosion in the reserves in surplus, the parent company pumps into its subsidiary company funds to stabilize its capital account. It was considering all these reasons that the CIT (A) came to the conclusion that it was on capital account. If the amount so paid by the company was treated as revenue income, it would amount to taxing the parent company itself. The other reason was that the parent company paying its subsidiary company, was within the same group and not for any purpose which was in the nature of income so as to be treated as taxable income.

Before the HC, the Revenue's counsel had submitted that the monies paid by Siemens AG to the assessee were of revenue account and was paid not only to make good the loss but to make the assessee's company run which had no monies to spend over day today expenditure to keep it running at the relevant time. It was also submitted that on the basis of the said monies/aid extended by Siemens AG, the assessee not only made their loss good, but started running their business in profit. It was also submitted that who paid the amount was absolutely an irrelevant fact and what was important was the object for which such assistance was extended. It was further submitted that, it was clear that in the AY 1999-2000, the assessee's company had suffered loss. Whereas in the subsequent AYs, 2000-01 and 2001-02, it started making profit which fact clearly shows that the amount paid by Siemens AG was used for running the business and therefore, it would fall under the category of revenue receipt and not capital receipt. On the other hand, assessee's counsel had submitted that the appeal deserves to be rejected outright, since no substantial question of law was involved. It was further submitted that having regard to the findings of fact recorded by the Appellate Authority and the Tribunal, the questions of law as raised, does not fall for consideration being a substantial question of law. It was further submitted that the findings of the Tribunal even on the question of law were justified and the Tribunal had rightly treated the amount paid by Siemens AG as "Subvention payment" and had rightly treated it against the capital account. It was further submitted that the judgments relied upon on behalf of the revenue were not applicable to the facts of the present case.

Held that,

++ the SC after considering its judgment in Sahney Steel, observed and noted that the assessee was free to use the 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., vs. Crook (1931) 16 Tax Cases 333 (HL), the assessee was obliged to spend the money for expansion of six docks. That aspect was taken into consideration as an important aspect. In this backdrop, the SC further observed that "in the present case (Ponni Sugars & Chemicals) also, receipt of the subsidy was capital in nature as the assessee was obliged to utilize the subsidy only for repayment of term loan undertaken by the assessee for setting up new units/expansion of existing business;

++ in Sahney steel's case, the payments were made only after the industries had been set up. Payments were not made for the purpose of setting up of the industries, but the package of incentives in that case were given to the industries to run more profitably for a period of five years from the date of the commencement of production. In other words, a helping hand was given to the industries during the early days to enable them to come to a competitive level with other established industries. It is in this backdrop, in Sahney Steel, the Supreme Court held that incentive which assessee extended was revenue and not capital in nature. SC also observed that by no stretch of imagination can the subsidies whether by way of refund of sales tax or relief of electricity charges or water charges can be treated as an aid to setting up of the industry of the assessee. It was also noticed that the payments were made only when the assessee commenced its production. The said payments were made for a period of five years calculated from the date of commencement of production in the assessee's factory. It is held that the subsidies were operational subsidies and not capital subsidies;

++ applying the above principles to the facts of the present case, and keeping in view the objective behind the payment made by Siemens AG, we are satisfied that it was received by the assessee on revenue account. From the facts of the case, it is clear that huge amounts were paid by Siemens AG not only to make good the loss, but also to see that the assessee would run more profitably. It was by way of assistance in carrying on the business. It is not the case of the assessee that the monies paid by Siemens AG were utilized either for repayment of the loan undertaken by the assessee for setting up their unit or for expansion of existing unit/business. As observed by the Supreme Court, the point of time at which the subsidy is paid is not relevant. The source and the form of subsidy is immaterial. The main eligibility condition with which we are concerned is that the amount ought to have been utilized by the assessee to meet recurring expenses and/or to run their business more profitably and so also to get out of the loss that they were suffering at the relevant time. In any case, it was not for acquiring capital assets or to bring into existence any new asset. As a matter of fact, after getting the financial aid from the Siemens AG, the assessee company turned its business from loss to profit, which is evident from the facts reflected in the return of income filed for all the three assessment years i.e., 1999-2000, 2000-2001 and 2001-2002. In this backdrop, if the purpose test is applied, it is clear that the payment was made by Siemens AG as recurring expenses/working capital;

++ it is not clear from the order of the Tribunal on what basis it observed that M/s.Siemens AG paid the assessee or compensated the assessee in view of the continued losses, and such financial aid was extended to augment the capital base and to improve the net worth which had eroded the losses suffered by the company. The facts on record speak otherwise. Only in the AY 1999- 2000, the assessee had suffered loss and thereafter, in the assessment years 2000-01 and 2001-02, the assessee made profit. These facts, on the other hand, support the case of the revenue that the financial aid was extended by Siemens AG not only to make good the loss for the assessment year 1999-2000 but to see that the company run more profitably. It is the object which is relevant for the financial assistance which determines the nature of such assistance. In other words, the character of the receipts in the hands of the assessee has to be determined with respect to the purpose for which payment was made. If the financial assistance is extended for repayment of the loan undertaken by the assessee for setting up new unit or for expansion of existing business then the receipt of such aid could be termed as capital in nature. On the other hand, if the financial assistance is extended to run business more profitably or to meet recurring expenses, such payment will have to be treated as revenue receipt. It is not the case of the assessee, in the present case, that the financial assistance was extended by Siemens AG either for setting up any unit or expansion of existing business or for acquiring any assets. In the result, the revenue succeeds. The question of law is accordingly answered in favour of the revenue and against the assessee. Consequently, the orders passed by the Tribunal and the first appellate authority are set-aside.