Mr.Chirumamilla Kranthi Kumar*
ABSTRACT
Infrastructure is the cornerstone upon which a nation rests its developmental underpinnings. Infrastructure in turn draws its sustenance from the gold dust known as capital which is far-flung and arduous to obtain. The arduousness increases exponentially when capital is needed for Infrastructure in the social sector like providing basic amenities where the profits are literally non-existent making the projects commercially unviable. To overcome this tumultuous obstacle India has launched the Viability Gap Funding(VGF) Scheme in 2006 for the Public Private Partnership(PPP) Projects in the social sector which was revamped recently disbursing higher percentage of project costs as governmental Grants to the projects in which the recovery rate of operational costs is low. Firstly this write-up seeks to delineate the existing jurisprudence and principles regarding the taxability of different kinds of Grants/Subsidies(any other benefit ejusdem generis) disbursed by the Government. Secondly this write-up seeks to clarify the ambiguity surrounding the taxable nature of Government Grants/Subsidies crept in after the enactment of the Finance Act,2015. And lastly this write-up determines the taxability of VGF.
Key Words: Taxability, Viability Gap Funding(VGF), Public Private Partnership(PPP), Capital Receipts, Revenue Receipts, Purpose Test, Government Grants, Subsidies
- Introduction
What does the term ‘income’ mean? It is defined by renowned economist Haig as “the money value of the net accretion to economic power between two points of time”1.Direct Taxes are levied on a legal person(individual/entity like company etc) based on the quantum of ‘income’ earned by that person in a specific Assessment year and the subject person is known as the Assessee. Through this Article it will be argued and deduced from a catena of jurisprudence that the disbursements in the form of a Government Grant/Subsidy (or any other benefit ejusdem generis) known as the Viability Gap Funding(VGF) made to the parties of a Public Private Partnership(PPP) does not fall under the purview of the term ‘income’ in the Indian Jurisdiction and hence are exempt from direct taxation.
1.1 What are PPPs?
Vijay Kelkar Committee in its report on revisiting and revitalizing the PPP model of infrastructure in 2015 have defined that PPPs in infrastructure “refers to the provision of a public asset and service by a private partner who has been conceded the right (the “Concession”) for the purpose over a specified period on the basis of market-determined revenue streams that allow a commercial return on investment.” [1] There are numerous models of PPPs like BOT, DBOT, Annuity, Hybrid Annuity etc and in any of those either the assets created in PPP mode will revert back to the government or the ownership lies with the Government and hence PPPs do not include public investment in private infrastructure or private investment in private infrastructure or private investment in avenues other than providing a public service/good/joint venture with the government.[2]
1.2 Huge dearth of Investment in the Infrastructure Sector in India
There is a huge funding gap between what is required and what is available for India’s infrastructure needs. The Government of India(GoI) has launched the National Infrastructure Pipeline(NIP) for the Financial Years(FYs) 2020-25 with a projected investment requirement of INR111 Lakh Crore($1.5 Trillion).For the year FYs 2020 and 2021 INR 3 Lakh Crores and INR 4.5 Lakh Crores were envisaged to be brought in by the Private Sector of which PPP was the predominant mode of inviting Private Investment in Infrastructure. Whereas the projected scenario stood as aforementioned, the reality is far from ideal, which is apparent from the actual investment brought in by the private players. The GoI’s Public Private Partnership Appraisal Committee (PPPAC) which is responsible for the appraisal of PPP projects in the Central sector, has recommended only a meagre 5 projects with total project cost of ` INR 4,321 crore during FY20 and only a meagre 7 projects with a total project cost of INR 66,600.59 crore during FY 21 (data available only till the date of the publication of the Economic Survey-2020-21)[3]. These figures are nowhere near the requirement levels. These figures indicate that there is a huge dearth of investment in the Infrastructure sector in India. Further the Kelkar committee acknowledged that there was a general slowdown in the PPP infrastructure projects and identified that financing issues including over-leveraged debt and paucity of equity as among the primary challenges faced by the PPP projects in India. The committee further went on to identify that new PPP projects are finding it increasingly difficult to attract sponsors and financing of equity and debt has become strained and that the increased ‘perceived risk’ of PPP projects has further led to the perfunctory nature of pension and insurance funds which are among the crucial source of financing of such projects, to limit their exposure to such projects[4].
- VGF accorded to PPPs
VGF means a grant disbursed one-time or over a period of time (deferred), provided to support infrastructure projects that are economically justified but are commercially unviable due to large capital investment requirements, long gestation periods and the inability to increase user charges to commercial levels. The Department of Economic Affairs, Ministry of Finance of the GoI have launched the Scheme for Financial Support to PPPs in Infrastructure (Viability Gap Funding Scheme) in 2006 with a view to support infrastructure projects undertaken through PPP mode. Originally VGF up to 40% of the Total Project Cost (TPC) is provided by the GoI and the sponsoring authority, in the form of capital grant at the stage of project construction (20%+20%)[5].
In FY21, the GoI approved the continuation of the revamped Infrastructure Viability Gap Funding (VGF) scheme till 2024-25. The proposed revamping of the VGF scheme is to attract more PPP projects and facilitate the private investment in the social sectors (Health, Education, Waste Water, Solid Waste Management, Water Supply etc.) The revamped Scheme is mainly related to introduction of the two sub-schemes for mainstreaming private participation in social infrastructure[6].
Sub scheme -1 is envisaged to cater to social sectors like Waste Water Treatment, Water Supply, Solid Waste Management, Health & Education sectors etc. The stipulation is that the projects eligible under this category should have at least 100 per cent operational cost recovery. Under this sub scheme the Central Government will provide a maximum of 30 per cent of total project cost (TPC) of the project as VGF and the State Government/Sponsoring Central Ministry/Statutory Entity may provide additional support up to 30 per cent of TPC and the rest should be brought in by the other parties.[7]
Sub scheme -2 is envisagedto support demonstration/pilot social sectors projects. The projects may be from health & education sectors where there is at least 50 per cent operational cost recovery. So basically this sub scheme covers the projects which are not covered in sub scheme-1 because of the lower recovery of operational cost. For the projects selected under this sub scheme, the Central Government and State Governments together will provide up to 80 per cent of capital expenditure and up to 50 percent of operation & maintenance costs for the first five years. The Central Government will provide a maximum of 40 per cent of the TPC of the project and a maximum of 25 per cent of operational costs of the project in the first five years of commercial operations which leaves the onus of financing the rest of the 80% and 50% of the capital expenditure and the operation and maintenance cost to the State Government/other statutory entities.[8]
For the FY 2020 as part of the Aatma Nirbhar Bharat Package for fiscal stimulus INR 8000 Crore which is 0.08% of the GDP of India has been earmarked for Viability Gap Funding Scheme for Social Infrastructure projects[9]. The Scheme requires the project authorities to seek ‘in-principle’ approval of the Empowered Institution/Empowered Committee prior to seeking of bids and obtain the final approval after the selection of the bidder. The approvals to projects are given prior to invitation of bids and actual disbursement takes place once the private entity has expended his portion of the equity and the final VGF is determined through the bidding. This Scheme will apply only if the contract/concession is awarded in favour of a private sector company which is not a “Government Company” as defined under section 2(45) of the Companies Act, 2013[10]. The Kelkar committee in its report suggested that in case of projects that are not viable on BOT toll basis due to issues of traffic and very high capital cost, the options to fund the project through the grant of VGF maybe explored for the purpose of reinvigorating the infrastructure sector[11].
- Taxability of VGF
VGFs are generally treated as Government Grants in the Indian eco system. Taxability of such Grants is subjected to the Tax Statutes, Accounting Standards and Income Computation and Disclosure Standards(ICDS) normally followed in the Indian jurisdiction. The Direct Tax Statute applicable for taxation purposes is the Income Tax Act,1961. ICDSs are applicable only for the purpose of computation of taxable income whereas Accounting Standards are applicable for the purpose of maintenance of books of accounts. Accounting Standards (AS) are rules regarding recognition, measurement and disclosure aspects in financial statements and relate to the codification of generally accepted accounting policies. In case of any repugnancy between the Income Tax Act,1961 and the ICDS the provision in the Act would prevail[12]. The Ministry of Corporate Affairs (MCA) which is the regulatory and overseeing body in India, has notified the Companies (Indian Accounting Standards) Rules, 2015(IndAS), with a view to converge with the international norms of accounting as laid down in International Financial Reporting Standards (IFRS). In India, until FY 2015-16, all entities followed the Indian GAAP, notified under Companies (Accounting Standards) Rules, 2006 however, with effect from FY 2016-17, the overseeing authority i.e the MCA has prescribed a roadmap for adoption of Ind AS in phases.
3.1 Methods of assessment to be applied to Grants/Subsidies
Based on the nature of the grant received two kinds of approaches and consequent methods are delineated under the IndAS and other relevant standards of taxation to account for the Government Grants, namely:
- Capital approach
- Income / Revenue approach
Grants which are given as a proportion of total investment in a business are treated as a part of capital or shareholder’s funds under the Capital Approach model. Ordinarily, the government does not expect a repayment of such grants and due to this reason, such grants are credited to the capital or shareholder’s funds. These grants are divided primarily into three types[13]:
i) Non-monetary grants
ii) The proportion of capital in a business
iii) For specific fixed assets
Where grants are of such nature that they are treated as a proportion of total capital in a business, they are treated as Capital Reserves and are shown as Capital Reserve in the Balance Sheet and consequently the amount received will not have any effect on Income Statement or Fixed Assets carrying amount. The emergent corollary would be that such amounts cannot be distributed as a dividend to shareholders and are not eligible to be considered as a deferred income. The consequence would be such grants are not subject to any taxation as Income derived under the Income Tax Act,1961 .
3.2 Legal position prior to the enactment of the Finance Act-2015 and the consequent amendment to the Section-2 of the Income Tax Act,1961
Prior to 2015, there is no provision in the Income tax Act,1961 to levy a tax on Grants, Subsidies or any other benefit ejusdem generis disbursed to the Assesses. The grundnorm is that monies in the capital nature cannot be taxed unless specified explicitly in the statute like that of capital gains. Prior to the 2015 Amendment, the question of the taxability of Grants and any other benefit ejusdem generis was not Res integra and the jurisprudence was well established. The established norms were that if the nature of the grants is of ‘capital receipts’, such receipts cannot be taxed and if the nature of the grants is that of ‘revenue receipts’ then such receipts would fall under the ambit of taxation as ‘income’ and these disputes used to be decided by the Courts.
- Sahney Steel & Press Works Ltd. v. CIT
The courts have expounded the ‘purpose test’ to determine the nature of the Grants/Subsidy i.e whether they are capital receipts or revenue receipts. In the case of Sahney Steel & Press Works Ltd. v. CIT[14],the Hon’ble Supreme Court of India have delineated that, it is not the source from which the amount is paid to the Assessee but what determines the question whether the subsidy payments are of revenue or capital nature is the purpose behind such Grant/Subsidy. The court relying on the proposition(Purpose test) by Viscount Simon in Ostime case[15] that if payments in the nature of Subsidy/Grants from public funds are made to the Assessee to assist him in carrying on his trade or business,then such payments are trade receipts. The proposition was that if any Subsidy/Grants is disbursed, the character of the Subsidy/Grants in the hands of the recipient — whether revenue or capital — will have to be determined by having regard to the purpose for which the Subsidy/Grant is given.
The court elucidated and distinguished the Seaham Harbour Dock Co. case[16] and held that that if the purpose is to help the assessee to set up its business or complete a project as in , the monies must be treated as to have been received for capital purpose. The Court countenanced the ‘Purpose Test’ and laid down that if the monies are given in the manner of an assistance to the Assessee in carrying on of his trade or business in the nature of production expenses after the production has started and not for directly or indirectly for setting up of industries, such as incentives or subsidies by way of refund of sales tax, power and electricity consumed on production, water rate etc. such payments should be treated as trading/revenue receipts. Per contra, if the assistance was that the Assessee will be given refund of monies on purchase of machinery as well as on raw materials to enable the Assessee to acquire new plants and machinery for further expansion of its manufacturing capacity in a backward area, or in the form of an assistance for setting up new industries, the entire Subsidy/Grant must be held to be a capital receipt in the hands of the Assessee. The source of the fund is quite immaterial. The resultant dicta which is deduced is that the Subsidy/Grant received on revenue account is certainly taxable but subsidy received on capital account is not taxable as income and the ‘purpose test’ should be used to determine the nature of grant and this lead to a catena of litigation.
- CIT v. Ponni Sugars and Chemicals Ltd
The Hon’ble Supreme Court in the case of CIT v. Ponni Sugars and Chemicals Ltd[17] further countenanced and relied upon the ‘purpose test’ expounded in the Sahney Steel case(supra) while deciding the question that whether the incentive subsidies provided to the sugar manufacturers by allowing an increase in free sale sugar quota falls under the capital receipt or revenue receipt. The Court held that inter alia since the Subsidies provided were dependent on increase in production capacity, such intensive subsidies are Capital Receipts. The Court held 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 and other factors like the point of time at which the subsidy is paid, the source from which the subsidy is paid, the form of the subsidy are not relevant and are immaterial. The main eligibility condition in the subject case which tipped the scales in favour of a decision as ‘Capital Receipts’ was that the incentive must be utilised for repayment of loans taken by the Assessee to set up new units or for substantial expansion of existing units.
- Siemens Public Communication Networks (P) Ltd. v. CIT
Further the Hon’ble Supreme Court in the case of Siemens Public Communication Networks (P) Ltd. v. CIT[18],where the disbursements related to the AY 1999-2000, 2000-2001, 2001-2002were in question the Court distinguished the case of Sahney Steel(supra) and held that the voluntary payments made by the parent company to its loss-making Indian subsidiary can also be understood to be payments made in order to protect the capital investment of the assessee Company and that such payments cannot be treated as Revenue Receipts to levy tax. While deciding in the aforementioned manner the Hon’ble Supreme Court held the mirror to a decision of the Division Bench of the Delhi High Court namely Commissioner of Income Tax(CIT) v. Handicrafts and Handlooms Export Corpn. of India Ltd[19] wherein similar facts were involved.
- Commissioner of Income Tax(CIT) v. Handicrafts and Handlooms Export Corpn. of India Ltd
In this case the issue under consideration by the Delhi High Court was whether the grant of INR 25 lakhs received by respondent Assessee, M/s Handicrafts and Handlooms Exports Corporation of India Ltd from its holding company State Trading Corporation of India (STC, for short) constitutes revenue receipt and whether such amount received should be taxed as income. The court applied the purpose test propounded in Sahney Steels Case(Supra) and Ponni Sugars Case(Supra) and upheld the decision of the Income Tax Appellate Tribunal regarding the AY 1986-87 which decided that the Grant received was not taxable as Revenue Receipt as this grant was given to recoup losses incurred by the respondent corporation and was in the nature of capital contribution. The Court further lucidly laid down that the source from which the amount is paid is not determinative, as in such cases the subsidy is paid from public fund but the character of the subsidy in the hands of recipient determines whether the subsidy is revenue or capital in nature.
3.3 Position after the enactment of Finance Act,2015 and the consequent amendment to the Section-2 of the Income Tax Act,1961
Clause(xviii) of sub section 24 of Section-2 of the Income Tax Act,1961 as amended by Finance Act 2015, brought the government Grants/Subsidies within the definition of Income for the first time.
The amended clause reads as:-
“(xviii)assistance in the form of a subsidy or grant or cash incentive or duty drawback or waiver or concession or reimbursement (by whatever name called) by the Central Government or a State Government or any authority or body or agency in cash or kind to the assessee [other than,—
(a) the subsidy or grant or reimbursement which is taken into account for determination of the actual cost of the asset in accordance with the provisions of Explanation 10 to clause (1) of section 43; or
(b)[20] the subsidy or grant by the Central Government for the purpose of the corpus of a trust or institution established by the Central Government or a State Government, as the case may be];]”
The Central Board of Direct Taxes(CBDT) has initially notified that the ICDS would me made applicable from A.Y. 2016-17, but later the enforcement was deferred by one year and finally made applicable from A.Y. 2017-18. Through a circular it was clarified by the CBDT that the amendment under Section 2(24)(xviii) of the Act was made in order to align the provisions of ICDS-VII with the provisions of the Income Tax Act[21]. For computing ‘income’ under the Income Tax Act,1961 the Government Grants shall be recognised and dealt with as per the provisions of the said ICDS-VII.
Whereas earlier only revenue receipts would be liable for taxation and the onus of deciding whether a particular Grant/any other benefit ejusdem generis is in the nature of revenue receipts would fall upon the Courts, the amendment brought all kinds of Grant/any other benefit ejusdem generis, under the ambit of taxation except in the following two cases:-
1)where subsidy or grant or reimbursement is considered for determination of the actual cost of the asset, in accordance with the provisions of Explanation 10 to Section 43(1) of the Act such subsidy/grant will be deducted from the actual cost and will be shown in the capital account and is exempted from the ambit of the definition of income.
2)If the subsidy/grant is for the corpus of an institution or Trust established by the Government.
The resultant position that emerges after the enforcement of the 2015 Amendment is that any Subsidy, Grant (except those of capital nature) and any other benefit ejusdem generis etc. has been included in the definition of “Income” and so it is expressly made taxable and to fall outside the ambit of taxation the Subsidy/Grant etc must belong to the two classes of grant expressly exempted. Henceforth only Grant/ any other benefit ejusdem generis of a nature which are inherently part of the actual cost of the asset are exempted from taxation and they are required to be reduced from the actual cost of the asset or written down value of block of assets to which concerned asset or assets belonged to and depreciation shall be admissible on the balance amount only as per Explanation 10 of Section 43(1) read with section-2(24)(viii).The other class of Grants/ any other benefit ejusdem generis exempted from taxation are in the nature of disbursements as part of a corpus to the Governmental Institutions.
Conclusion
Under VGF monies proportionate to the capital required for setting up and operation of a project are disbursed to make it commercially viable and which wouldn’t be setup otherwise due to the low rates of recovery of capital. Such grants are of capital nature, disbursed to meet the infrastructural needs in the form of a grant by the government and what is being given with one hand should not be taken away with the other in the form of taxation. Such denudation will serve no purpose and would detrimentally affect the project as it would further deprecate the funds available to the execution of the infrastructure project and would reduce the whole efforts to naught. Also, it is well established as a principle of taxation that the capital utilized for establishment, expansion of a business is not liable to direct taxation as such monies are monies already available to the Assessee and are not newly generated.
Applying the catena of jurisprudence laid down by the Indian Courts inter alia in the cases of Sahney Steels(supra), Ponni Sugars(Supra), Siemens Public Communications(Supra) etc., prior to the amendment of 2015 it is trite law that capital receipts like that of VGFs granted for PPPs for the purpose of making the projects commercially viable does not fall under the purview of income and hence are not liable to Direct Taxation. Whereas pursuant to the dearth of a provision delineating what constitutes capital receipts and what doesn’t, such ambiguity lead to evergreen litigation and created a Lawyers Paradise concerning the taxability of subsidy/grants, the issue was put to rest by the Finance Act, 2015. Pursuant to the amendment Assessee shall not be allowed depreciation on cost of the asset which has been met by way of the subsidy/grant amount received, and this provision is w.r.t depreciation benefits alone. Other than that the Grants/Subsidies/any other benefits ejusdem generis, of a capital nature like that of the disbursements from the VGF generally fall in the exempted category. Even otherwise the corpus provided to Government institutions are exempted from taxation. A PPP is an entity what has an inherent Government presence for building and maintain public assets and hence disbursal of VGFs to PPPs must be construed as a provision in the nature of corpus to Governmental institutions and therefore should be exempt from taxation.
Thus, it can be safely and soundly concluded that assistance in the form of Subsidy/Grant or any other benefit ejusdem generis under VGF, shall not be considered as income of the Assessee even after the 2015 Amendment and hence the monies of VGFs which are disbursed for the sole purpose of establishing and making the project commercially viable are not taxable as income either before the 2015 Amendment or after the 2015 Amendment.
*The author is a practicing Advocate at the Supreme Court of India and a partner at Subramanian & Kumar Attorneys LLP.
[1] Report of the Committee on revisiting and revitalizing the PPP model of infrastructure, 2015, https://www.pppinindia.gov.in/documents/20181/33749/Report+of+the+Committee+on+Revisiting+%26+Revitalizing+the+Public+Private+Partnership+Model+of+Infrastructure+(Kelkar+Committee+Report)/ca0d7db8-27e2-480c-8349-993f46a38b8a , last visited on 23rd October 2021.
[2] Id.
[3] The Government of India,The Economic Survey,2020-21.
[4] Supra, Note 2.
[5]DrishtiIAS , Financial Support to Public Private Partnerships in Infrastructure, available at https://www.drishtiias.com/daily-updates/daily-news-analysis/financial-support-to-public-private-partnerships-in-infrastructure , Last assessed on 27th October,2021.
[6] Supra Note 4.
[7] Supra Note 4.
[8]Supra, Note 4.
[9]Supra, Note 4.
[10] Government of India, Scheme for Financial Support to Public Private Partnerships in Infrastructure (Viability Gap Funding Scheme), DEA , available at https://www.pppinindia.gov.in/schemes-for-financial-support , last accessed on 23rd October 2021.
[11]Supra, Note 2.
[12] Ram Dutt Sharma, Taxability of the subsidy/assistance provided by the Central/State Government under the Income Tax Act,1961, available at https://itatonline.org/digest/articles/taxability-of-subsidy-assistance-provided-by-the-central-state-government-under-the-income-tax-act-1961/ , last accessed on 30th October,2021.
[13] ClearTax, AS12 Accounting for Government Grants, available at https://cleartax.in/s/as-12-accounting-for-government-grants , last accessed on 28th October,2021.
[14] Sahney Steel & Press Works Ltd. v. CIT, (1997) 7 SCC 764
[15] Pontypridd and Rhondda Joint Water Board v. Ostime, [28 TC 261 : (1946) 1 All ER 668]
[16] Seaham Harbour Dock Co. v. Crook, (1931) 16 TC 333.
[17] CIT v. Ponni Sugars and Chemicals Ltd, (2008) 9 SCC 337.
[18] Siemens Public Communication Networks (P) Ltd. v. CIT, (2018) 12 SCC 281.
[19] Commissioner of Income Tax v. Handicrafts and Handlooms Export Corpn. of India Ltd, 2013 SCC OnLine Del 3452.
[20] Amended by Act No 28 of 2016, The Finance Act, Clause-3, Ministry of Law and Justice.
[21] CA Girija M Singh, Taxability of Grant, Subsidy or any Assistance, available at https://www.caclubindia.com/articles/taxability-of-grant-subsidy-or-any-assistance-35215.asp , last accessed on 30th October 2021.