Bombay High Court Rules Sales Tax Incentive as Capital Receipt, Not Taxable

The Bombay High Court has ruled that sales tax incentives given under a government scheme for industrial promotion are to be treated as capital receipts and are therefore not subject to income tax. The decision came in response to a long-standing dispute between Bajaj Auto and the Income Tax Department over the taxability of benefits received under a state industrial incentive scheme.

Background of the Case

The case was heard by a bench comprising Chief Justice Alok Aradhe and Justice Sandeep V. Marne. The issue at hand was whether the incentives received by the assessee under a state government scheme should be treated as capital in nature (exempt from tax) or revenue in nature (taxable).

Bajaj Auto, the assessee, is a well-known manufacturer of two-wheelers, three-wheelers, and vehicle spare parts. The company had availed a sales tax incentive under a scheme introduced by the Government of Maharashtra on May 4, 1983, which provided sales tax exemption or deferral for five years. Bajaj Auto received an eligibility certificate under this scheme for three years, beginning February 1, 1986.

Tax Department’s Stand

During assessment proceedings, the Assessing Officer (AO) rejected Bajaj Auto’s claim that the incentive should be treated as a capital receipt. Instead, the AO classified the benefit as a revenue receipt, which meant it would be added to the company’s taxable income.

Bajaj Auto challenged the decision before the Commissioner of Income Tax (Appeals), or CIT(A), which partially allowed the appeal, but gave no relief on the tax treatment of the sales tax incentive. Bajaj Auto then filed a further appeal before the Income Tax Appellate Tribunal (ITAT). The ITAT also ruled against Bajaj Auto, stating that the incentive was a revenue receipt, not a capital one.

Assessee’s Argument

Bajaj Auto argued that the incentive was granted to promote industries in backward areas, and was not directly related to the company’s production or sales activities. The scheme did not provide a cash subsidy but instead allowed the company to adjust the incentive amount against sales tax payable once production began. Therefore, the incentive should be treated as a capital subsidy, aimed at encouraging industrialisation, not boosting business profits.

Court’s Observation

The Bombay High Court carefully considered whether the purpose of the incentive was to help run the business more profitably or to encourage setting up or expanding industrial units. The Court observed:

“If the incentive is offered for the purpose of setting up a new industrial unit or expansion of an existing unit, the receipt of the incentive would be on account of capital. If it is meant to make the business more profitable, then it would be on revenue account.”

The bench further clarified that even if the grant of the incentive is linked to the start of production, it will still be treated as a capital receipt as long as the purpose of the scheme is to promote industrialisation.

Purpose Test Applied

The Court applied what is commonly known as the “purpose test” and concluded that the sales tax incentives under both the 1979 and 1983 Maharashtra Government schemes were provided solely for the purpose of encouraging the setting up of industries in backward and underdeveloped areas. The incentives were not designed to boost profitability but to offer initial support to new units.

Final Judgment

In light of these observations, the Bombay High Court ruled in favour of Bajaj Auto. The Court allowed the assessee’s appeal and dismissed the appeal filed by the revenue authorities.

This ruling reinforces the principle that government incentives meant for industrial development should be treated as capital receipts and should not be taxed as business income, provided they meet the purpose-based criteria.

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