Victory for Bajaj Auto & Reliance: Bombay HC Rules Sales Tax Incentives for New Units in Backward Areas Are Capital Receipts, Not Taxable

The dispute in this case was connected to sales tax incentives granted under the State Government’s schemes of 1979 and 1983. These schemes were introduced to promote industries in backward areas and reduce pressure on already developed belts like Mumbai, Thane, and Pune. Eligible businesses were allowed to set off incentives against their sales tax liability once production began.

The Revenue argued that since the benefit was linked to production and sales, it should be taxed as a revenue receipt. The assessees, on the other hand, argued that the real purpose of the schemes was to encourage industrial growth by supporting new investments in underdeveloped areas, and therefore, the incentives were capital in nature. After conflicting rulings of the ITAT in appeals concerning different assessees on the same issue, the case came up in appeal before the High Court.

Issue Raised: Whether sales tax incentives given under State Government schemes are to be treated as capital receipts (not taxable) or revenue receipts (taxable).

HC’s Decision: The High Court ruled that sales tax incentives under the 1979 and 1983 schemes were capital receipts, exempt from taxation. Applying the “purpose test” laid down in Ponni Sugars and reiterated in Chaphalkar Brothers, the Court held that the object of the scheme is the decisive factor, and not the form of payment. Since the incentives were designed to promote setting up of new industrial units in backward areas and developed belts, they were clearly on capital account.

The Court reasoned that the mechanism of adjusting incentives against sales tax payable after commencement of production did not alter their essential purpose. The HC emphasized that the form and timing of the incentive are immaterial when the purpose is to industrialize the State.

Thus, the court overturned the ITAT’s order and dismissed Revenue’s appeal (ITA No. 156 of 2003) while allowing the Assessee’s appeal (ITA No. 505 of 2003). It mandated that the subsidies and incentives obtained through the State Government program be regarded as capital gains and exempt from taxation. The disallowances made by the Assessing Officer and upheld by the CIT(A) were quashed.

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