Grant Received by Subsidiary from its Holding – Is it a Revenue Receipt?

When a bigger firm buys at least 50% of a company’s stock, the small company becomes a subsidiary to it. When the main firm gains control, it appoints a board of directors to manage the subsidiary business. There is one question that may arise in the mind of people; is a grant from a holding company by a subsidiary firm to offset a subsidiary’s continuous trading loss will act as Revenue Receipt/Capital Receipt?; In this article, we shall try to reach the conclusion about the nature of Grant Received by Subsidiary from its Holding company that whether it will act as Revenue Receipt or not.

Before we shall jump to the nature of the grant we should have a clear knowledge of distinction between the Subsidiary company and Holding company. Let us understand them one by one.

Subsidiary Company under Grant Received by Subsidiary from its Holding

A Subsidiary Company is a company that is owned by a Parent firm or Holding Company owns. A Parent company is often a larger corporation that controls a smaller company that serves as a subsidiary. A Subsidiary company can take a form of a Limited Liability Company (LLC).  To have a controlling stake in subsidiary, parent businesses must possess 50% or more of it. When a parent firm owns 100% of a subsidiary’s equity, then it takes the form of a wholly-owned subsidiary.

When a parent firm owns less than 50% of another company, the latter will act as an associate company. Sister firms are subsidiaries of the same parent corporation.

Working Mechanism of Subsidiary Company

When a bigger firm buys at least 50% of a company’s stock, the small company becomes a subsidiary to it. When the main firm gains control, it appoints a board of directors to manage the subsidiary business. The board of directors of a subsidiary serves as the company entity’s decision-making body. Subsidiary firms share their financial accounts with their parent company to undertake the auditing process. To construct a subsidiary structure, a subsidiary business might incorporate or purchase its own subsidiaries. These subsidiaries are classified as first-tier, second-tier, and third-tier.

Holding Company

A Holding company is a parent company, limited liability company, or limited partnership that owns a significant number of voting shares in another firm. The ownership by the holding company is in such a manner that the holding company has influence over the policies of its subsidiary firm. As well as oversight over management choices. Although a Holding company owns the assets of other companies, it only retains managerial powers. Further, it is not actively involved in the day-to-day operations of a firm.

According to the Companies Act, 2013, a firm that is owned and managed by another business is referred to as a subsidiary; while the former is referred to as a holding company. As a result, the term “control” is defined in company law to assess a business’s ability to act as a holding company. Control can be exercised by management or via share ownership.

Characteristics of a Holding Company

The following are the characteristics that a Holding company possesses:

• A holding company’s principal goal is to manage other businesses, like, limited liability partnerships, or limited liability corporations.
• Property owned by holding corporations might include immovable things, patents, trademarks, stocks, and so on.
• “Wholly-owned subsidiaries” are businesses that are wholly owned by a holding company.
• A holding company can hire and fire the management from the firms it controls. Further, the managers are ultimately accountable for the operations of those companies.
• Holding companies benefit from loss insurance. If a subsidiary declares bankruptcy, the owning company may experience a capital loss and a fall in net value.
• For an asset management policy, a parent organisation may organise itself as a holding company. In addition, it can form subsidiaries for each of its business lines.

Grant Received by Subsidiary from its Holding – Revenue Receipt?

Let us understand this concept by an example of S Ltd. (Say), a subsidiary of H Ltd., has consistently lost money. To recuperate the losses, the holding firm H Ltd. made a grant of Rs. 1 crore to S Ltd. The assessing officer maintains that this item is a trade receipt and that it should include in the assessable income.

Now let us examine this issue while taking cognizance of provisions of the Income Tax Act, 1961 and with relevant case law if any.

Solution: The facts of the case are similar to those in CIT v. Handicrafts and Handlooms Export Corporation of India Ltd. (2014) 360 ITR 0130 (Delhi), in which the assessee was a government corporation that operated a channelling agency for the sale of handicrafts and handlooms overseas. It got a grant of Rs. 25 lakhs from its parent company, the State Trading Corporation of India (STC), to recoup the losses in the previous year. According to the Assessing Officer (AO), the aforementioned sum constituted a revenue receipt and hence taxable.

Opinion of Judiciary on nature Grant Received by Subsidiary from its Holding

The following are the opinion of the judiciary upon the Grant received by the Subsidiary from its Holding company:

TRIBUNAL’S OPINION

As per the Appellate Tribunal, the grant was not taxable as a revenue receipt because it was given to recuperate the assessee’s losses and was therefore in the character of a capital contribution.

OBSERVATIONS OF THE HIGH COURT

The High Court considered the Supreme Court’s decision in Sahney Steel and Press Works Ltd. v. CIT (1997) 228 ITR 253, which established the rule for evaluating whether a subsidy received by an assessee is subject to tax as capital or revenue receipt.

According to the above criteria, when at the time of granting of any subsidy, the character of the subsidy is in the hands of the receiver – whether income or capital – the holding company must decide it by considering the reason for which they were granting the subsidy. The point in time, the source, and the form of the subsidy are immaterial. The company can determine the character of the subsidy by the goal or purpose of the grant. Moreover, it must act as a trading receipt if it supplies to aid the assessee in continuing on his trade or company.

As noted by the Division Bench in Handicrafts and Handlooms Corporation Ltd. v. CIT (1983) 140 ITR 532, the High Court distinguished between Government Grant and payment made by the holding company. The grants were precise sums provided by the holding company to the assessee to allow the assessee, who was its subsidiary and was suffering losses year after year. To recuperate these losses and satisfy its responsibilities. As a result, the company cannot include these sums in the assessee’s commercial receipts since they were not in the kind of donations from an outsider or the government on broad grounds, for carrying on the business.

Thus, the holding company’s grant in this circumstance is in the type of capital receipt since its goal is to secure and protect the capital investment made in the subsidiary firm. The judgement of AO to treat the grant granted by Holding Company to its subsidiary as revenue/trading receipt is untenable.

Endnote

Taking cognizance of the above facts and judgements, we can come to the conclusion that the holding company’s grant to the subsidiary company for restoring or for coping up the loss in the business activities will not act as Revenue Receipts or taxable.