1. Introduction
Government incentives play a crucial role in supporting businesses and infrastructure development. Among these, Government Grants and Viability Gap Funding (VGF) are two key mechanisms used to provide financial assistance.
However, a fundamental question arises:
- How should interest-free loans provided by the government be accounted for?
- Should VGF be treated as a government grant under Ind AS 20 or as a financial liability?
This article provides an in-depth analysis of these questions, covering their treatment under Ind AS 20 (Accounting for Government Grants and Disclosure of Government Assistance) and Income Tax Act provisions, supported by practical examples.
2. Understanding Government Grants and Viability Gap Funding (VGF)
A. What are Government Grants?
Government grants refer to financial aid provided by the government to an entity, typically with certain conditions attached. These may be in the form of:
- Capital Grants – For purchasing fixed assets (e.g., land, buildings, machinery).
- Revenue Grants – To cover operational costs (e.g., R&D subsidies, interest subsidies).
- Tax Incentives – Deductions or exemptions given to promote investments in specific industries.
- Interest-Free Loans or Soft Loans – Loans provided at concessional interest rates to encourage business growth.
B. What is Viability Gap Funding (VGF)?
VGF is a financial support mechanism provided by the government, primarily for Public-Private Partnership (PPP) infrastructure projects. It aims to:
- Make projects financially viable by bridging the gap between project cost and expected revenue.
- Provide either capital grants (one-time funding) or operational subsidies (continuous support).
- Encourage private sector participation in sectors like roads, energy, water supply, and urban infrastructure.
Example:
A private company constructing a highway under a PPP model may receive 20% of the total project cost as VGF from the government.
The key accounting challenge is whether this VGF should be classified as a government grant (Ind AS 20) or a financial liability (Ind AS 109 – Financial Instruments).
3. Accounting for Interest-Free Loans Provided by the Government
Interest-free loans (IFLs) provided by the government are a form of financial assistance, but their treatment depends on:
- Whether they meet the definition of a government grant under Ind AS 20.
- Whether they create a financial liability under Ind AS 109.
A. Classification of Interest-Free Loans under Ind AS 20 vs. Ind AS 109
- If IFL is conditional (e.g., must be repaid upon non-fulfillment of conditions):
- Treated as a financial liability under Ind AS 109.
- The difference between the fair value of the loan and amount received is recognized as a government grant under Ind AS 20.
- Subsequent interest is unwound using the effective interest rate (EIR) method.
- If IFL is unconditional and non-repayable:
- Treated as a government grant under Ind AS 20.
- Recognized in income either immediately or over the period of benefit.
Example 1: Interest-Free Loan with Conditions
A government provides ₹100 crore interest-free loan to a solar energy company, provided it generates 50 MW of power annually for 10 years.
- Fair value of the loan (discounted at market rate) = ₹85 crore.
- The difference of ₹15 crore is recognized as a government grant.
- The ₹85 crore liability is accounted for using the EIR method.
Example 2: Non-Repayable Interest-Free Loan
A startup receives a ₹50 lakh grant from the government to set up a biotech R&D center, with no repayment obligation.
- This is recognized entirely as a government grant and recorded as income over the useful life of assets purchased.
Key Takeaway:
- If there are repayment conditions, treat it as a financial liability.
- If it is non-repayable, treat it as a government grant.
4. Accounting for Viability Gap Funding (VGF) – Grant or Liability?
VGF can be structured in two ways:
- As a non-refundable government grant (Ind AS 20).
- As a repayable liability (Ind AS 109).
A. When VGF is Treated as a Government Grant (Ind AS 20)
If the funding is a one-time non-repayable contribution to support project viability, it qualifies as a government grant under Ind AS 20.
- Recognized as deferred income and amortized over the project’s useful life.
- Presented in Other Income in the Profit & Loss (P&L) statement.
Example 3: VGF as a Government Grant
A company receives ₹200 crore from the government to build a metro rail system. The grant is provided with no repayment obligation.
- The amount is not classified as a liability.
- It is amortized over the life of the metro infrastructure (say, 20 years).
- Annual P&L impact: ₹10 crore recognized as income per year.
B. When VGF is Treated as a Financial Liability (Ind AS 109)
If the VGF is structured as a loan or repayable amount, it should be recognized as a financial liability under Ind AS 109.
- Initial recognition at fair value.
- Interest is recognized using the EIR method.
Example 4: VGF as a Financial Liability
The government provides ₹500 crore to a private toll-road operator with a 20-year repayment schedule.
- The amount is recognized as a loan under Ind AS 109.
- The interest expense is recorded using EIR.
Key Takeaway:
- If VGF is non-repayable, treat it as a government grant (Ind AS 20).
- If VGF is structured as a loan, treat it as a financial liability (Ind AS 109).
5. Taxation of Government Grants and VGF Under the Income Tax Act
A. Capital vs. Revenue Treatment
- Capital grants used for asset acquisition → Reduced from asset cost (depreciation impact).
- Revenue grants used for operations → Taxable as income under Section 2(24)(xviii).
B. Tax Treatment of Interest-Free Loans
- Interest-free loans may be subject to notional interest taxation under Section 28(iv) if treated as business income.
C. Tax Treatment of VGF
- Non-repayable VGF → Treated as a capital receipt (not taxable) if used for infrastructure projects.
- Repayable VGF → Considered debt financing and not deductible as an expense.
Example 5: Taxation Impact
A government grant of ₹50 crore used for R&D expenses is recognized as taxable income. If used for machinery, depreciation is claimed on net cost after reducing the grant.
6. Conclusion
The accounting and taxation of government grants and VGF depend on their structure and conditions:
- Interest-free loans → Treated as grants or liabilities based on conditions.
- VGF → If non-repayable, accounted under Ind AS 20; if repayable, classified as a liability.
- Tax treatment → Depends on capital vs. revenue nature of the grant.
Stox N Tax 
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