The Supreme Court of India has dismissed a batch of appeals filed by the National Cooperative Development Corporation (NCDC), holding that the corporation is not entitled to deductions under Section 36(1)(viii) of the Income Tax Act, 1961, in respect of dividend income, interest on short-term bank deposits, and service charges for monitoring Sugar Development Fund (SDF) loans.
A Bench comprising Justice Pamidighantam Sri Narasimha and Justice Atul S. Chandurkar held that these receipts do not qualify as “profits derived from the business of providing long-term finance” as envisioned by the strict legislative framework of the Act. The Court emphasized that the phrase “derived from” connotes a “direct, first-degree nexus” and rejected the “integrated activity” argument.
Legal Issue and Outcome
The central question for adjudication was whether the NCDC could claim deductions under Section 36(1)(viii) for:
- Dividend income on investments in shares.
- Interest earned on short-term deposits with banks.
- Service charges received for monitoring SDF loans.
The Court concluded that the legislative transition brought by the Finance Act, 1995, aimed to “ring-fence” the fiscal benefit. By using the restrictive term “derived from” and defining “long-term finance” exhaustively, Parliament intended to exclude ancillary or incidental income. Consequently, the appeals were dismissed.
Factual Background
The appellant, NCDC, is a statutory corporation mandated to advance agricultural and cooperative initiatives. The dispute arose during assessment proceedings when the Assessing Officer (AO) noted that the appellant claimed deductions on its total income. The AO disallowed deductions for the three specific heads, reasoning that they were not profits “derived from the business of providing long-term finance.”
The AO’s findings were:
- Dividend Income: This was a return on investment in shares, legally distinct from interest on long-term loans.
- Short-term Interest: This accrued from investing idle surplus funds, not from the core activity of providing agricultural credit.
- SDF Service Charges: The appellant acted merely as a nodal agency for Central Government funds, receiving a fee for administrative roles.
The Commissioner of Income Tax (Appeals) and the Income Tax Appellate Tribunal (ITAT) upheld these disallowances. The High Court also affirmed the findings, leading to the present appeals before the Supreme Court.
Arguments of the Parties
The Appellant’s Contentions: Ms. Christi Jain, counsel for the NCDC, argued that the phrase “derived from” should be interpreted broadly. Relying on CIT v. Meghalaya Steels Ltd. (2016), she contended that receipts flowing directly from the business chargeable under Section 28 should qualify. The appellant further argued that its operations constituted a “single, indivisible integrated activity,” and that earning interest on idle funds was interlinked with its business, citing National Co-operative Development Corporation v. CIT (2021). Regarding preference shares, it was argued that their substance—having fixed redemption schedules—assimilated them to debt.
The Respondent’s Submissions: Additional Solicitor General Mr. Raghavendra P. Shankar, appearing for the Revenue, argued that “derived from” signifies a strict, first-degree nexus, relying on CIT v. Sterling Foods (1999) and Pandian Chemicals Ltd. v. CIT (2003). The Revenue maintained that under Section 85 of the Companies Act, 1956, preference shares remain share capital, not loans. Regarding SDF loans, it was emphasized that the funds belonged to the Government, and the appellant merely received a service fee.
The Court’s Analysis
The Supreme Court provided a detailed analysis of the statutory scheme and the interpretation of “derived from.”
1. Interpretation of Section 36(1)(viii) and “Derived From” The Court observed that the Finance Act, 1995, introduced a strict framework. The Memorandum explaining the amendment explicitly stated the objective was to limit the deduction “only to the income derived from providing long term finance,” thereby excluding income from diversified activities.
The Bench cited Cambay Electric Supply Industrial Co. Ltd. v. CIT (1978) to distinguish between “attributable to” and “derived from,” noting that the latter is narrower. The Court observed:
“We find merit in the respondent’s submission that this phrase ‘derived from’ connotes a requirement of a direct, first-degree nexus between the income and the specified business activity… it requires a direct or immediate nexus with the specific business activity, for if the income is even a ‘step removed’ from the business in question, that nexus is snapped.”
The Court distinguished Meghalaya Steels, noting that it dealt with Section 80-IB (“any business”), whereas Section 36(1)(viii) is “extremely narrow.”
2. Rejection of “Integrated Activity” Theory Citing Orissa State Warehousing Corpn. v. CIT (1999), the Court rejected the appellant’s argument that its business should be treated as indivisible to claim deductions on all receipts. The Court affirmed that fiscal statutes must be construed strictly based on the plain language used.
3. Dividend Income The Court held that dividends are returns on investment based on a contractual shareholding relationship, distinct from lending. Relying on the Constitution Bench decision in Bacha F. Guzdar v. CIT (1954), the Court noted:
“A fundamental distinction exists between a shareholder and a creditor… Since the statute specifically mandates ‘interest on loans’, extending this fiscal benefit to ‘dividends on shares’ would defy the legislative intent.”
4. Interest on Short-term Deposits The Court clarified that while interest on idle funds is “Business Income” (as held in NCDC v. CIT, 2021), it does not automatically qualify for the special deduction under Section 36(1)(viii). The Court stated:
“The legislative intent was to incentivize the specific act of providing long-term credit, not the passive investment of surplus capital… interest earned from bank deposits fails this test as it is, at best, attributable to the business, but certainly not derived from the activity of providing long-term finance.”
5. Service Charges on SDF Loans Regarding the SDF loans, the Court noted the admitted position that the funds belonged to the Government of India. The appellant acted as an intermediary.
“A fee received for agency services cannot be equated with ‘profits derived from the business of providing long-term finance,’ which implies the deployment of the corporation’s own funds and the earning of interest thereon.”
Decision
The Supreme Court dismissed the appeals, affirming the High Court’s judgment. It held that Section 36(1)(viii) is not a general exemption for statutory corporations but a specific incentive attached strictly to defined activities.
“By employing the narrowest possible connective verb ‘derived from’ and coupling it with an exhaustive definition of ‘long-term finance’ in the Explanation, the Legislature has explicitly excluded ancillary, incidental, or second-degree sources of income.”
Case Details
- Case Title: National Cooperative Development Corporation v. Assistant Commissioner of Income Tax
- Case No: Civil Appeal No. 4612 of 2014 (and connected matters)
- Coram: Justice Pamidighantam Sri Narasimha and Justice Atul S. Chandurkar
- Citation: 2025 INSC 1414
