The Supreme Court has dismissed a batch of appeals filed by the National Cooperative Development Corporation (NCDC), ruling that the statutory deduction under Section 36(1)(viii) of the Income Tax Act, 1961, is strictly limited to profits “derived from” the specific business of providing long-term finance. The Court held that ancillary income such as dividends from shares, interest on short-term bank deposits, and service charges for government fund monitoring do not qualify for this benefit.
A Bench comprising Justice Pamidighantam Sri Narasimha and Justice Atul S. Chandurkar affirmed the decision of the Delhi High Court, clarifying that the legislative transition in the Finance Act, 1995, intended to “ring-fence” the fiscal benefit to the core activity of long-term lending.
Legal Issue and Summary
The central issue for adjudication was whether the NCDC was entitled to claim deductions under Section 36(1)(viii) of the Act on three specific heads of income:
- Dividend income on investments in shares.
- Interest earned on short-term deposits with banks.
- Service charges received for monitoring Sugar Development Fund (SDF) loans.
The provision allows financial corporations providing long-term finance for industrial or agricultural development to deduct up to 40% of the profits “derived from such business.” The Supreme Court held that these receipts did not qualify as “profits derived from the business of providing long-term finance,” observing that the legislature explicitly excluded “ancillary, incidental, or second-degree sources of income.”
Background of the Case
The appellant, NCDC, is a statutory corporation mandated to advance cooperative initiatives. During the assessment proceedings for several years, the Assessing Officer (AO) disallowed the deductions claimed under Section 36(1)(viii) for the three disputed income streams. The AO reasoned that the dividend income arose from investments, interest on short-term deposits from idle funds, and SDF service charges from acting as a nodal agency—none of which constituted the business of providing long-term finance.
The Commissioner of Income Tax (Appeals) and the Income Tax Appellate Tribunal (ITAT) upheld these disallowances. Subsequently, the High Court affirmed the findings, noting that the strict “derived from” test was not met. The NCDC then approached the Supreme Court.
Arguments of the Parties
The appellant argued that the phrase “derived from” should be interpreted broadly. Relying on the Supreme Court’s decision in CIT v. Meghalaya Steels Ltd., the NCDC contended that since the receipts flowed directly from its business and were chargeable under Section 28, they should qualify for the deduction. The corporation also argued that its operations constituted a “single, indivisible integrated activity,” and that earnings on idle funds were interlinked with its business. Regarding redeemable preference shares, the appellant claimed their substance was akin to debt.
The Revenue, represented by the Additional Solicitor General, argued that judicial authority has consistently established that “derived from” signifies a strict, “first-degree nexus.” Citing decisions like CIT v. Sterling Foods and Pandian Chemicals Ltd. v. CIT, the respondent submitted that the income must come directly from the specified activity. It was further argued that preference shares remain share capital under the Companies Act, and acting as an agent for government funds does not equate to providing long-term finance.
Court’s Analysis and Observations
The Supreme Court conducted a detailed analysis of the statutory scheme, particularly the amendment introduced by the Finance Act, 1995, which restricted the deduction from “total income” to profits “derived from such business.”
1. Interpretation of “Derived From” The Bench observed that the legislature deliberately used the narrow connective verb “derived from” rather than “attributable to.” The Court held that “derived from” requires a “direct, first-degree nexus” between the income and the specified business activity.
Distinguishing the Meghalaya Steels judgment, the Court noted that the present case involves a specific, restrictive deduction provision. The Bench rejected the “integrated activity” theory, citing Orissa State Warehousing Corpn. v. CIT, and stated:
“When a fiscal statute grants a benefit based on a specific source, the concept of an integrated business cannot be utilized to expand the scope of that benefit to cover distinct streams of income that do not strictly satisfy the statutory definition.”
2. Dividend on Redeemable Preference Shares The Court ruled that dividends are a return on investment in share capital, distinct from interest on loans. Relying on the Constitution Bench decision in Bacha F. Guzdar v. CIT, the Court noted:
“In fact and truth dividend is derived from the investment made in the shares of the company and the foundation of it rests on the contractual relations between the company and the shareholder… Since the statute specifically mandates ‘interest on loans’, extending this fiscal benefit to ‘dividends on shares’ would defy the legislative intent.”
3. Interest on Short-Term Bank Deposits The Court rejected the appellant’s reliance on the previous judgment in National Co-operative Development Corporation v. CIT (2021), noting that it dealt with tax years 1976-1984, which predated the 1995 amendment. The Bench emphasized that the earlier judgment merely established such interest as “business income” for expense deduction purposes, whereas Section 36(1)(viii) operates on a “much narrower plane.”
The Court explained that the 1995 amendment was designed specifically to prevent the kind of broad “integrated business” claims being made by the appellant. The judgment stated:
“We cannot use a judgment based on the old, broader law to interpret the new, stricter provision… There is a vital judicial distinction between the general genus of ‘Business Income’ and the specific species of ‘profits derived from the business of providing long-term finance’. Just because an income falls into the broad bucket of ‘Business Income’ does not automatically mean it qualifies for the 40% deduction…”
4. Service Charges on Sugar Development Fund Loans Regarding the SDF loans, the Court noted that the funds belonged to the Government of India, and the appellant merely acted as a nodal agency receiving fees for administrative tasks like monitoring and disbursement. The Court identified the “proximate source” of this income as the agency agreement with the Government, not the lending activity. The Court observed:
“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 concluded that the legislative intent was to incentivize the specific act of providing long-term credit, not the passive investment of surplus capital or agency services. The Court held:
“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.”
Accordingly, the Court dismissed the appeals and affirmed the disallowance of the deductions.
Case Details:
- Case Title: National Cooperative Development Corporation vs Assistant Commissioner of Income Tax
- Case No.: Civil Appeal No. 4612 of 2014 (with connected matters)
- Citation: 2025 INSC 1414
- Coram: Justice Pamidighantam Sri Narasimha and Justice Atul S. Chandurkar
