National Cooperative Development Corporation Vs CIT

Civil Appeal Nos.5105-5107 of 2009

Following where the important observation by the Supreme Court in above case:

1. Whether, for the purpose of an income to qualify as business income, profit motive is an essential ingredient –

NO: SC

2. Whether if an income is clearly an interest income, there is no need to take recourse to provisions of Sec 56 –

YES: SC

3. Whether if interest income merges with monies in common fund, it loses it character of revenue receipt and becomes capital in nature –

NO: SC

Assessee’s appeal allowed: SUPREME COURT OF INDIA

Overview of the Case:

The assessee, the National Co-operative Development Corporation, was established to advance loans or grant subsidies to State Governments for financing cooperative societies; provide loans and grants directly to the national level cooperative societies, as also to the State level cooperative societies, the latter on the guarantee of State Governments. The assessee was required to maintain a Fund which was credited with all monies received by it by way of grants and loans from the Central Government, as well as sums of money as may from time to time be realized out of repayment of loans made from the Fund or from interest on loans or dividends or other realizations on investments made from the Fund. The assessee invested the idle funds in fixed deposits from time to time, which generated income. Income by way of interest on debentures and loans advanced to the State Governments/Apex Cooperative Institutions were credited to this account. Even though the assessee was an intermediary or “pass through” entity, it was a distinct juridical entity.

The issue arose was – whether the component of interest income earned on the funds received under Section 13(1), and disbursed by way of “grants” to national or state level co-operative societies, was eligible for deduction for determining the “taxable income”. The AO opined that the non-refundable grants were in the nature of capital expense and not a revenue expense and, thus, disallowed the same as a deduction. What weighed with the AO was also the fact that the grants received from the Central Government were in the nature of a capital receipt exempt from tax. The AO noted that no deduction as sought for had been claimed in the previous assessment years. Of course, subsequently, the stand of the assessee was that the same was a mistake and they could not be bound by the same for the subsequent years.

On appeal, the CIT(A) opined that the grants made by the assessee undisputed fell within its authorized activities, which were interlinked and interconnected with its main business of advancing loans on interest to State Governments and cooperative societies. These grants were intended to be utilised for various projects which were admittedly of capital nature and resulted in the acquisition of capital assets, but not by the assessee itself. Thus, a conclusion was reached that, in terms of Section 37 of the Income Tax Act, 1961 as it stood for the relevant assessment year, any expenditure (except of the prohibited type) laid out or expended wholly and exclusively for the purpose of the business was allowable as a deduction while computing business income. The CIT(A), thus, found that the approach adopted by the AO was fallacious as the functions and activities of the assessee included giving loans and grants which, in fact, was the very purpose for which it had been set up. However, the ITAT accepted the view taken by the AO and did not agree with the approach of the CIT(A). Even the High Court ruled in favor of the Revenue.

On appeal, the SC held that,

++ We are in agreement with the view taken by the High Court, as the only business of the assessee is to receive funds and then to advance them as loans or grants. The interest income arose on account of the fund so received and it may not have been utilised for a certain period of time, being put in fixed deposits so that the amount does not lie idle. That the income generated was again applied to the disbursement of grants and loans. The income generated from interest is necessarily interlinked to the business of the assessee and would, thus, fall under the head of ‘profits and gains of business or profession’. There would, therefore, be no requirement of taking recourse to Section 56 of the IT Act for taxing the interest income under this residuary clause as income from other sources. In our view, to decide the question as to whether a particular source of income is business income, one would have to look to the notions of what is the business activity. The activity from which the income is derived must have a set purpose. The business activity of the assessee is really that of an intermediary to lend money or give grants. Thus, the generation of interest income in support of this only business (not even primary) for a period of time when the funds are lying idle, and utilised for the same purpose would ultimately be taxable as business income. The fact that the assessee does not carry on business activity for profit motive is not material as profit making is not an essential ingredient on account of self-imposed and innate restriction arising from the very statute which creates the assessee and the very purpose for which the assessee has been set up;

++ in view of the finding the crucial issue would be whether the amounts advanced as grants from this income generated could be adjusted against the income to reduce the impact of taxation as a revenue expense. If it is revenue expense the amount can be deducted but if it is capital expense then the answer would be in the negative;

++ no doubt the interest income is not directly received as a capital amount. It is actually generated by utilizing the capital receipts when the fund is lying idle though the income so generated is then applied for the very objective for which the assessee was set up, i.e., disbursement of grants and advancement of loans. The judgment of the High Court appears to us to have dealt with both loans and grants, but the question of references framed, and which is a position accepted before us, is that the dispute related to only grants. It was not the assessee’s case that the amounts advanced as loans, the same being payable with interest, could be adjusted as expenses against the business income generated by investing the amounts and consequently earning interest on the same. The argument was predicated on a reasoning that since the interest generated is treated as a business income, the grants made, which would never come back, should be adjustable as expenses against the same. In fact, to the extent grants were returned back, the CIT(A) did not allow the entire deduction as claimed for but only did so qua the amount which was disbursed as grant and never received back;

++ the role of the assessee is confined to receiving funds from the Central Government and appropriately advancing the same as loans, grants or subsidies. In a larger canvas the assessee plans, promotes and makes financial programmed for the benefit of these societies and other entities to which such loans, grants and subsidies are advanced. We may say it is really in the nature of an intermediary with expertise in the financial sector to carry forward the intent of the Central Government to assist State Governments, Cooperative Societies, etc. Since this is the business activity, that is what has persuaded us to opine that the income generated in the form of interest on the underutilized capital is in the nature of business income. The objectives are wholly socio-economic and the amounts received including grants come with a prior stipulation for the funds received to be passed on to the downstream entities. This is the reason they have been treated as capital receipts. However, we are unable to opine that since this is a pass-through entity on the basis of a statutory obligation, the advancement of loans and grants is not a business activity, when really it is the only business activity. Once it is business activity, the interest generated on the unutilised capital has been held by us to be the business income;

++ we are unable to accept the contention of the Revenue Department that merely because the interest income received has merged with the monies in the common Fund it loses its revenue character and becomes a capital receipt. This line of argument is inconsistent with the position where interest money is received, it is held to be of revenue character, and chargeable to tax under the head ‘Profits and Gains of Business or Profession’. This amount while lying in the same fund cannot acquire the character of a capital receipt. The interest having been treated as revenue receipt on which taxes are paid, it must continue to retain the character of revenue receipt. If the nature of receipt is treated as capital receipt then consistent with such approach, no taxes would have been payable on the amount. The corollary is that all expenses incurred in connection with the business are deductible;

++ the question arises whether prior to 2003 amendment assessee’s expenses were not allowable under the prevailing tax regime for such entitles which were not exempt from tax. In the years prior to the amendment, as we are dealing with AY 1976-77 on wards, the tax jurisprudence has evolved on the basis of ordinary principles of commercial accountancy for determining the taxable income. Thus, prior to insertion of this sub-clause, such expenses would be permissible under the general Section 37(1) of the IT Act, which provides for deduction of permissible expenses on principles of commercial accountancy. Post amendment, such expenses get allowed under the specific section, viz. Section 36(1)(xii) after the amendment by the Finance Act, 2003.