National Co-Operative Development Corporation vs Commissioner of Income Tax, Delhi-V

Disposing of the appeals, the Court

HELD: 1.1 The appellant-Corporation, National Cooperative Development Corporation, was established under the National Cooperative Development Corporation Act, 1962 (NCDC Act). The functions of the appellant-Corporation are set out in Section 9 of the NCDC Act, which is, inter alia, 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 funding process for the appellant-Corporation is set out in Section 12 of the NCDC Act, by way of grants and loans received from the Central Government. The appellantCorporation is required to maintain a fund called the National Cooperative Development Fund (for short ‘the Fund’) which is, inter alia, 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 realised out of repayment of loans made from the Fund or from interest on loans or dividends or other realisations on investments made from the Fund. In furtherance of this, as and when surplus funds accumulated, the appellant-Corporation 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 are credited to this account. Even though the appellant-Corporation is an intermediary or “pass through” entity, it is a distinct juridical entity. Its taxation status is as follows:

i. Insofar as funds are received from the Central Government, these are treated as capital receipts, and hence are not chargeable to tax. There is no dispute about this.

ii. With respect to the interest component, it is treated as taxable income and is logically taxed as “business income.” The issue which has arisen for consideration is 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, is eligible for deduction for determining the “taxable income” of the appellant-Corporation. This was contrary to the earlier accounting practice and arose for the first time for the assessment year 1976-77. [Paras 2-4][528F-G; 529-A-C; 530-C-G]

1.2 The first aspect to be adverted to is whether interest on loans or dividends would fall under the head of ‘Income from other sources’ under Section 56 of the IT Act or would it amount to income from ‘Profits and gains of business or profession’ under head ‘D’ of Section 14 of the IT Act. In terms of Section 28 of the IT Act such profits and gains of any business or profession under the head ‘D’ of Section 14 of the IT Act would be chargeable to income tax if the income is relatable to profits and gains of business or profession carried out by the assessee at any time during the previous year [Clause (i) of Section 28 of the IT Act]. Section 56 of the IT Act is in the nature of a residuary clause, i.e., if the income of every kind which is not to be excluded from total income under the IT Act would be chargeable under this head if it is not chargeable under Section 14 heads ‘A’ to ‘E’. The aforesaid aspect did not form a part of the rationale of the view taken by the AO, but the CIT(A) opined that the grants made by the appellant-Corporation undisputedly fall within its authorised business activities and, thus, even the advancing of grants from the interest income would be a revenue expense as it had not resulted in acquisition of capital assets by the appellantCorporation and, thus, would be adjustable under Section 37(1) of the IT Act. The ITAT, while reversing the order of the CIT(A), does not deal with this aspect but the impugned judgment of the High Court, once again, adverted to this aspect and came to the conclusion that the interest income would fall under head ‘D’ of Section 14 of the IT Act and would not fall under the head of ‘income from other sources’ under Section 56 of the IT Act. This Court is in agreement with this view taken by the High Court, as the only business of the appellant-Corporation 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 appellant-Corporation 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. 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 appellant-Corporation 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 appellant-Corporation 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 appellant-Corporation and the very purpose for which the appellant-Corporation has been set up. [Paras 21-23][538-D-H; 539-A-F]

The Sole Trustee, Lok Shikshana Trust v. The

Commissioner of Income Tax, Mysore (1976) 1 SCC

254 : [1976] 1 SCR 461- relied on.

1.3 In view of the aforesaid 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. The facts clearly set out that undoubtedly the amount received to be advanced as loans and grants by the appellant-Corporation from the Central Government are treated as capital receipts. In fact, if it was otherwise, they would have become taxable in the hands of the appellantCorporation. Over this, there is no dispute.There can be an amount treated as a capital receipt while the same amount expended may be a revenue expenditure. The question is whether this is so in the present case. [Paras 24-26][539-F-H; 540-A, D-E]

1.4 No doubt the interest income is not directly received as a capital amount. It is actually generated by utilising the capital receipts when the fund is lying idle though the income so generated is then applied for the very objective for which the appellant-Corporation was set up, i.e., disbursement of grants and advancement of loans. The impugned judgment of the High Court appears to have dealt with both loans and grants, but the question of references framed, and which is a position accepted before this Court, is that the dispute related to only grants. It was not the appellant-Corporation’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. To decide the aforesaid question, it would be appropriate to advert to the very purpose for which the statutory appellant-Corporation has been set up. It is in this context that the functions of the appellant-Corporation have been set out, i.e., to advance loans or grant subsidies to State Governments for financing cooperative societies, etc. There is no other function which the appellant-Corporation carries out nor does it generate any funds of its own from any other business. In a sense the role is confined to receiving funds from the Central Government and appropriately advancing the same as loans, grants or subsidies. In a larger canvas the appellant-Corporation plans, promotes and makes financial programmes for the benefit of these societies and other entities to which such loans, grants and subsidies are advanced. 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 this Court to opine that the income generated in the form of interest on the unutilised capital is in the nature of business income. The objectives are wholly socioeconomic 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, this Court is 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 to be the business income. This Court is 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 the aforesaid approach, no taxes would have been payable on the amount. The corollary is that all expenses incurred in connection with the business are deductible. [Paras 27-29][540-E-H; 541-A-H; 542-A-B]

1.5 The legal position, which emerges is that if an assessee carries on business, all that is required to be seen is whether any outlay constitutes an expenditure ‘for the purpose of business’ as used in Section 37(1) of the IT Act. The disbursement of grants has already been held to be the core business of the appellantCorporation. Once that requirement is satisfied, the expenditure incurred in the course of business and for the ‘purpose of business’, would naturally be an allowable deduction under Section 37(1) of the IT Act. The source of funds from which the expenditure is made is not relevant. It is also not really relevant as to whether the expenditure is incurred out of the corpus funds or from the interest income earned by the appellant-Corporation. The disbursement of non-refundable grants is an integral part of business of the appellant-Corporation as contemplated under Section 13(1) of the NCDC Act and, thus, is for the purpose of its business. The purpose is direct; merely because the grants benefit a third party, it would not render the disbursement as ‘application of income’ and not expenditure. The logical conclusion is that every application of income towards business objective of the appellant-Corporation is a business expenditure and nothing else. There is also really no force in the submission of the Revenue Department that the direct nexus of monies given as outright grants from the taxable interest income cannot be distinctly identified. This is a question of fact. The plea of the respondents is based on a pure conjecture. It is the case of the appellant-Corporation throughout that it can easily demonstrate the direct and proximate nexus of interest earned through grants made, as its accounts were duly audited. In fact, CIT(A) allowed the business expenditure only to a certain amount on the basis of the facts and figures as emerged from the balance sheet. This is a burden which was to be discharged by the appellant-Corporation and the CIT(A) had been satisfied with the nexus of interest income with the disbursement of grants made, as having been established. [Paras 30, 31, 33 and 34][542-B-C; D-G; 543-B-F]

1.6 Another principle may also be noted to test the proposition, i.e., of diversion by overriding title. This principle was originally set out in the Sitaldas Tirathdas case and the principle has been since followed. If a portion of income arising out of a corpus held by the assessee consumed for the purposes of meeting some recurring expenditure arising out of an obligation imposed on the assessee by a contract or by statute or by own volition or by the law of the land and if the income before it reaches the hands of the assessee is already diverted away by a superior title the portion passed or liable to be passed on is not the income of the assessee. The test, thus, is what amounts to application of income and what is the diversion by overriding title. The principle, in a sense would apply, if the Act or the Rules framed thereunder or other binding directions bind the institution to spend the interest income on disbursal of grants.The appellantCorporation has devised a procedure of sanction/disbursal of its system for institutional development of cooperatives. The appellant-Corporation actually supplements the efforts of the State Governments. Thus, State Governments recommend proposals of individual societies/projects to the appellantCorporation in a prescribed systematic format and that society may also avail direct funding of projects under various schemes of assistance on fulfillment of stipulated conditions. The formal sanction is thereafter conveyed to the State Government or the Society as the case may be and the release of funds depends on progress of implementation and is on a non-reimbursement basis. Part of the funds are advanced as loans ranging from a period 3 to 8 years with rate of interest varying from time to time, while another part is applied to grants, which are not received back naturally. This modus-operandi has also been set out as a stand of the appellant-Corporation as contained in para 5 of the assessment order. The NCDC Act does not specify as to who should be the grantee; what should be amount to be granted. All that is prescribed is that the business of the appellant-Corporation is to provide loans or grants for the avowed object for which it has been set up. The decision with regard to who should get the grant is taken by the appellant-Corporation directly in the course of, and for the purpose of its business. Thus, the amount agreed to be given should be given as a loan or grant, or both is entirely at the business discretion of the appellant-Corporation. No grantee has a superior title to the funds. Hence, this is not a case of diversion of income by overriding title. Income has to be determined on the principles of commercial accountancy. There is, thus, a distinction between ‘real profits’ ascertained on principles of commercial accountancy. In the case of a business, the profits must be arrived at on ordinary commercial principles. The scheme of the IT Act requires the determination of ‘real income’ on the basis of ordinary commercial principles of accountancy. To determine the ‘real income’, permissible expenses are required to be set off. There is, thus, a clear distinction between deductions made for ascertaining real profits and thereafter distributions made out of profits. The distribution would be application of income. There is also a distinction between real profits ascertained on commercial principles and profits fixed by a statute for a specific purpose. Income tax is a tax on real income. [Paras 35-38][543-F-H; 544-A-H; 545-C]

Commissioner of Income Tax, Bombay v. Shri Sitaldas Tirathdas [1961] 2 SCR 634 – distinguished.

Poona Electric Supply Co. Ltd. v. CIT Bombay City, [1965] 3 SCR 818 – relied on.

1.7 Even though in the own view of the appellantCorporation for preceding years in question, it never claimed any such adjustments, but that of course does not preclude the right of the appellant-Corporation as they sought to make out a case of mistake at a subsequent date. There is another statutory development. The Finance Act of 2003 added a provision in Section 36 of the IT Act as sub-clause. The amendment has to be appreciated in the context of the Departmental Circular No.7/2003 dated 5.9.2003, which provides for deduction for expenditure incurred by entities established under any Central, State or Provincial Act. Entities that are created under an Act of Parliament have the basic object and function of carrying on developmental activities in the areas as specified in the said Acts. By the Finance Act, 2001 and the Finance Act, 2002, tax exemption of certain bodies set up through an Act of Parliament was withdrawn. Subsequent to the removal of the tax shield, a doubt has arisen that some of the activities having no profit motive being carried on by such entities cannot be said to be business and therefore, expenditure incurred on such developmental activities may not be allowed as a deduction when computing the income under the head ‘profits and gains of business or profession’. [Paras 3941][545-D-E; 546-B-D]

1.8 The Finance Act, 2003, thus, inserted a new clause mentioned aforesaid so as to provide that an expenditure not being capital expenditure incurred by a corporation or body corporate, by whatever name called, constituted or established by a Central, State or Provincial Act for the objects and purposes authorised by such Act under which such corporation or body corporate was constituted or established, shall be allowed as a deduction in computing the income under the head ‘profits and gains of business or profession’.The amendment had been introduced into the Act with effect from 1.4.2002. The question, thus, arises whether prior to this amendment such 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 this Court is dealing with AY 1976-77 onwards, 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. This Court is unable to agree with the findings arrived at by the AO, ITAT and the High Court albeit for different reasons and concur with the view taken by the CIT(A) for the reasons set out hereinbefore. It is, thus, left to this Court as stated above to strike the final blow and allow the appeals, leaving the parties to bear their own costs, while noticing with regret the inordinately long passage of time and the wastage of judicial time on deciding, who is principally right when in either eventuality it benefits the Central Government. [Paras 42-44][546-D-H; 547-A-C]

CIT Kerala, Ernakulam v. The Travancore Sugar & Chemicals Ltd. (1973) 3 SCC 274 : [1973] 2 SCR 738; CIT, Gujarat v. S.C. Kothari (1972) 4 SCC 402 : [1972]

1 SCR 950 – relied on.

Commissioner of Income Tax, Bombay v. Associated Cements Companies Ltd., 1988 (Supp) SCC 378 : [1988] SCR 917; M/s. Empire Jute Co. Ltd. v. Commissioner of Income Tax (1980) 4 SCC 25 : [1980] 3 SCR 1370 – referred to.

Oil and Natural Gas Commission & Anr. v. Collector of Central Excise 1995 Supp (4) SCC 541; Electronics Corporation of India v. Union of India (2011) 332 ITR

58 (SC); Union of India & Ors. v. Pirthwi Singh & Ors. (2018) 16 SCC 363 : [2018] 3 SCR 935; Columbia Sportswear Company v. Director of Income Tax

Bangalore (2012) 11 SCC 224: [2012] 7 SCR 187 – referred to.

Chaturvedi & Pithisaria’s Income Tax Law, Volume 3, Sixth Edition (2014), Pg. 3310, published by

LexisNexis – referred to.

Atherton v. British Insulated and Helsby Cables Ltd. (1924) 10 Tax Cases 155, 192-83: (1926) AC 205 (HL) – referred to.