Case number: Civil Appeal Nos. 5105-5107 of 2009

Judges name: Hon’ble Justice Sanjay Kishan Kaul J, Indu Malhotra J

Order dated: 11.09.2020

Facts of the Case:

• The Appellant-Corporation, National Co-operative Development Corporation, was established under the National Cooperative Development Corporation Act, 1962 (hereinafter referred to as the ‘NCDC Act’). The Preamble of the NCDC Act reads as under: “An Act to provide for the incorporation and regulation of a Corporation for the purpose of planning and promoting programmes for the production, processing, marketing, storage, export and import of agricultural produce, foodstuffs, industrial goods, livestock, certain other commodities and services on cooperative principles and for matters connected therewith or incidental thereto.”
• 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 Appellant-Corporation 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. Section 13 mandates maintenance of a Fund and the same reads as under:
  “13. Corporation to maintain fund. – (1) The Corporation shall maintain a fund called the National Cooperative Development Fund (hereinafter referred to as the Fund) to which shall be credited-
  (a) all moneys and other securities transferred to it under clause (a) of sub-section (2) of section 24;(b) the grants and other sums of money by way of loans paid to the Corporation by the Central Government under section 12;(bb) all moneys received under section 12B;(bbb) all moneys received for services rendered;

  (ba) all moneys borrowed under section 12A;

  (c) such additional grants, if any, as the Central Government may make to the Corporation for the purposes of this Act; and

  (d) such 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.

  (2) The moneys in the Fund shall be applied for-

  (a) advancing loans and granting subsidies to State Governments on such terms and conditions as the Corporation may deem fit for the purpose of enabling State Governments to subscribe to the share capital of co-operative societies or for otherwise financing co-operative societies;

  (b) meeting the pay and allowances of the managing director, the officers and other employees of the Corporation and other administrative expenses of the Corporation; and

  (c) carrying out the purposes of this Act.”

  (emphasis supplied)

• 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. It may also be noted that 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, as stated herein, contrary to the earlier accounting practice and arose for the first time for the assessment year 1976-77. Accordingly, the factual matrix pertaining to this aforementioned assessment year has been taken on record.
• The aforesaid endeavour of the Appellant-Corporation did not succeed before the Assessing Officer (for short ‘AO’). 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 has been claimed in the previous assessment years. Of course, subsequently, the stand of the Appellant-Corporation, as the assesse, was that the same was a mistake and they could not be bound by the same for the subsequent years. This round went to the Revenue Department.
• An appeal was preferred before the Commissioner of Income Tax (Appeals), New Delhi (for short ‘CIT(A)’), which in terms of the order dated 22.8.1980 opined that the grants made by the Appellant-Corporation undisputedly fall within its authorised activities, which are 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 Appellant-Corporation itself.
• Thus, a conclusion was reached that, in terms of Section 37 of the Income Tax Act, 1961 (hereinafter referred to as the ‘IT Act’) 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 Appellant-Corporation included giving loans and grants which, in fact, was the very purpose for which it had been set up. The Appellant-Corporation was, thus, held entitled to the deduction of Rs. 19,35,950/-. The net deduction, however, allowed was limited to Rs. 13,66,187/- on account of refund of the grants to the extent of Rs. 5,69,763/-, which had remained unutilised. The second round, thus, went to the Appellant-Corporation.
• It was now the turn of the Revenue Department to prefer an appeal before the Income Tax Appellate Tribunal (for short ‘ITAT’), Delhi Bench, which, however, accepted the view taken by the AO and did not agree with the approach of the CIT(A), setting aside the order of the CIT(A). The rationale for doing so was slightly different. It held that the grants, additional grants and other sums received by the appellant- Corporation from the Central Government went to a single fund and were not treated as its income and, thus, the disbursements made from the same could not be treated as revenue expenses. The disbursement of monies to State Governments and cooperative societies were held to be a pure and simple application of the Fund under Section 13(2) of the NCDC Act and could not be an expenditure in the nature of revenue. Round three, thus, went to the Revenue Department.
• The fourth round was before the Delhi High Court where on a reference made under Section 256(1) of the IT Act, the High Court accepted the question of law to be answered as under: “Whether on the facts and in the circumstances of the case, the Income Tax Appellate Tribunal was justified on facts and in law in holding that amount of Rs.19,35,950/- being grants disbursed by the assessee-applicant to various State Governments during the financial year 1975-76 relevant to asstt. year 1976-77 was not in the nature of Revenue expenditure, hence not allowable in computing the total income of the assessee for the asstt. year under reference.”
• It appears that the aforesaid practice of claiming allowable deductions was sought to be followed in the subsequent assessment years and the High Court by the common impugned judgment dated 24.11.2006 answered the reference qua the assessment years 1976-77 and 1981-82.
• Now turning to the High Court order, this fourth round again went in favour of the Revenue Department answering the reference accordingly. In terms of the reasoning of the High Court, it was a mixed bag for the two sides. The argument of the Revenue Department that such interest income of the Appellant-Corporation would fall within the category of income from other sources under Section 56 of the IT Act, for which allowable deductions are enumerated under Section 57 of the IT Act was, however, repelled.
• The Revenue Department further sought to argue that the advances were in the form of application of income rather than expenditure of income. It also argued that the loans disbursed were liable to be refunded in terms of the agreement under which they were advanced, making them ineligible to be treated as expenditure. Moreover, once the interest income was received, it merged into Section 13 Fund of the Appellant-Corporation and lost its character as business income.
• The High Court opined that since the business of the appellant- Corporation was to receive funds and to then advance them as loans or grants, the interest income earned which was so applied would also fall under the head ‘D’ of Section 14 of Chapter IV of the IT Act under the head of ‘profits and gains of business or profession’ being a part of its normal business activity.
• The High Court delved into the scheme of the NCDC Act and in view of Section 13, which provided for the creation of a fund, being the common pool where all accretions get amalgamated, including from interest on loans and dividends and interest earned on FDRs. It was held that the monies which were advanced from the Fund cannot be distinctly identified as forming part of the interest income.
• The other aspect the High Court opined on was that in order to claim deduction as a revenue expenditure, the Appellant-Corporation has to first establish that it incurred an expenditure. The advancement of loans to the State Governments and cooperative societies could not be claimed as expenditure as the same does not leave the hands of the appellant- Corporation irretrievably. It is not necessary for us to delve further into this issue as that was not the question framed to be answered.
• We are now faced with Civil Appeals in relation to different assessment years, which arise from the common judgment dated 24.11.2006 and the common order dated 12.7.2007, which had in turn relied on the 24.11.2006 judgment.

Issues:

Whether interest on loans or dividends would fall under the head of ‘Income from other sources’ under section 56 of the Income Tax Act or would it amount to income from ‘profits and gains for business or Profession’ under head ‘D’ of Section 14 of the Income Tax Act?

Supreme Court held:

• The Supreme Court held that the income granted from interest of fund was again applied to the disbursement of grants and loans and therefore income generated from interest is necessity interlinked to the business of the Corporation and would, thus fall under the head of ‘Profits and gains of business or profession’.