National Co-operative Development Corporation v. Commissioner of Income Tax, Delhi-v
SANJAY KISHAN KAUL, J.
1. Which pocket of the Government should be enriched has taken
forty-four (44) years to decide – a classic case of what ought not to be!
The factual matrix:
2. The appellant-Corporation, National Co-operative Development
Corporation, was established under the National Coo perative
Development Corporation Act, 1962 (hereinafter referr ed 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 a nd
import of agricultural produce, foodstuffs, industrial goods,
livestock, certain other commodities and services on cooperative
principles and for matters connected therewith or in cidental
thereto.”
529
3. 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-Corpor ation 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 re alised out of
repayment of loans made from the Fund or from interest on loa ns or
dividends or other realisations on investments made from the Fund.
Section 13 mandates maintenance of a Fund and the same re ads 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
NA TIONAL CO-OPERATIVE DEVELOPMENT CORPORATION
v. COMMISSIONER OF INCOME TAX, [SANJAY KISHAN KAUL, J.]
the purpose of enabling State Governments to subscribe t o 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 t o the State
Governments/Apex Cooperative Institutions are credited to this account.
4. 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 Governm ent,
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 treat ed as
taxable income and is logically taxed as “business income.”
The issue which has arisen for consideration is whet her 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 fa ctual matrix
pertaining to this aforementioned assessment year has been t aken on
record.
5. 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 dedu ction.
What weighed with the AO was also the fact that the grant s received
531
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 assessee, was that the
same was a mistake and they could not be bound by the same for t he
subsequent years. This round went to the Revenue Departme nt.
6. An appeal was preferred before the Commissioner of Incom e
Tax (Appeals), New Delhi (for short ‘CIT(A)’), which in ter ms 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 assessm ent year, any
expenditure (except of the prohibited type) laid out or expended wholly
and exclusively for the purpose of the business was allowabl e as a
deduction while computing business income.The CIT(A), thus, fou nd
that the approach adopted by the AO was fallacious as the f unctions
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.
7. 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 appellan t-
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 dis bursement
of monies to State Governments and cooperative societies were held to
NA TIONAL CO-OPERATIVE DEVELOPMENT CORPORATION
v. COMMISSIONER OF INCOME TAX, [SANJAY KISHAN KAUL, J.]
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 re venue.
Round three, thus, went to the Revenue Department.
8. The fourth round was before the Delhi High Court where on a
reference made under Section 256(1) of the IT Act, the High C ourt
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 duri ng
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.”
9. It appears that the aforesaid practice of claiming a llowable
deductions was sought to be followed in the subsequent assess ment
years and the High Court by the common impugned judgment dated
24.11.2006 answered the reference qua the assessment years 19 76-77
and 1981-82.
10. Now turning to the High Court order, this fourth round again
went in favour of the Revenue Department answering the refe rence
accordingly. In terms of the reasoning of the High Court, it was a mixed
bag for the two sides. The argument of the Revenue Departmen t 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 exp enditure.
Moreover, once the interest income was received, it merged into Section
13 Fund of the appellant-Corporation and lost its character as business
income.
11. The High Court opined that since the business of the appellant-
Corporation was to receive funds and to then advance them as loans or
533
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 pa rt 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 intere st income.
The other aspect the High Court opined on was that in order to claim
deduction as a revenue expenditure, the appellant-Corporation ha s 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 ap pellant-
Corporation irretrievably. It is not necessary for us to delve further into
this issue as that was not the question framed to be answer ed.
12. We are now faced with Civil Appeals in relation to different
assessment years, which arise from the common judgm ent dated
24.11.2006 and the common order dated 12.7.2007, which had in turn
relied on the 24.11.2006 judgment. The particulars are in a tabula ted
form as under:
13. It is, thus, left to this Court as usual to give the final knock-out
punch, being the fifth round of adjudicatory process on this issue itself!
14. We may also notice a fact that originally the Speci al Leave
Petition was dismissed leaving it to the appellant-Corporation to get its
petition revived in case permission was granted by the High Powered
Committee. This was in view of the fact that the Committ ee existed
then to settle inter-governmental disputes, but was subsequently
NA TIONAL CO-OPERATIVE DEVELOPMENT CORPORATION
v. COMMISSIONER OF INCOME TAX, [SANJAY KISHAN KAUL, J.]
disbanded. The record shows that a meeting of the Committee was held
on 14.8.2007 and it was felt that the question regarding the nature of
grants disbursed by the appellant-Corporation needed adjudicati on by
the Court, though the Committee did not itself settle the i ssue. The
representative of the appellant-Corporation before the Committee faulted
the view taken by the High Court inter alia on the ground that expenditure
as monies advanced as loans do not go out of the hands of the Corporation
irretrievably was a finding, which was not based on the facts of the case
as the issue pertained only to the grants and not to the loans. The grants
were disbursed in accordance with the provisions of Sect ion 9 of the
NCDC Act and, thus, monies advanced as grants never came ba ck to
the appellant and were in the nature of expenditure of the appellant-
Corporation. The Committee was of the view that the grants disbursed
by the appellant-Corporation were not in the nature of loans an d were
exclusively for business of the Corporation and should have been treated
as revenue expenditure.
Contentions of the parties:
15. On behalf of the appellant-Corporation, Mr. Rajat Navet
contended that the High Court has fallen into an error in discussing the
issue as if it was one of loans as opposed to grants, which was the
subject matter of the reference. Thus, what was contended was that
there was some confusion in the impugned order vis-à-vis this aspect of
loans and grants. It was, thus, submitted on behalf of the ap pellant-
Corporation as under:
i. Any grants disbursed (to National or State Governments,
for further disbursal to co-operative societies) out of the
‘Interest Income’, which is admittedly taxed as “business
income” by the Revenue Department, is allowable as a
revenue expenditure under Section 37(1) of the IT Act,
1961.
ii. The error and anomaly in the judgment of the High Court,
is that in para 22, it has treated “grants” and “loans” at par,
or as identical in nature. There is a distinction between
“grants” and “loans”, since the monies advanced as ‘loans’
come back into the coffers of the appellant-Corporation;
however, with respect to “grants” or “subsidies”, there is
an irretrievable outgo from the coffers of the appellant-
535
Corporation. This distinction has not been examined by the
High Court.
The claim of the appellant-Corporation is restricted only
with respect to “grants,” and not “loans.”
iii. The High Court erred in holding that as the taxable inte rest/
income or the revenue stream of income gets amalgamated
in the common pool of the Fund under Section 13(1) of the
NCDC Act, along with the funds received from the Central
Government, it loses its revenue character, and becomes a
capital receipt.
iv. The High Court erred in holding that it cannot be identified
as to which component of the funds has been advanced by
way of “grants”. It is not ascertainable as to whether i t is
from the income earned, or capital receipts. The appellant-
Corporation submitted that merely because a common Fund
is maintained by it in terms of Section 13 of the NCDC Act,
the interest income earned/received by the appellant -
Corporation cannot lose its character of “business income”
and gets transformed into a capital receipt. If this contention
is accepted, then even the interest income will not be liable
to tax under profits and gains of business, and must be
treated as a capital receipt.
v. Since the accounts of the appellant-Corporation are duly
audited, it would be able to demonstrate the nexus of the
income receipts to the amounts disbursed by way of grants.
The claim of deduction is restricted to the outright grants
made from the revenue receipts, which are subjected to
tax in the normal course of business. The CIT(A) has rightly
allowed only those grants, which were in fact disbursed out
of the taxable interest income of the appellant as
expenditure.
vi. Since the grants are given in the normal course of th e
appellant-Corporation’s business, those grants which are
from the interest income, and assessed as “business
income,” should be allowed as deductions from the taxable
income of the appellant-Corporation. The requisite
conditions for being allowed as a deduction under Section
37(1) of the IT Act stand fulfilled since:
NATIONAL CO-OPERATIVE DEVELOPMENT CORPORATION
v. COMMISSIONER OF INCOME TAX, [SANJAY KISHAN KAUL, J.]
a. the expenditure has been incurred wholly and
exclusively for the purpose of business being carried
out by the assessee;
b. it has been expended during the accounting year in
question.
c. it is not on any personal account of the assessee;
d. it is not in the nature of capital expenditure.
vii. The expenditure incurred by the appellant-Corpora tion
cannot be capital expenditure as neither any enduring
advantage or benefit has accrued to it, nor had any asset
come into existence which belonged to or was owned by
the appellant-Corporation.
16. A reference was made to the judgment of this Co urt in
Commissioner of Income Tax, Bombay v. Associated Ce ments
Companies Ltd., 1 which in turn cited with approval the dictum of
Viscount Cave. L.C. in Atherton v. British Insulated and Helsby Cables
Ltd.2 as under:
“But when an expenditure is made, not only once and for all, but
with a view to bringing into existence an asset or an advanta ge
for the enduring benefit of a trade. I think that there is very good
reason (in the absence of special circumstances leading t o an
opposite conclusion) for treating such an expenditure as properly
attributable not to revenue but to capital.”
It was opined that there may be cases where expenditure, even if
incurred for obtaining an advantage of enduring benefit, may, nonetheless,
be on the revenue account and the test of enduring benefit may break
down, but what is material to consider is the nature of the advantage in
a commercial sense and it is only where the advantage is in the capital
field, that the expenditure would be disallowable on an application of this
test. If the advantage consists merely in facilitating the assessee’s trading
operations or enabling the management and conduct of the asses see’s
business to be carried on more effectively or more profitably while leaving
the fixed capital untouched, the expenditure would be on the rev enue
account, even though the advantage may endure for an indefinite future.
1 1988 (Supp) SCC 378
2 (1924) 10 Tax Cases 155, 192-83: (1926) AC 205 (HL)
537
17. A reference was also made to the judgment in M/s. Empire
Jute Co. Ltd. v. Commissioner of Income Tax 3 to contend that what
may be a capital receipt in the hands of the payee, may be a revenue
expenditure in relation to the payer. Para 5 of the said judgment read as
under:
“5. In the first place it is not a universally true pr oposition that
what may be a capital receipt in the hands of the paye e must
necessarily be capital expenditure in relation to the pa yer. The
fact that a certain payment constitutes income or capital receipt
in the hands of the recipient is not material in determining whether
the payment is revenue or capital disbursement qua the payer. It
was felicitously pointed out by Macnaghten, J. in Race Course
Betting Control Board v. Wild that a “payment may be a revenue
payment from the point of view of the payer and a capital payment
from the point of view of the receiver and vice versa. Therefore,
the decision in Maheshwari Devi Jute Mills case cannot be
regarded as an authority for the proposition that payment m ade
by an assessee for purchase of loom hours would be capi tal
expenditure. Whether it is capital expenditure would have to be
determined having regard to the nature of the transaction and
other relevant factors.”
18. On the other hand, Mr. Arijit Prasad, learned senior counsel,
on behalf of the Revenue Department, submitted as under:
i. Since the interest income received has merged with the
monies in the common Fund, it loses its revenue character,
and becomes a capital receipt.
ii. The grants given to State Governments and national co-
operatives are not in the course of trade business of the
appellant-Corporation, but are a mere application o f
income.4
iii. The giving of grants was an application of income hence it
was not an expenditure. Even if it was to be considered as
a case of expenditure, it would, at best, be in the nature of
capital expenditure.
3 (1980) 4 SCC 25
4 Commissioner of Income Tax, Bombay v. Shri Sitaldas Tirathdas, (1961) 2 SCR 634
NATIONAL CO-OPERATIVE DEVELOPMENT CORPORATION
v. COMMISSIONER OF INCOME TAX, [SANJAY KISHAN KAUL, J.]
iv. The direct nexus of monies given as outright grants from
the taxable interest income, cannot be distinctly identified
in the common Fund.
19. The Revenue Department sought to revive the debate on the
issue repelled by the High Court, i.e., that the income should be treated
as income from other sources under Section 56 of the IT Act and not
under Section 28 of the IT Act. The exemption, if any, thus, would be
under Section 57 and not under Section 37 of the IT Act.
Conclusion:
20. We have given considerable thought to the rival contentions
of learned counsels for the parties even though the dispute is really in a
narrow compass.
21. The first aspect which we would advert 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 inc ome
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’.
22. The aforesaid aspect did not form a part of the ration ale 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 appellant-Corporation and, th us, 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 a nd
came to the conclusion that the interest income would fall under he ad
539
‘D’ of Section 14 of the IT Act and would not fall under the hea d of
‘income from other sources’ under Section 56 of the IT Act.
23. We are 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 t he amount
does not lie idle. That the income generated was again appl ied to the
disbursement of grants and loans. The income generated from int erest
is necessarily inter-linked 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. In our view, to decide
the question as to whether a particular source of income i s business
income, one would have to look to the notions of what is the busine ss
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. Our view finds support from
the judgment in The Sole Trustee, Lok Shikshana Trust v. The
Commissioner of Income Tax, Mysore. 5
24. In view of the aforesaid finding the crucial issue w ould be
whether the amounts advanced as grants from this income generat ed
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.
25. The facts before us 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
5 (1976) 1 SCC 254
NATIONAL CO-OPERATIVE DEVELOPMENT CORPORATION
v. COMMISSIONER OF INCOME TAX, [SANJAY KISHAN KAUL, J.]
it was otherwise, they would have become taxable in the hands of the
appellant-Corporation. Over this, there is no dispute. The line of argument
on behalf of the appellant-Corporation was, however, predicate d on a
plea that assuming it to be so, the grants (and not loans) cannot be treated
as a capital expenditure as neither any enduring advantage or benefit
has accrued to the appellant-Corporation nor has any ass et come into
existence which belongs to or was owned by the appellant-Corporation.
Thus, what may be a capital receipt in the hands of t he appellant-
Corporation may still be a revenue expenditure and it is in that context
that the observations in Atherton v. British Insulated and Helsby Cables
Ltd. 6 referred to in Commissioner of Income Tax, Bombay v.
Associated Cement Companies Ltd., Bombay 7 were relied upon. The
context was slightly different in those cases because if an expenditure
was to bring into existence an asset or advantage for enduring benefit of
the trade, it was opined that a case could be made out attributed not to
revenue but to capital. In this case, of course, this proposition is really
the reverse and advantage was sought to be taken of the af oresaid
principle.
26. We are not in disagreement with the aforesaid proposition to
the extent that 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.
27. 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 wa s set up,
i.e., disbursement of grants and advancement of loans. The impugned
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 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 am ounts 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
6 (supra)
7 (supra)
541
adjustable as expenses against the same. In fact, to the extent grants
were returned back, the CIT(A) did not allow the entire deduct ion as
claimed for but only did so qua the amount which was disbursed as grant
and never received back.
28. 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 we have set out the functions of
the appellant-Corporation in para 3 hereinabove, 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 ot her
business. In a sense the role is confined to receiving funds f rom 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 benef it 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 Socie ties, 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 unutilised capital
is in the nature of business income. The objectives are wholl y socio-
economic and the amounts received including grants come with a prior
stipulation for the funds received to be passed on to the downst ream
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.
29. We are unable to accept the contention of the R evenue
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
NATIONAL CO-OPERATIVE DEVELOPMENT CORPORATION
v. COMMISSIONER OF INCOME TAX, [SANJAY KISHAN KAUL, J.]
treated as revenue receipt on which taxes are paid, it mus t 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.
30. 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 provision reads as under:
“37. General. – (1) Any expenditure (not being expenditure of the
nature described in sections 30 to 36 and not being in the nature
of capital expenditure or personal expenses of the assessee), laid
out or expended wholly and exclusively for the purposes of the
business or profession shall be allowed in computing the income
chargeable under the head “Profits and gains of busines s or
profession”.”
The disbursement of grants has already been held to be the core
business of the appellant-Corporation. 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 t o whether the
expenditure is incurred out of the corpus funds or from the interest income
earned by the appellant-Corporation.
31. We are also unable to accept the contention of the respondent
that the payouts constitute a mere application of income, which does not
tantamount to expenditure. 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.
32. In support of the aforesaid view, we may rely on the judgment
of this Court in CIT Kerala, Ernakulam v. The Travancore Sugar &
Chemicals Ltd.,8 which gave an occasion to examine the issue whether
the discharge of an obligation paid to the Government was application of
8 (1973) 3 SCC 274 (more specifically para 23)
543
income or diversion of profits. This Court came to the conclusion th at
from any point of view, whether as revenue expendit ure or as an
overriding charge of the profit-making apparatus or laid out and expended
wholly and exclusively for the purposes of trade, this was an allowable
revenue expenditure.
33. The logical conclusion is that every application of incom e
towards business objective of the appellant-Corporation i s a business
expenditure and nothing else. The endeavour of the Revenue Department
to rely on the judgment in the Sitaldas Tirathdascase9 is not appreciable
since that was a case dealing with the obligation of an indivi dual who
was compelled to apply a portion of his income for the maintenance of
persons whom he was under a personal and legal obligation to maintain.
The IT Act does not permit any deduction from the total income in such
circumstances.
34. We also find 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 ba sis of the
facts and figures as emerged from the balance sheet. Thi s 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.
35. We may also note another principle to test the proposition, i.e.,
of diversion by overriding title. This principle was originally set out in the
Sitaldas Tirathdas case10 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 sup erior 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
9 (supra)
10 (supra)
NATIONAL CO-OPERATIVE DEVELOPMENT CORPORATION
v. COMMISSIONER OF INCOME TAX, [SANJAY KISHAN KAUL, J.]
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.
36. The appellant-Corporation has devised a procedure of sanction/
disbursal of its system for institutional development of cooperatives. The
appellant-Corporation actually supplements the effort s of the State
Governments. Thus, State Governments recommend prop osals of
individual societies/projects to the appellant-Corporation 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 dep ends 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 a nother part is
applied to grants, which are not received back naturally. T his modus-
operandi has also been set out as a stand of the appellant-Corporation
as contained in para 5 of the assessment order.
37. 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.
38. We may record here that 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 Poona Electric Supply Co. Ltd. v. CIT
Bombay City11 this Court has held that income tax is on the real income.
In the case of a business, the profits must be arrived at on ordinary
commercial principles. The scheme of the IT Act req uires the
determination of ‘real income’ on the basis of ordinary commer cial
principles of accountancy. To determine the ‘real income’, permissible
11 (1965) 3 SCR 818
545
expenses are required to be set off. In this behalf, we may also usefully
refer to the judgment in CIT, Gujarat v. S.C. Kothari 12 where the
following principle was laid down:
“6. …The tax collector cannot be heard to say that he will bring
the gross receipts to tax. He can only tax profits of a trade or
business. That cannot be done without deducting the losses an d
the legitimate expenses of the business...”
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.
39. We may also note that even though in the own view of the
appellant-Corporation 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.
40. We may also note another statutory development. The Finance
Act of 2003 added a provision in Section 36 of the IT Act as sub-clause
(1)(xii) in the following terms:
“36. Other deductions. – (1) The deductions provided for in the
following clauses shall be allowed in respect of the matters dealt
with therein, in computing the income referred to in section 28 –
(i) to (xi) xxxx
(xii) any expenditure (not being in the nature of capital expenditure)
incurred by a corporation or a body corporate, by whatever name
called, if, -
(a) It is constituted or established by a Central, State or Provincial
Act;
(b) Such corporation or body corporate, having regard to the objects
and purposes of the Act referred to in sub-clause (a), is notified
by the Central Government in the Official Gazette for the purposes
of this clause; and
12 (1972) 4 SCC 402
NATIONAL CO-OPERATIVE DEVELOPMENT CORPORATION
v. COMMISSIONER OF INCOME TAX, [SANJAY KISHAN KAUL, J.]
(c) The expenditure is incurred for the objects and pur poses
authorised by the Act under which it is constituted or established;
xxx”
41. 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 cr eated 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 s ome of the
activities having no profit motive being carried on by such entities cannot
be said to be business and therefore, expenditure incur red on such
developmental activities may not be allowed as a deduct ion when
computing the income under the head ‘profits and gains of business or
profession’.
42. 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 Provincia l Act for the
objects and purposes authorised by such Act under w hich such
corporation or body corporate was constituted or establish ed, 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 1.4.2002.13
43. The question, thus, arises whether prior to this amendment
such expenses were not allowable under the prevailing ta x 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 onward s, the tax
jurisprudence has evolved on the basis of ordinary p rinciples 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 accountanc y. Post
13 Chaturvedi & Pithisaria’s Income Tax Law, Volume 3, Sixth Edition (2014), Pg. 3310,
published by LexisNexis
547
amendment, such expenses get allowed under the specific section, viz.
Section 36(1)(xii) after the amendment by the Finance Act, 2003.
44. We would, thus, like to conclude that we are 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, w ho is
principally right when in either eventuality it benefi ts the Central
Government.
Postscript 1:
1. The Indian legal system is reeling under a docket explosion.
The Government and public authorities are active contributories to this
deluge. To top it, a number of litigations arise inter se the Government
and its bodies and, thus, the only question, as stated in the beginning, is
which pocket of the Government will be benefitted?
2. The aforesaid position resulted in a judicial innovation with the
Supreme Court passing orders in Oil and Natural Gas Commission &
Anr. v. Collector of Central Excise14 requiring that such cases must be
referred to a Committee to be appointed by the Government to facilitate
a resolution of such disputes and that no case should be filed without the
approval of this Committee. This system was a failure as is apparent
from the facts of the present case, where the SLP filed by the appellant-
Corporation was initially dismissed with liberty to revive the same in
case the High Powered Committee granted such a permission which
was so granted in a meeting held on 14.08.2009. The said Committee
discussed the legal ramifications, and in some way opined in favour of
the appellant-Corporation, as is apparent from the discussion aforesaid.
But the ball was again lobbed back into the Court to adjudicate the said
issue rather than a resolution being reached. The result w as only the
revival of the appeal, and the consequent decision which has seen the
light of the day only now.
14 1995 Supp (4) SCC 541
NATIONAL CO-OPERATIVE DEVELOPMENT CORPORATION
v. COMMISSIONER OF INCOME TAX, [SANJAY KISHAN KAUL, J.]
3. The aforesaid failure of the system resulted in the Su preme
Court recalling its orders in the ONGC cases vide Electronics
Corporation of India v. Union of India. 15
4. The Central Government and the State authorities have been
repeatedly emphasising that they have evolved a litigation policy. Our
experience is that it is observed more in breach. The approach is one of
bringing everything to the highest level before this Court, so that there is
no responsibility in the decision-making process – an unfortunate situation
which creates unnecessary burden on the judicial system. This asp ect
has also been commented upon in a judgment of this Court in Union of
India & Ors. v. Pirthwi Singh & Ors.,16 albeit between the Government
and the private parties, where the question of law had been settled and
yet the appeal was filed only to invite a dismissal. The object appears to
be that a certificate for dismissal is obtained from the highest court so
that a quietus could be put to the matter in the Government Departments.
Undoubtedly, this is complete wastage of judicial time and i n various
orders of this Court it has been categorized as “certifi cate cases”, i.e.,
the purpose of which is only to obtain this certificate of dismissal.
5. The 126th Law Commission of India Report titled ‘Government
and Public Sector Undertaking Litigation Policy and Strategies’ debated
the Government versus Government matters which weighed heavily on
the time of the Courts as well as the public exchequer. This was as far
back as in 1988. It was only in the year 2010 that the National Litigation
Policy (for short ‘NLP’) was formulated with the aim of reducing litigation
and making the Government an efficient and responsible litigant. Five
(5) years later it reportedly saw a revision to increase its efficacy, but it
has hardly made an impact. In the year 2018, the Central Government
gave its approval towards strengthening the resolution of com mercial
disputes of Central Public Sector Enterprises (for short ‘CPSEs’)/ Port
Trusts inter se , as well as between CPSEs and other Government
Departments/Organisations. The aim was and is to put in place a
mechanism within the Government for promoting a speedy resolution of
disputes of this kind, however it excluded disputes relating to Railways,
Income Tax, Customs and Excise Departments. It has now been made
applicable to all disputes other than those related to taxation matters.
This was pursuant an order passed in The Commissioner of Income
15 (2011) 332 ITR 58 (SC)
16 (2018) 16 SCC 363
549
Tax (Exemptions) v. National Interest Exchange of India 17 by a bench
of which one of us (Sanjay Kishan Kaul, J.) was a part.
6. Insofar as non-taxation matters are concerned, t he
Administrative Mechanism for Resolution of CPSEs Disputes was
conceptualised to replace the Permanent Machinery of Arbitration and
to promote equity through collective efforts to resolve disputes. It has a
two-tiered structure.
7. At the first level, commercial disputes will be ref erred to the
Committee comprising Secretaries of the Administrati ve Ministries/
Departments to which the disputing parties belong and the Se cretary,
Department of Legal Affairs. In case the two disputing parties belong
to the same Ministry/Department, the Committee will comprise Secretary
of Administrative Ministry/Department concerned; th e Secretary,
Department of Legal Affairs and the Secretary, Department of Public
Enterprises. If a dispute is between a CPSE and a State Government
Department/Organisation, the Committee will comprise of the Secretary
of the Ministry Department of the Union to which the CPSE belongs,
the Secretary, Department of Legal Affairs and the Chief Secretary of
the State concerned. Such disputes are ideally to be resolved at the first
level itself within a time schedule of three (3) months, and in the eventuality
of them remaining unresolved, the same may be referred to the Cabinet
Secretary at the second level, whose decision will be final and binding
on all concerned.
8. We are of the opinion that one of the main impediments to such
a resolution, plainly speaking, is that the bureaucrats are reluctant to
accept responsibility of taking such decisions, apprehending that at some
future date their decision may be called into question and they may face
consequences post retirement. In order to make the system functi on
effectively, it may be appropriate to have a Committee of legal experts
presided by a retired Judge to give their imprimatur to the settlement so
that such apprehensions do not come in the way of arriving at a settlement.
It is our pious hope that a serious thought would be given to the aspect of
dispute resolution amicably, more so in the post-COVID period.
9. In most countries, mediation has proved to be an efficac ious
remedy and here we are talking about mediation inter se the Government
authorities or Government departments. India is now a signatory to the
17 SLP (C) Diary No. 35567 of 2019
NATIONAL CO-OPERATIVE DEVELOPMENT CORPORATION
v. COMMISSIONER OF INCOME TAX, [SANJAY KISHAN KAUL, J.]
Singapore Convention on Mediation and we understand that a serious
thought is being given to bring forth a comprehensive legis lation to
institutionalise mediation, in furtherance of this function to which India
has committed itself.
Postscript 2:
10. We now turn to the issue of matters pertaining to CPSEs and
Government authorities insofar as taxation matters are concerned,
because they are consistently sought to be carved out as a sepa rate
category of cases. One of the largest areas of liti gation for the
Government is taxation matters. The petition rate of the tax department
before the Supreme Court is at 87%.18 So, the question is can something
be done about it?
11. In our opinion, a vibrant system of Advance Ruling can go a
long way in reducing taxation litigation. This is not only true of these
kinds of disputes but even disputes between the taxation depar tment
and private persons, who are more than willing to comply with the law
of the land but find some ambiguity. Instead of first filing a return and
then facing consequences from the Department because of a different
perception which the Department may have, an Advance Ruling System
can facilitate not only such a resolution, but also avoid the tiers of litigation
which such cases go through as in the present case. In f act, before
further discussing this Advance Ruling System, we can unhesitatingly
say that, at least, for CPSEs and Government authorities, the re would
be no question of taking this matter further once an Advance Ruling is
delivered, and even in case of private persons, the scope of any further
challenge is completely narrowed down.
12. It is as far back as in 1971 that a report was submitted by the
Direct Taxes Enquiry Committee under the Chairmanship of Dr. K.N.
Wanchoo, recognising the need for providing Advance Ruling System,
particularly in cases involving foreign collaboration. The aim was to give
advance rulings to taxpayers or prospective taxpayers, which would then
considerably reduce the Revenue’s workload and decrease the number
of disputes. This finally resulted in a scheme of Advance Ruling being
brought into effect in 1993, with the introduction of a new Chapter in the
Income Tax Act, 1961 (hereinafter referred to as the ‘IT Act’). A quasi-
18 See ‘Economic Survey 2017-19 – Volume 1’ by the Department of Economic Affairs,
Ministry of Finance, Government of India
551
judicial tribunal was established as the Authority for Advance Rulings
(for short ‘AAR’) to provide certainty and avoid litigation r elated to
taxation of transactions involving non-residents. The scope of the
transactions on which an advance ruling can be sought from the AAR
has gradually increased to now include both residents and non-residents,
who can seek the same for issues having a substantial ta x impact.
Chapter XIX-B of the IT Act deals with advance rulings and it has been
defined in Section 245N(a) of the IT Act. These rulings are binding both
on the Income Tax Department and the applicant, and while there is no
statutory right to appeal, the Supreme Court has held in Columbia
Sportswear Company v. Director of Income Tax Bangalore 19 that a
challenge an advance ruling first lies before the Hi gh Court, and
subsequently before the Supreme Court. The advance ruling m ay be
reversed in the event a substantial question of general public importance
arises or a similar question is already pending before the Supreme Court
for adjudication.
13. The ground level situation is that this methodology has proved
to be illusionary because there is an increasing number of applications
pending before the AAR due to its low disposal rate and contrary to the
expectation that a ruling would be given in six (6) months (as per Section
245R(6) of the IT Act), the average time taken is stated to be reaching
around four (4) years!20 There is obviously lack of adequate numbers
of presiding officers to deal with the volume of cases. Interestingly, the
primary reason for this is the large number of vacancies a nd delayed
appointments of Members to the AAR.21 In view of the time taken, the
very purpose of AAR is defeated, resulting in the mechanism being used
infrequently as is evident from the ever-increasing tax related litigation.
14. We may notice a significant development in Section 245N of
the IT Act. It was through Notification No.11456 dated 3.8.2000 that
public sector companies were added to the definition of ‘applicant’, and
in 2014, it was made applicable to a resident who had undertaken one or
more transactions of the value of Rs. 100 crore or more.
15. Insofar as a resident is concerned, the limit is so high that it
cannot provide any solace to any individual, and we do believe that it is
19 (2012) 11 SCC 224
20 See Deloitte Report on Advance Rulings in India: Delive ring Greater Tax Certainty
(Deloitte Tax Policy Paper 5, 2019)
21ibid.
NATIONAL CO-OPERATIVE DEVELOPMENT CORPORATION
v. COMMISSIONER OF INCOME TAX, [SANJAY KISHAN KAUL, J.]
time to reconsider and reduce the ceiling limit, more so in terms of the
recent announcement stated to be in furtherance of a tax friendly face-
less regime!
16. We may refer to the international scenario where there has
been an incremental shift towards mature tax regimes adopting advance
ruling mechanisms. The increase in global trade puts the rulings system
at the centre-stage of a robust international tax cooperation regime. The
Organisation for Economic Cooperation and Development (for sh ort
‘OECD’) lists advance rulings as one of the indicators to as sess trade
facilitation policies, making it an aspirational international best practice
standard. For example, Australia and New Zealand have a robust system
of advance rulings wherein the decisions (which are public r ulings
affecting a large number of taxpayers) are given teeth by being made
binding on the revenue authorities. New Zealand has gone a step further
and innovated “status rulings” under which a taxpayer can apply to the
Commissioner for a ruling on how a change in the law impacts an existing
ruling.
17. In the United States, there is a mechanism for the Treasury to
authorise guidance in the form of revenue rulings, procedures and notices.
The mechanism again, has been bolstered by subsequent prac tice and
interpretations of the United States courts, where rulings have indicated
that taxpayers may be penalised if they act inconsistent ly with legal
interpretations set out in the revenue rulings, procedures or notices.
18.Tax transparency has been a hallmark trait of the Swe dish
legal system. Swedish law requires public disclosure of ex ante tax
administration such as advance rulings. Both the taxpayer as well as the
Swedish Tax Agency can request an advance tax ruling, these rulin gs
are published without information identifying the taxpayer that requested
them. The Skatterättsnämnden, or the Council for Advance Tax Rulings
is the Swedish Government agency which is vested with th is power.
The advance ruling system has played a crucial role in Sweden’s position
as a country with one of the highest tax compliance rates in the world.
19. The aim of any properly framed advance ruling system ought
to be a dialogue between taxpayers and revenue authorities to fulfil the
mutually beneficial purpose for taxpayers and revenue auth orities of
bolstering tax compliance and boosting tax morale. This mechanism should
not become another stage in the litigation process.
553
20. We, thus, consider it appropriate to recommend to the Central
Government to consider the efficacy of the advance tax rul ing system
and make it more comprehensive as a tool for settlement of disputes
rather than battling it through different tiers, whether private or public
sectors are involved. A council for Advance Tax Ruling based o n the
Swedish model and the New Zealand system may be a possible way
forward.
21. We have been persuaded to write two postscripts on account
of the backbreaking dockets which are ever increasing and as a move
towards a trust between the Tax Department and the asses see, and we
hope that both the aspects meet consideration at an appropriate level.
22. In the end before parting we may refer to the legal legend Mr.
Nani A. Palkhivala, who while addressing a letter of congratulations to
Mr. Soli J. Sorabjee on attaining his appointment as the Attorney General
on 11.12.1989 referred to the greatest glory of Attorney General as not
to win cases for the Government but to ensure that justice is done to the
people. In this behalf, he refers to the motto of the Department of Justice
in the United States carved out into the Rotunda of the Attorney General
Office:
“The United States wins its case whenever justice is done to
one of its citizens in the courts .”
The Indian citizenry is entitled to a hope that the aforesaid is what
must be the objective of Government litigation, which should prevail even
within the Indian legal system. In the words of Martin Luther King, Jr.,
“We must accept finite disappointment, but never lose infin ite hope.”
23. A copy of this order be sent to the Department of R evenue,
Department of Expenditure and Department of Economic Affairs,
Ministry of Finance and to the Ministry of Law & Justice.
Divya Pandey Appeals disposed of.
NATIONAL CO-OPERATIVE DEVELOPMENT CORPORATION
v. COMMISSIONER OF INCOME TAX, [SANJAY KISHAN KAUL, J.]