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 4 societies, is eligible for deduction for determining the “taxable income” of the appellant-Corporation
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 1.4.2002.13 43. 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 we are 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. 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, who is principally right when in either eventuality it benefits the Central Government.
REPORTABLE
IN THE SUPREME COURT OF INDIA
CIVIL APPELLATE JURISDICTION
CIVIL APPEAL NOS. 5105-5107 OF 2009
NATIONAL CO-OPERATIVE
DEVELOPMENT CORPORATION …Appellant
Versus
COMMISSIONER OF INCOME TAX,
DELHI-V …Respondent
J U D G M E N T
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 Cooperative
1
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.”
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-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
2
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
3
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.
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 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
4
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.
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 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 assessee, 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.
6. An appeal was preferred before the Commissioner of Income Tax
(Appeals), New Delhi (for short ‘CIT(A)’), which in terms of the order
5
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
6
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 appellantCorporation 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.
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 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
7
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.”
9. 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.
10. 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
8
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.
11. The High Court opined that since the business of the appellantCorporation 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
9
State Governments and cooperative societies could not be claimed as
expenditure as the same does not leave the hands of the appellantCorporation irretrievably. It is not necessary for us to delve further into
this issue as that was not the question framed to be answered.
12. 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. The particulars are in a tabulated
form as under:
Civil Appeal
Number
Assessment
Year(s)
Deduction
Sought
Arising out of
5105/2009 1976-77
1981-82
Rs. 19,35,950
Rs. 1,96,17,920
Common order
dated 24.11.2006
5106/2009 1982-83 Rs. 1,26,90,860 Order dated
12.7.2007 decided
in terms of order
dated 24.11.2006
5107/2009 1983-84 Rs. 1,39,38,943 Order dated
12.7.2007 decided
in terms of order
dated 24.11.2006
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!
10
14. We may also notice a fact that originally the Special 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 Committee existed then to settle
inter-governmental disputes, but was subsequently 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 adjudication by the Court, though the
Committee did not itself settle the issue. 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 Section 9 of the
NCDC Act and, thus, monies advanced as grants never came back to the
appellant and were in the nature of expenditure of the appellantCorporation. The Committee was of the view that the grants disbursed
by the appellant-Corporation were not in the nature of loans and were
11
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 appellant-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
12
“grants” or “subsidies”, there is an irretrievable outgo from the
coffers of the appellant-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
interest/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 it 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
13
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 the
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 appellantCorporation. The requisite conditions for being allowed as a
deduction under Section 37(1) of the IT Act stand fulfilled since:
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
14
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-Corporation
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 Court in
Commissioner of Income Tax, Bombay v. Associated Cements
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 advantage for
the enduring benefit of a trade. I think that there is very good
reason (in the absence of special circumstances leading to 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
11988 (Supp) SCC 378
2(1924) 10 Tax Cases 155, 192-83: (1926) AC 205 (HL)
15
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 assessee’s
business to be carried on more effectively or more profitably while
leaving the fixed capital untouched, the expenditure would be on the
revenue account, even though the advantage may endure for an indefinite
future.
17. A reference was also made to the judgment in M/s. Empire Jute
Co. Ltd. v. Commissioner of Income Tax3
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 proposition that
what may be a capital receipt in the hands of the payee must
necessarily be capital expenditure in relation to the payer. 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
3(1980) 4 SCC 25
16
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 made by an assessee
for purchase of loom hours would be capital 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 cooperatives are not in the course of trade business of the appellantCorporation, but are a mere application of 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.
iv. The direct nexus of monies given as outright grants from the
4Commissioner of Income Tax, Bombay v. Shri Sitaldas Tirathdas, (1961) 2 SCR
634
17
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 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
18
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 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 appellant-Corporation 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.
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
19
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. In our view, to decide the question as to
whether a particular source of income is business income, one would
have to look to the notions of what is the business activity. The activity
from which the income is derived must have a set purpose. The business
activity of the 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 appellantCorporation does not carry on business activity for profit motive is not
20
material as profit making is not an essential ingredient on account of selfimposed and innate restriction arising from the very statute which creates
the appellant-Corporation and the very purpose for which the appellantCorporation 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 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.
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 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,
predicated on a plea that assuming it to be so, the grants (and not loans)
5 (1976) 1 SCC 254
21
cannot be treated as a capital expenditure as neither any enduring
advantage or benefit has accrued to the appellant-Corporation nor has any
asset come into existence which belongs to or was owned by the
appellant-Corporation. Thus, what may be a capital receipt in the hands
of the 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., Bombay7
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 aforesaid 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.
6(supra)
7(supra)
22
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 was 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 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.
28. To decide the aforesaid question, it would be appropriate to advert
23
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 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. We
may say it is really in the nature of an intermediary with expertise in the
financial sector to carry forward the intent of the Central Government to
assist State Governments, Cooperative Societies, etc. Since this is the
business activity, that is what has persuaded us to opine that the income
generated in the form of interest on the unutilised capital is in the nature
of business income. The objectives are wholly socio-economic and the
amounts received including grants come with a prior stipulation for the
funds received to be passed on to the downstream entities. This is the
24
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 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.
25
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 business 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 to 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
26
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
income or diversion of profits. This Court came to the conclusion that
from any point of view, whether as revenue expenditure 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 income towards
business objective of the appellant-Corporation is a business expenditure
and nothing else. The endeavour of the Revenue Department to rely on
8 (1973) 3 SCC 274 (more specifically para 23)
27
the judgment in the Sitaldas Tirathdas case9
is not appreciable since that
was a case dealing with the obligation of an individual 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 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.
9 (supra)
28
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 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.
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 efforts
of the State Governments. Thus, State Governments recommend
proposals of individual societies/projects to the appellant-Corporation in
10 (supra)
29
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 nonreimbursement 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.
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
30
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 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. In this behalf, we may also usefully
refer to the judgment in CIT, Gujarat v. S.C. Kothari12 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 and 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.
11 (1965) 3 SCR 818
12 (1972) 4 SCC 402
31
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, -
32
(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
(c) The expenditure is incurred for the objects and purposes
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 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
33
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 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 1.4.2002.13
43. 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 we are 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
13 Chaturvedi & Pithisaria’s Income Tax Law, Volume 3, Sixth Edition (2014), Pg.
3310, published by LexisNexis
34
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.
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, who is principally
right when in either eventuality it benefits 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
35
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 was 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
36
3. The aforesaid failure of the system resulted in the Supreme
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 aspect 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
15 (2011) 332 ITR 58 (SC)
16 (2018) 16 SCC 363
37
complete wastage of judicial time and in various orders of this Court it
has been categorized as “certificate 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 commercial 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
38
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 Tax
(Exemptions) v. National Interest Exchange of India17 by a bench of
which one of us (Sanjay Kishan Kaul, J.) was a part.
6. Insofar as non-taxation matters are concerned, the
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 referred to the
Committee comprising Secretaries of the Administrative
Ministries/Departments to which the disputing parties belong and the
Secretary, 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
17 SLP (C) Diary No. 35567 of 2019
39
concerned; the 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
function effectively, it may be appropriate to have a Committee of
legal experts presided by a retired Judge to give their imprimatur to
40
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 efficacious
remedy and here we are talking about mediation inter se the
Government authorities or Government departments. India is now a
signatory to the Singapore Convention on Mediation and we
understand that a serious thought is being given to bring forth a
comprehensive legislation 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,
41
because they are consistently sought to be carved out as a separate
category of cases. One of the largest areas of litigation 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 department
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 fact, before further discussing this Advance Ruling System,
we can unhesitatingly say that, at least, for CPSEs and Government
authorities, there would be no question of taking this matter further
once an Advance Ruling is delivered, and even in case of private
18See ‘Economic Survey 2017-19 – Volume 1’ by the Department of Economic
Affairs, Ministry of Finance, Government of India
42
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-judicial tribunal was established as the
Authority for Advance Rulings (for short ‘AAR’) to provide certainty
and avoid litigation related to taxation of transactions involving nonresidents. 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 tax impact. Chapter XIX-B of the IT Act deals
with advance rulings and it has been defined in Section 245N(a) of the
43
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 Bangalore19 that a challenge an advance
ruling first lies before the High Court, and subsequently before the
Supreme Court. The advance ruling may 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
19 (2012) 11 SCC 224
20See Deloitte Report on Advance Rulings in India: Delivering Greater Tax
Certainty (Deloitte Tax Policy Paper 5, 2019)
44
vacancies and 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 everincreasing 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 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
21ibid.
45
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 short ‘OECD’) lists advance rulings as one of the
indicators to assess 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 rulings 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
practice and interpretations of the United States courts, where rulings
have indicated that taxpayers may be penalised if they act
46
inconsistently with legal interpretations set out in the revenue rulings,
procedures or notices.
18. Tax transparency has been a hallmark trait of the Swedish 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
rulings 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
this 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 authorities of
bolstering tax compliance and boosting tax morale. This mechanism
should not become another stage in the litigation process.
47
20. We, thus, consider it appropriate to recommend to the Central
Government to consider the efficacy of the advance tax ruling 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 on 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 assessee, 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
48
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
infinite hope.”
49
23. A copy of this order be sent to the Department of Revenue,
Department of Expenditure and Department of Economic Affairs,
Ministry of Finance and to the Ministry of Law & Justice.
...……………………………J.
[Sanjay Kishan Kaul]
..……………………………J.
[Indu Malhotra]
New Delhi.
September 11, 2020.
50
