2020 (9) TMI 496 - SC - Income Tax

Supreme Court Rules Interest Income as Business Income; Grants Qualify as Deductible Revenue Expenditure for Tax Purposes.

NATIONAL CO-OPERATIVE DEVELOPMENT CORPORATION Versus COMMISSIONER OF INCOME TAX, DELHI-V

The SC allowed the appeals, overturning the AO, ITAT, and HC's decisions. It ruled that the appellant-Corporation's interest income is taxable as ... Interest income of the appellant-Corporation - whether would fall within the category of income from other sources under Section 56 for which allowable deductions are enumerated under Section 57 of the IT Act OR income from business - High Court opined that since the business of the appellant-Corporation was to receive funds and to then advance them as loans or grants, the interest income earned which was so applied would also fall under the head ‘D’ of Section 14 of Chapter IV of the IT Act under the head of ‘profits and gains of business or profession’ being a part of its normal business activity - HELD THAT:- 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 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 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. To decide the question as to whether a particular source of income is business income, one would have to look to the notions of what is the business activity. The activity from which the income is derived must have a set purpose. The business activity of the appellant-Corporation is really that of an intermediary to lend money or give grants. Thus, the generation of interest income in support of this only business (not even primary) for a period of time when the funds are lying idle, and utilised for the same purpose would ultimately be taxable as business income. The fact that the appellant- Corporation does not carry on business activity for profit motive is not material as profit making is not an essential ingredient on account of self- imposed and innate restriction arising from the very statute which creates the appellant-Corporation and the very purpose for which the appellant- Corporation has been set up. 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? - 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 the judgment in the Sitaldas Tirathdas case [1960 (11) TMI 17 - SUPREME COURT] 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. 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. 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. 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.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. As 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. 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. Issues Involved:1. Taxability of interest income earned on funds received under Section 13(1) of the NCDC Act.2. Eligibility of grants disbursed by the appellant-Corporation as revenue expenditure under Section 37(1) of the Income Tax Act, 1961.Detailed Analysis:1. Taxability of Interest Income:The core issue was whether the interest income earned on funds received under Section 13(1) of the NCDC Act and disbursed as grants is taxable as 'business income' or 'income from other sources.' The Court concluded that the interest income should be taxed as 'profits and gains of business or profession' under Section 28 of the IT Act. The rationale was that the appellant-Corporation's primary business is to receive funds and advance them as loans or grants, and the interest income generated from these funds is interlinked with this business activity. The Court stated, '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.' Therefore, the interest income is part of the appellant-Corporation's normal business activities and should be taxed accordingly.2. Eligibility of Grants as Revenue Expenditure:The next issue was whether the grants disbursed by the appellant-Corporation could be considered revenue expenditure eligible for deduction under Section 37(1) of the IT Act. The Court examined the nature of these grants and concluded that they should be treated as revenue expenditure. The Court emphasized that the disbursement of grants is an integral part of the appellant-Corporation's business activities, stating, 'The disbursement of grants has already been held to be the core business of the appellant-Corporation.' The Court rejected the Revenue Department's argument that the grants were merely an application of income and not an expenditure, noting that the grants were non-refundable and incurred wholly and exclusively for the purpose of the appellant-Corporation's business. The Court also highlighted that the grants did not create any enduring advantage or asset for the appellant-Corporation, thereby qualifying them as revenue expenditure.Conclusion:The Supreme Court allowed the appeals, agreeing with the view taken by the CIT(A) and rejecting the findings of the AO, ITAT, and the High Court. The Court ruled that the interest income earned by the appellant-Corporation is taxable as business income and that the grants disbursed qualify as revenue expenditure deductible under Section 37(1) of the IT Act. The Court noted that the appellant-Corporation's role as an intermediary to lend money or give grants is its only business activity, and the interest income generated from unutilized funds should be considered business income. The Court also emphasized that the grants disbursed are for the purpose of the appellant-Corporation's business and should be allowed as deductions.Postscript:The Court expressed concern over the high volume of litigation involving government entities and suggested the need for a more efficient dispute resolution mechanism. The Court recommended considering the efficacy of the advance tax ruling system to reduce litigation and emphasized the importance of making the government an efficient and responsible litigant. The Court also highlighted the need for a comprehensive legislation to institutionalize mediation, particularly for disputes involving government authorities.