Section 36(1)(viii) Income Tax Act Not A General Exemption; Deduction Limited To Profits From Long-Term Finance: Supreme Court

The Court was hearing a challenge to a common judgment of the Delhi High Court upholding orders of the Assessing Officer, CIT(A) and ITAT, all of which held that the disputed receipts were not profits “derived from” the business of providing long-term finance.

The matter arose from appeals filed by the National Cooperative Development Corporation challenging the disallowance of deduction on three income streams: dividend income, interest on short-term bank deposits, and service charges received for monitoring Sugar Development Fund loans.

A Bench of Justice Pamidighantam Sri Narasimha and Justice Atul S. Chandurkar upon examining the material placed on record and examining the scope of the Section, held that “Section 36(1)(viii) of the Act is not a general exemption granted to a statutory corporation for all its business activities, rather, it is a specific incentive attached strictly to the profits arising from a defined activity namely, the provision of long-term finance”.

Advocates Christi Jain, AOR, and Madhulika Upadhyay, AOR, represented the appellants and the respondents, respectively.

Background

The appellant-corporation (National Cooperative Development Corporation) is mandated to promote cooperative development across agricultural and notified sectors by providing financial assistance.

For the relevant assessment years, the appellant claimed a deduction under Section 36(1)(viii) for income earned from investments in redeemable preference shares, interest accrued on short-term bank deposits, and service charges received from the Government of India for monitoring Sugar Development Fund loans.

The Assessing Officer disallowed these claims on the ground that none of the receipts constituted profits “derived from the business of providing long-term finance.” The disallowance was upheld by the CIT(A), the Tribunal, and later by the High Court.

The appellant approached the Supreme Court, contending that all its income was integrally connected with its statutory mandate and therefore eligible for deduction.

COURT’S OBSERVATION

A. Scope of Section 36(1)(viii) and the Legislative Amendment

The Supreme Court held that Section 36(1)(viii), after its amendment in 1995, created a narrow incentive available only in respect of profits derived from a specific activity, namely “the business of providing long-term finance.” It emphasised that Parliament deliberately replaced the earlier reference to “total income” with a strict requirement that the deduction must be limited to profits that arise directly from long-term lending.

Referring to the Memorandum explaining the Finance Bill, the Court noted that the amendment was introduced because corporations were previously claiming a deduction for income unrelated to long-term finance. The provision was therefore re-drafted to “take outside the purview of deduction, income arising from other business activities or from sources other than business.” Its ambit being narrowly tailored, the Court concluded that the assessee’s contrary interpretation would defeat the legislative purpose.

B. Interpretation of “Derived From”

The Court reaffirmed that the expression “derived from” requires a direct and proximate first-degree nexus, distinguishing it from the wider expression “attributable to.” It relied on Sterling Foods, Pandian Chemicals and Liberty India, reiterating that the statute demands a strict source-based enquiry to determine whether the income flows immediately from the specified activity.

The Bench rejected the appellant’s reliance on Meghalaya Steels and the argument that all its income is part of a single, indivisible, integrated activity. It held that the concept of integrated business cannot override section-specific statutory language and that fiscal incentives must be construed in accordance with precise legislative text. Section 36(1)(viii), being narrowly crafted, therefore excludes income that is merely incidental, remote, or derived from secondary activities.

C. Dividend Received on Redeemable Preference Shares

The appellant argued that redeemable preference shares resemble long-term loans and that dividends on such shares should be treated as interest derived from long-term finance. The Court rejected this position, holding that preference shares are share capital under the Companies Act, and not loans or advances. The immediate source of dividends is the investment in shares and not any lending activity.

The Court relied on the Constitution Bench decision in Bacha F. Guzdar, reaffirming that dividend “is derived from the investment made in the shares of the company.” As the Explanation to Section 36(1)(viii) expressly restricts the definition of long-term finance to loans and advances of not less than five years’ duration, dividend income cannot satisfy the statutory test. The Court therefore upheld its exclusion from the deduction.

D. Interest on Short-Term Bank Deposits

The appellant contended that interest earned on short-term parking of funds is integrally connected with its lending operations and should be treated as business income derived from long-term finance. The Court noted that while such interest may indeed constitute “business income” under Section 28, that classification does not automatically qualify it for deduction under Section 36(1)(viii).

The Court clarified that its earlier decision in NCDC v. CIT dealt only with the classification of income and preceded the 1995 amendment. Under the amended provision, the deduction must be confined to profits that arise directly from the act of providing long-term finance. The Court held that Interest on bank deposits arises from parking surplus funds, not from lending activity, and therefore fails the statutory requirement of a first-degree nexus with long-term finance.

E. Service Charges on Sugar Development Fund Loans

Regarding service charges earned for monitoring SDF loans, the appellant argued that they formed part of its statutory role in facilitating long-term finance. The Court noted that the appellant did not deploy its own funds and acted merely as a nodal agency administering a Government corpus. The income, therefore, arose from an agency relationship rather than from financing activity.

The Court held that service charges represent compensation for administrative services and cannot be equated with profits derived from the business of providing long-term finance. As the proximate source of this income is the Government’s entrustment and not the corporation’s lending functions, it cannot qualify for deduction under Section 36(1)(viii).

Conclusion

The Supreme Court concluded that “the claim of the appellant-assessee is not correct in law.” It reiterated that Section 36(1)(viii) is a specific and narrow incentive, applicable only to profits derived from the business of providing long-term finance, and that dividend income, interest on short-term deposits, and service charges on SDF loans fall outside its scope.

“While agreeing with the findings of the High Court and by supplying additional reasons with supportive precedents, we have held that receipts are not profits derived from the business of providing long-term finance”, the Apex Court concluded.

Accordingly, civil appeals were dismissed with no order as to costs.

Cause Title: National Cooperative Development Corporation v. Assistant Commissioner of Income Tax & Others (Neutral Citation: 2025 INSC 1414)

Appearances

Appellant: Advocates Christi Jain, AOR, Mann Arora, Akriti Sharma, Harsh Jain, Om Sudhir Vidyarthi and Others

Respondent: Anil Katiyar, AOR, Madhulika Upadhyay, AOR

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