Supreme Court Clarifies Tax Deductibility of Grants by National Cooperative Development Corporation: National Co-operative Development Corporation vs. Commissioner of Income Tax, Delhi-V (2020) INSC 649 (11 September 2020)

Case Background

The National Co-operative Development Corporation (NCDC), established under the National Co-operative Development Corporation Act, 1962, is tasked with planning and promoting programs for agricultural and industrial development through cooperatives. The NCDC receives funds from the Central Government, which are considered capital receipts and not taxable. The NCDC invests surplus funds, generating interest income, which is treated as taxable business income. The dispute arose when the NCDC claimed deductions for grants disbursed to cooperative societies from this interest income, which was contested by the Income Tax Department.

Timeline

Course of Proceedings

The Assessing Officer (AO) initially disallowed the deduction claimed by NCDC, stating that the grants were capital expenses. The Commissioner of Income Tax (Appeals) (CIT(A)) reversed this decision, allowing the deduction, as the grants were part of NCDC’s business activities. However, the Income Tax Appellate Tribunal (ITAT) sided with the AO, stating that the grants were an application of funds and not revenue expenditure. The Delhi High Court upheld the ITAT’s decision, leading to the appeal before the Supreme Court.

Legal Framework

The case revolves around the interpretation of Section 13 of the National Co-operative Development Corporation Act, 1962, which mandates the maintenance of the National Cooperative Development Fund. It specifies that the fund includes grants and loans from the Central Government, as well as interest on loans and investments. The funds are to be used for advancing loans and grants to State Governments and cooperative societies. The other key provision is Section 37(1) of the Income Tax Act, 1961, which allows deductions for expenditures laid out wholly and exclusively for the purposes of business, provided they are not capital expenditures.

Section 13 of the NCDC Act states:
“13. Corporation to maintain fund.— (1) The Corporation shall maintain a fund called the National Cooperative Development Fund (hereinafter referred to as the Fund) to which shall be credited—
(a) all moneys and other securities transferred to it under clause (a) of sub-section (2) of section 24;
(b) the grants and other sums of money by way of loans paid to the Corporation by the Central Government under section 12;
(bb) all moneys received under section 12B;
(bbb) all moneys received for services rendered;
(ba) all moneys borrowed under section 12A;
(c) such additional grants, if any, as the Central Government may make to the Corporation for the purposes of this Act; and
(d) such sums of money as may, from time to time, be realised out of repayment of loans made from the Fund or from interest on loans or dividends or other realisations on investments made from the Fund.
(2) The moneys in the Fund shall be applied for —
(a) advancing loans and granting subsidies to State Governments on such terms and conditions as the Corporation may deem fit for the purpose of enabling State Governments to subscribe to the share capital of co-operative societies or for otherwise financing co-operative societies ;
(b) meeting the pay and allowances of the managing director, the officers and other employees of the Corporation and other administrative expenses of the Corporation; and
(c) carrying out the purposes of this Act.”

Section 37(1) of the Income Tax Act, 1961 states:
“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”.”

Arguments

NCDC’s Arguments:

• Grants disbursed from interest income, which is taxed as business income, should be allowed as revenue expenditure under Section 37(1) of the Income Tax Act, 1961.
• There is a clear distinction between grants and loans. Loans are recoverable, while grants are an irretrievable outflow of funds.
• The High Court erred in treating grants and loans as identical.
• The interest income does not lose its revenue character just because it is amalgamated in the common fund under Section 13(1) of the NCDC Act.
• The NCDC can demonstrate the direct link between income receipts and grants disbursed.
• The grants are given in the normal course of NCDC’s business and are not capital expenditure.
• NCDC relied on Commissioner of Income Tax, Bombay v. Associated Cements Companies Ltd. [1988 (Supp) SCC 378] and M/s. Empire Jute Co. Ltd. v. Commissioner of Income Tax [(1980) 4 SCC 25] to argue that what may be a capital receipt for the payee can be a revenue expenditure for the payer.

Income Tax Department’s Arguments:

• The interest income loses its revenue character when merged into the common fund.
• Grants are not part of NCDC’s business but are merely an application of income.
• Grants are not an expenditure but an application of income, and if considered expenditure, it would be capital expenditure.
• A direct link between grants and taxable interest income cannot be identified in the common fund.
• The income should be treated as income from other sources under Section 56 of the Income Tax Act, 1961, not under Section 28.
• The department relied on Commissioner of Income Tax, Bombay v. Shri Sitaldas Tirathdas [(1961) 2 SCR 634] to argue that the grants were an application of income.

Submissions Table

Issues Framed by the Supreme Court

The Supreme Court considered the following issue:

1. Whether the amount of Rs. 19,35,950/- being grants disbursed by the assessee-applicant to various State Governments during the financial year 1975-76 relevant to assessment year 1976-77 was in the nature of Revenue expenditure, hence allowable in computing the total income of the assessee for the assessment year under reference.

Treatment of the Issue by the Court

Authorities

Cases Considered:

• Commissioner of Income Tax, Bombay v. Associated Cements Companies Ltd. [1988 (Supp) SCC 378] – The Court referred to this case to discuss the distinction between capital and revenue expenditure, noting that an expenditure that brings an enduring benefit is generally considered capital expenditure. The Court also noted that there may be cases where expenditure, even if incurred for obtaining an advantage of enduring benefit, may, nonetheless, be on the revenue account.
• Atherton v. British Insulated and Helsby Cables Ltd. [(1924) 10 Tax Cases 155] – This case was cited to highlight the principle that expenditure made to bring an asset or advantage for the enduring benefit of a trade is capital expenditure, while expenditure that facilitates trading operations is revenue expenditure.
• M/s. Empire Jute Co. Ltd. v. Commissioner of Income Tax [(1980) 4 SCC 25] – The Court relied on this case to emphasize that what may be a capital receipt for the payee can be a revenue expenditure for the payer.
• Commissioner of Income Tax, Bombay v. Shri Sitaldas Tirathdas [(1961) 2 SCR 634] – This case was discussed to distinguish between application of income and diversion of income by overriding title. The court held that the case dealt 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, and was not applicable to the present case.
• The Sole Trustee, Lok Shikshana Trust v. The Commissioner of Income Tax, Mysore [(1976) 1 SCC 254] – The court relied on this case to support the view that the generation of interest income in support of the business of the appellant-Corporation would ultimately be taxable as business income.
• CIT Kerala, Ernakulam v. The Travancore Sugar & Chemicals Ltd. [(1973) 3 SCC 274] – The Court cited this case to support the view that the discharge of an obligation paid to the Government was an allowable revenue expenditure.
• Poona Electric Supply Co. Ltd. v. CIT Bombay City [(1965) 3 SCR 818] – The Court referred to this case to state that income tax is on the real income, and in the case of a business, the profits must be arrived at on ordinary commercial principles.
• CIT, Gujarat v. S.C. Kothari [(1972) 4 SCC 402] – The Court cited this case to emphasize that the tax collector can only tax profits of a trade or business, which cannot be done without deducting the losses and the legitimate expenses of the business.
• Electronics Corporation of India v. Union of India [(2011) 332 ITR 58 (SC)] – The Court recalled its orders in the ONGC cases vide this case.
• Union of India & Ors. v. Pirthwi Singh & Ors. [(2018) 16 SCC 363] – This case was cited to comment on the wastage of judicial time and categorized such cases as “certificate cases”.
• The Commissioner of Income Tax (Exemptions) v. National Interest Exchange of India [SLP (C) Diary No. 35567 of 2019] – This case was cited to note that the Administrative Mechanism for Resolution of CPSEs Disputes was made applicable to all disputes other than those related to taxation matters.
• Columbia Sportswear Company v. Director of Income Tax Bangalore [(2012) 11 SCC 224] – The Court cited this case to state that a challenge to an advance ruling first lies before the High Court, and subsequently before the Supreme Court.
• Oil and Natural Gas Commission & Anr. v. Collector of Central Excise [1995 Supp (4) SCC 541] – The Court referred to this case to note that such cases must be referred to a Committee to be appointed by the Government to facilitate a resolution of such disputes.

Legal Provisions Considered:

• Section 9 of the National Co-operative Development Corporation Act, 1962
• Section 12 of the National Co-operative Development Corporation Act, 1962
• Section 13 of the National Co-operative Development Corporation Act, 1962
• Section 14 of the Income Tax Act, 1961
• Section 28 of the Income Tax Act, 1961
• Section 36 of the Income Tax Act, 1961
• Section 37 of the Income Tax Act, 1961
• Section 56 of the Income Tax Act, 1961
• Section 57 of the Income Tax Act, 1961
• Section 245N of the Income Tax Act, 1961
• Section 245R of the Income Tax Act, 1961
• Chapter XIX-B of the Income Tax Act, 1961

Authorities Table

Judgment

How each submission made by the Parties was treated by the Court?

How each authority was viewed by the Court?

• Commissioner of Income Tax, Bombay v. Associated Cements Companies Ltd. [1988 (Supp) SCC 378]*: The Court used this case to discuss the distinction between capital and revenue expenditure, agreeing that an expenditure that brings an enduring benefit is generally considered capital expenditure but also noting that there may be cases where expenditure, even if incurred for obtaining an advantage of enduring benefit, may, nonetheless, be on the revenue account.
• Atherton v. British Insulated and Helsby Cables Ltd. [(1924) 10 Tax Cases 155]*: The Court used this case to highlight the principle that expenditure made to bring an asset or advantage for the enduring benefit of a trade is capital expenditure, while expenditure that facilitates trading operations is revenue expenditure.
• M/s. Empire Jute Co. Ltd. v. Commissioner of Income Tax [(1980) 4 SCC 25]*: The Court agreed with the principle that what may be a capital receipt for the payee can be a revenue expenditure for the payer.
• Commissioner of Income Tax, Bombay v. Shri Sitaldas Tirathdas [(1961) 2 SCR 634]*: The Court distinguished this case, stating that it dealt with the obligation of an individual under a personal obligation to maintain, and was not applicable to the present case.
• The Sole Trustee, Lok Shikshana Trust v. The Commissioner of Income Tax, Mysore [(1976) 1 SCC 254]*: The Court used this case to support its view that the generation of interest income in support of the business of the appellant-Corporation would ultimately be taxable as business income.
• CIT Kerala, Ernakulam v. The Travancore Sugar & Chemicals Ltd. [(1973) 3 SCC 274]*: The Court used this case to support the view that the discharge of an obligation paid to the Government was an allowable revenue expenditure.
• Poona Electric Supply Co. Ltd. v. CIT Bombay City [(1965) 3 SCR 818]*: The Court used this case to state that income tax is on the real income, and in the case of a business, the profits must be arrived at on ordinary commercial principles.
• CIT, Gujarat v. S.C. Kothari [(1972) 4 SCC 402]*: The Court used this case to emphasize that the tax collector can only tax profits of a trade or business, which cannot be done without deducting the losses and the legitimate expenses of the business.

Reasoning of the Court:

The Supreme Court held that the interest income earned by NCDC is indeed business income, as the primary business of NCDC is to receive funds and disburse them as loans or grants. The Court stated that the interest income, though generated from idle funds, is directly linked to the business of NCDC. The Court rejected the argument that the interest income loses its revenue character when it is merged into the common fund under Section 13 of the NCDC Act. The Court also held that the grants disbursed by NCDC are not an application of income but an expenditure incurred for the purpose of its business. The court emphasized that the grants are an integral part of NCDC’s business and do not create any capital asset for the corporation. The Court also noted that the source of funds from which the expenditure is made is not relevant. The Court relied on the principles of commercial accountancy to conclude that the grants are a deductible expense.

The Court stated that, “The logical conclusion is that every application of income towards business objective of the appellant-Corporation is a business expenditure and nothing else.”

The Court also noted that, “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 Court further stated that, “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 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.”

What weighed in the mind of the Court?

The Supreme Court’s decision was heavily influenced by the fact that the NCDC is a statutory body whose primary function is to disburse funds for the development of the cooperative sector. The court emphasized that the grants were an integral part of the NCDC’s business and that the interest income generated was directly linked to this business. The court also noted that the grants did not create any capital asset for the NCDC, supporting the view that they were revenue expenditure. The court was also influenced by the principles of commercial accountancy, which dictate that expenses incurred for the purpose of business should be deducted from the income.

Fact:Law Ratio

Logical Reasoning

Key Takeaways

• Grants disbursed by statutory bodies for their core business activities are deductible as revenue expenditure.
• Interest income earned by such bodies is considered business income if it is directly linked to their business activities.
• The source of funds for expenditure is not relevant as long as the expenditure is for the purpose of business.
• This judgment provides clarity on the tax treatment of grants and has implications for similar government bodies.

Directions

The Supreme Court did not issue any specific directions in this judgment, apart from allowing the appeals of the NCDC.

Development of Law

The ratio decidendi of this case is that grants disbursed by a statutory body like the NCDC, as part of its core business activity, are considered revenue expenditure and are deductible from its taxable income. This judgment clarifies that the nature of the expenditure is determined by its purpose and not by the source of funds. The Supreme Court has clarified that the interest income generated by the NCDC is business income and the grants are an expenditure for the purpose of business. This ruling hasclarified the previous position of law by distinguishing between the application of income and expenditure for business purposes. It also clarifies that what may be a capital receipt for the payee can be a revenue expenditure for the payer, and that the source of funds is not relevant as long as the expenditure is for the purpose of business.

Conclusion

The Supreme Court’s judgment in the case of National Co-operative Development Corporation vs. Commissioner of Income Tax, Delhi-V is a significant ruling that clarifies the tax treatment of grants disbursed by statutory bodies. The court’s decision to allow the deduction of grants as revenue expenditure has far-reaching implications for similar government bodies and has provided much-needed clarity on the taxability of such grants. The judgment reinforces the principle that the nature of expenditure is determined by its purpose and not by the source of funds and has also reaffirmed that the tax collector can only tax profits of a trade or business, which cannot be done without deducting the losses and the legitimate expenses of the business. The decision underscores the importance of the business purpose of an expenditure in determining its tax deductibility.