The Appellant, National Co-operative Development Corporation is established under the National Cooperative Development Corporation Act, 1962 (“NCDC Act”). The functions of the Appellant Corporation are prescribed under Section 9 of the Act, which includes advancing loans to cooperative societies. Section 12 stipulates the process of funding cooperative societies by way of grants and loans. The present case deals with the question of eligibility of deductions for determining ‘taxable income’ concerning grants disbursed by the Appellant.
The Assessing Officer (“AO”) opined that the non-refundable grants were like capital expenses hence not eligible for deductions. The Revenue Department was approached for seeking correction of the stand of the AO. An appeal was preferred before the CIT. The CIT held that as per Section 37 of the Income Tax Act, 1961 (“IT ACT’), any business expense incurred was allowable as a deduction. Thereafter, the Revenue Department preferred an appeal before the ITAT. The ITAT accepted the opinion of the AO and set aside the order of the CIT. The next round was at the High Court of Delhi. A reference under Section 256(1) of the IT Act was made. Herein, the reference was in favour of the Revenue Department. Hence, the present appeal.
It was contended that the grants disbursed out of the interest income are allowable as revenue expenditure under Sec. 37(1) of the IT Act. Further that ‘grants’ and ‘loans’ are not identical as is considered by the High Court erroneously. In the case of ‘grants’, they are irretrievable outgo from the coffers of the Appellant. Additionally, the High Court erred in considering that the taxable income gets amalgamated in the common pool of the Fund as per Sec. 13(1) of the NCDC Act. This makes it lose its character of a revenue receipt. Merely because the interest income is amalgamated, the interest income earned cannot transform itself into the capital receipt. Therefore, the grants given in the normal course of the Appellant’s business must be assessed as ‘business income’ eligible for deduction under Sec. 37(1) of the IT Act.
On the contrary, it is submitted that the amalgamation of the interest income with common Fund, the interest income loses its revenue character. Further, the grants given are not in the course of trade business and are a mere application of income, therefore, not an expenditure. Lastly, the income must be treated as income from ‘other sources’ under Sec. 56 of the IT Act. Hence, if any exemption is to be accorded is governed under Sec. 57 of the IT Act and not Sec.37.
- Determination of Head of Income
The Court first looked under which category does the interest on loans or dividends falls (that is, whether under Sec. 56 or Sec.14 of the IT Act). The Court agreed with the decision of the High Court on this aspect. It found that the only business that the Appellant was involved in was the receipt of funds and then to advance them as loans or grants. Thus, the income generated from the interest by the Appellant would fall under the head ‘profits and gains of business or profession’. Hence, recourse to Sec. 56 is not necessary. The Court observed as follows:
“…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 utilized for the same purpose would ultimately be taxable as business income.”
- Determination of nature of grants – Capital or Revenue Receipts
The Court categorically stated that the amount received to be advanced as loans and grants be treated as capital receipts. If not, it would be taxable in the hands of the Appellant. The Court observed that the interest is not directly received but generated when the fund is lying idle. The Appellant has no other function but to receive funds and disburse the same as grants or loans. It is considered by the Court as an intermediary with expertise in the financial sector. Considering the nature and the objective of the Appellant, the Court held that the interest income is to be treated as capital receipts.
- Determination of whether the expenditure is under Sec. 37(1) of the IT Act and Question of Application of Income.
The Court observed that once the disbursements of the grants have been considered to be the core of the Appellant’s business, the deduction under Sec. 37 would be allowable. Additionally, merely because the grants benefit a third party does not render the disbursement ‘application of money’. The Court referenced CIT Kerala, Ernakulam v. The Travancore Sugar and Chemicals Ltd., (1973) 3 SCC 274. Therein the Court observed that ‘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’.
The Court also referred to the established principle of application of money in its landmark decision of Commissioner of Income Tax, Bombay v. Shri Sitaldas Tirathdas, (1961) 2 SCR 634. Wherein it was observed as follows:
“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 any 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 the application of income and what is the diversion by overriding title.”
The Court conferred with the decision of the CIT and allowed the appeal. The Court held that the disbursement of the interest income as grants and loans was an application of the monies.
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