National Co-Operative … vs Commissioner Of Income Tax-V, … on 11 September, 2020

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Supreme Court of India

National Co-Operative … vs Commissioner Of Income Tax-V, … on 11 September, 2020

Author: Sanjay Kishan Kaul

Bench: Sanjay Kishan Kaul, Aniruddha Bose, Krishna Murari


                                        IN THE SUPREME COURT OF INDIA
                                         CIVIL APPELLATE JURISDICTION

                                        CIVIL APPEAL NOS. 5105-5107 OF 2009

                         NATIONAL CO-OPERATIVE
                         DEVELOPMENT CORPORATION                                  …Appellant


                         COMMISSIONER OF INCOME TAX,
                         DELHI-V                                                 …Respondent



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!

Signature Not Verified
The factual matrix:

Digitally signed by
Date: 2020.09.11
19:52:29 IST

2. The appellant-Corporation, National Co-operative Development

Corporation, was established under the National Cooperative

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
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

(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.”
(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


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
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

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

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 appellant-

Corporation 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

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

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


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

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


11. The 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. 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

State Governments and cooperative societies could not be claimed as

expenditure as the same does not leave the hands of the appellant-

Corporation 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     Assessment         Deduction          Arising out of
   Number           Year(s)           Sought
5105/2009        1976-77         Rs. 19,35,950        Common order
                 1981-82         Rs. 1,96,17,920      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!


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 appellant-

Corporation. The Committee was of the view that the grants disbursed

by the appellant-Corporation were not in the nature of loans and were

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

“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

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 appellant-

Corporation. 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


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)

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


17. A reference was also made to the judgment in M/s. Empire Jute

Co. Ltd. v. Commissioner of Income Tax 3 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

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 co-

operatives are not in the course of trade business of the appellant-

Corporation, 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


iv. The direct nexus of monies given as outright grants from the

4Commissioner of Income Tax, Bombay v. Shri Sitaldas Tirathdas, (1961) 2 SCR

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.


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

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

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. 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 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. 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

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., Bombay 7 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.



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

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

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.


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

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

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)

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


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)


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)

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 non-

reimbursement 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

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

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, –


(a) It is constituted or established by a Central, State or Provincial

(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


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

computing the income under the head ‘profits and gains of business or


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

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

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


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

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

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 India 17 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

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


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

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,

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

persons, the scope of any further challenge is completely narrowed


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 non-

residents. 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
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


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)

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 ever-

increasing 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


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

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.


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


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

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.”


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.


[Sanjay Kishan Kaul]


[Indu Malhotra]
New Delhi.

September 11, 2020.


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