The Supreme Court has ruled that statutory corporations cannot claim a 40 per cent tax deduction under Section 36(1)(viii) of the Income Tax Act for income earned from activities other than providing long-term finance for industrial, agricultural, or infrastructure development.
A Bench of Justice PS Narasimha and Justice Atul S Chandurkar dismissed an appeal filed by the National Cooperative Development Corporation (NCDC), holding that only profits directly arising from long-term financing, that is, loans repayable over a period of five years or more, are eligible for the deduction.
The Court made it clear that income from dividends, short-term deposits, or service charges does not qualify as income “derived from” long-term financing, but merely constitutes business income.
“The pivotal takeaway from the analysis is that Section 36(1)(viii) of the Act is not a general exemption granted to a statutory corporation for all its business activities,” the bench said.
“The legislative intent was to incentivise the specific act of providing long-term credit, not the passive investment of surplus capital. If we were to accept the appellant’s argument, it would create a perverse incentive for financial corporations to park funds in safe, short-term investments and claim the 40 per cent deduction, rather than fulfilling their statutory mandate of providing high-risk long-term credit to the agricultural sector,” the bench said.
Section 36 (1) (viii) allows a deduction of up to 40 per cent of profits derived from the business of providing long-term finance for industrial or agricultural development. The provision defines “long-term finance” as any loan or advance repayable over not less than five years.
The dispute arose when NCDC claimed that income from dividends, interest, and service charges formed part of its “integrated business” of financing cooperative development and was, therefore, eligible for deduction. The assessing officer rejected the claim, and the appellate authorities, the CIT(A), ITAT, and the High Court, upheld that finding, prompting NCDC to approach the Supreme Court.
Upholding the decisions of other courts, Justice Chandurkar, who authored the judgment, underscored that tax deductions must be strictly construed. The Court observed that tax law “needs to be strictly and narrowly interpreted, where the Court is to ascribe natural and ordinary meaning to the words used by the legislature and ought not, under any circumstances, to substitute its own impression or ideas in place of the legislative intent.”
Referring to that precedent, the bench explained that to claim the benefit of Section 36(1)(viii), three strict conditions must be met: “First, the phrase ‘derived from’ must be interpreted much more narrowly than ‘attributable to’. Second, it requires a direct or immediate nexus with the specific business activity, for if the income is even a step removed from the business in question, that nexus is snapped. Third, the deduction is limited to income from ‘first degree’ sources and explicitly keeps out ‘ancillary profits’ of the undertaking.”
Finding that NCDC’s earnings from short-term deposits and service activities did not have a direct connection with its core long-term lending operations, the Court held that the corporation was not entitled to the deduction.
