4. ………..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 4 societies, is eligible for deduction for determining the “taxable income” of the appellant-Corporation.

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…….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 interlinked 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.

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) 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. referred to in Commissioner of Income Tax, Bombay v. Associated Cement Companies Ltd., Bombay 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 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.

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 (more specifically para 23) 27 the judgment in the Sitaldas Tirathdas case 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 circumstances.

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.

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)………….

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 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 2:

10. We now turn to the issue of matters pertaining to CPSEs and Government authorities insofar as taxation matters are concerned, 41 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%. 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 by the Department of Economic Affairs, Ministry of Finance, Government of India persons, the scope of any further challenge is completely narrowed down.

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 forward.

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.