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Taxation on Revenue expense, Business Income & Real Income Explained

In National Co-operative Development Corporation vs. CIT, the appeal was filed before the Supreme Court after travelling through various courts and tribunals for 44 years

Background

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 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. The disputed began with the fact that 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. 

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.

The appellant-Corporation claimed it to be revenue expense while the Dept claimed capital expense.

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.

Judgment

While deciding in favour of the appellant-Corporation, the Supreme Court came up with some interesting observations :-

(1) 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. (1976) 1 SCC 254.

(2) 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 City (1965) 3 SCR 818 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. Kothari (1972) 4 SCC 402

(iii) Mediation inter se the Government authorities or Government departments is an efficacious remedy. A Committee of legal experts presided by a retired Judge can give its imprimatur to the settlement 

(iv) A vibrant system of Advance Ruling can go a long way in reducing taxation litigation. This is true even of 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.

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