Section 36(1)(viii) Deduction Ring-Fenced to Core Long-Term Lending Business — Ancillary Incomes Not Covered: Supreme Court Denies Tax Relief

"‘Derived From’ Demands Direct Nexus with Core Lending Activity — Ancillary Revenues Fail Eligibility Test", On December 10, 2025, the Supreme Court of India delivered a landmark judgment in National Cooperative Development Corporation v. Assistant Commissioner of Income Tax, dismissing a batch of appeals challenging the denial of tax deduction under Section 36(1)(viii) of the Income Tax Act, 1961. The ruling decisively held that dividend income, interest on short-term deposits, and service charges for administering government loans do not qualify as "profits derived from the business of providing long-term finance".

Delivering the judgment, a Bench of Justices Pamidighantam Sri Narasimha and Atul S. Chandurkar emphasized that post-1995, Parliament had clearly "ring-fenced" the deduction benefit to profits strictly and directly emanating from long-term finance, excluding incidental or ancillary income streams, however interlinked they may seem.

“By employing the narrowest possible connective verb ‘derived from’ and coupling it with an exhaustive definition of ‘long-term finance’… the Legislature has explicitly excluded ancillary, incidental, or second-degree sources of income,” the Court observed.

Investment Income, Agency Fees, and Short-Term Deposits Brought Under Tax Net

The National Cooperative Development Corporation (NCDC), a statutory body formed to promote agricultural development through cooperatives, had sought deduction under Section 36(1)(viii) on three specific income streams:

1. Dividends from redeemable preference shares;
2. Interest from short-term deposits of idle funds;
3. Service charges for managing Sugar Development Fund (SDF) loans as a nodal agency.

The Assessing Officer denied the deduction, observing that none of these heads of income stemmed directly from the core business of providing long-term finance, as narrowly defined under the amended statute. The Commissioner of Income Tax (Appeals), the Income Tax Appellate Tribunal (ITAT), and the Delhi High Court all upheld the disallowance.

The Supreme Court identified the pivotal legal question as whether the disputed income categories could be said to be "profits derived from the business of providing long-term finance", in light of the restrictive language introduced by the Finance Act, 1995.

“To accept the appellant's argument that all its income is deductible because it is a statutory corporation would be to restore the pre-amendment position and render the legislative change otiose,” the Court clarified.

Relying heavily on the Memorandum to the Finance Bill, 1995, the Court highlighted the legislative intent to prevent financial institutions from claiming tax benefits on unrelated business activities.

'Derived From' Is Not 'Attributable To': Strict Nexus Required

Rejecting the appellant’s broad interpretation of “derived from”, the Court held that the phrase demands a "first-degree nexus" with the core activity.

“The phrase ‘derived from’ must be interpreted much more narrowly than the phrase ‘attributable to’... Any income even a step removed from the business in question fails the statutory test,” the Court held.

It relied on precedents including Cambay Electric Supply Co. v. CIT, Sterling Foods, Pandian Chemicals, Liberty India, and Orissa State Warehousing Corp. to reiterate that tax incentive provisions are to be construed strictly, with no room for equitable or purposive expansion.

The Court distinguished Meghalaya Steels, emphasizing that the subsidy reimbursements in that case had a direct cost-link to the business, unlike the incidental earnings in the present appeal.

No Deduction for Dividends — Investment in Preference Shares Is Not a Loan

The appellant argued that preference shares were "quasi-loans" and hence, dividends thereon should be treated as profits from lending.

Rejecting this submission, the Court relied on the Constitution Bench ruling in Bacha F. Guzdar v. CIT:

“Dividend is derived from the investment made in shares… the foundation of it rests on the contractual relations between the company and the shareholder. It is not derived by a shareholder by his direct relationship with the land or loan.”

The Court reiterated that a shareholder is not a creditor, and preference shares represent capital investment, not credit advanced. Hence, dividend income fails the statutory definition of ‘long-term finance’ and cannot qualify for the deduction.

Short-Term Bank Interest Is Business Income, But Not Deductible

While accepting that interest earned on idle funds temporarily parked in bank deposits constitutes “business income”, the Court held that mere classification under Section 28 is not enough for deduction under Section 36(1)(viii).

“There is a vital distinction between the general genus of ‘Business Income’ and the specific species of ‘profits derived from the business of providing long-term finance’,” the Court emphasized.

It noted that accepting such a claim would create a perverse incentive for financial corporations to invest passively in low-risk avenues, instead of engaging in long-term developmental lending.

Service Charges for Government Loans Are Administrative Fees, Not Lending Profits

The Court decisively held that service charges received by NCDC for disbursing and monitoring SDF loans — where the funds belonged to the Government — were purely administrative receipts.

“The receipts in question are service charges paid by the Government for administrative tasks… not profits derived from providing long-term finance,” the Court said, clarifying that the appellant neither bore any risk nor used its own capital in these transactions.

Thus, agency or facilitation fees were excluded from the scope of deduction.

No Deduction for Ancillary Income Streams

Concluding the detailed judgment, the Bench emphasized the importance of legislative precision in tax deduction schemes:

“Section 36(1)(viii) is not a general exemption granted to a statutory corporation… It is a specific incentive attached strictly to profits arising from a defined activity, namely, the provision of long-term finance.”

Holding that none of the disputed income heads satisfied the statutory definition or the strict judicial test of derivation, the Supreme Court dismissed the appeals in entirety.

Date of Decision: December 10, 2025