Dividend, Bank Interest & SDF Service Charges Not Eligible for Section 36(1)(viii) Deduction: SC

The Supreme Court has ruled that dividend income, interest earned on short-term bank deposits, and service charges received for administering Sugar Development Fund (SDF) loans cannot be treated as “profits derived from the business of providing long-term finance” under Section 36(1)(viii) of the Income Tax Act, 1961. The bench of Justice Pamidighantam Sri Narasimha and Justice Atul S. Chandurkar observed that the income streams are not eligible for the special 40% deduction available under the provision. The dispute arose when the Assessing Officer scrutinised several assessment years and concluded that the corporation’s earnings from dividends, interest on temporary bank deposits, and SDF service charges could not be treated as income “derived from” long-term financing activities. The AO held that dividend income results from investments in redeemable preference shares, which represent share capital rather than loans, and therefore lack any connection with the activity of extending long-term finance. Similarly, interest on short-term deposits was earned by parking idle funds temporarily and did not arise from the corporation’s core lending operations. With respect to service charges earned for supervising SDF loans, the AO noted that the funds belonged entirely to the Central Government, and the corporation merely acted as a nodal agency. Consequently, these receipts were held to be outside the scope of the deduction under Section 36(1)(viii). The findings were affirmed by the CIT(A), the Income Tax Appellate Tribunal, and eventually the High Court. Upholding these findings, the Supreme Court extensively analysed the 1995 amendment to Section 36(1)(viii), observing that Parliament deliberately narrowed the deduction to only those profits strictly “derived from” long-term finance, as opposed to the broader pre-1995 standard which permitted deductions based on total income. Referring to the Finance Bill memorandum, the Court noted that the amendment was introduced to prevent financial corporations from claiming deductions on profits arising from unrelated or incidental activities. It emphasised that the statute must be interpreted strictly and that the phrase “derived from” requires an immediate, first-degree nexus between the income and the lending activity. Any income that is even one step removed cannot qualify for the deduction. In its reasoning on dividend income, the Court relied on the Constitution Bench ruling in Bacha F. Guzdar v. CIT, reiterating that dividends flow from the contractual relationship of shareholding and not from the underlying commercial activities of the company or the nature of funds invested. Since preference shares constitute share capital, a shareholder is not a creditor and cannot sue for repayment as in the case of a loan. Therefore, dividend income, irrespective of redemption terms or fixed rates, cannot be equated with interest on loans and fails the statutory definition of long-term finance. The Court also rejected the appellant’s argument that interest on short-term bank deposits formed part of a “single integrated business” of financing. It clarified that although such interest may be classified as business income under Section 28, that does not automatically qualify it for the incentive under Section 36(1)(viii), which operates on a much narrower plane. The Bench distinguished the 2021 Supreme Court ruling involving the same corporation, noting that it concerned classification of income under Section 28, not eligibility for the special deduction. Since bank-deposit interest arises from temporary investment of surplus funds and not from the deployment of long-term finance, the Court held that it cannot meet the strict “derived from” requirement. Regarding SDF service charges, the Bench noted that the appellant utilised no funds of its own and bore no financial risk. The income originated solely from its role as an implementing agency for the Government of India. The proximate source of such income was the agency agreement, not long-term lending. Therefore, service charges too could not fall within the statutory scope of the deduction. The Supreme Court stressed that Section 36(1)(viii) is not a general exemption for all income earned by a statutory financial corporation but a narrowly constructed incentive tied exclusively to profits generated from the provision of long-term finance repayable over at least five years. Since none of the disputed receipts satisfied this strict requirement, all appeals were dismissed without costs. Case Details Case Title: National Cooperative Development Corporation Versus Assistant Commissioner Of Income Tax Case No.: CIVIL APPEAL No. 4612 OF 2014 Date: 10/12/2025 Click Here To Read Order Read More: Guarantee Fee Taxable Only at 10%; ITAT Rejects CIT(A)’s Move to Levy 40% Under ‘Other Income’

Dividend, Bank Interest & SDF Service Charges Not Eligible for Section 36(1)(viii) Deduction: SC

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