Derived From’ Means First-Degree Nexus: Supreme Court Rejects NCDC’s Claim for Deduction u/s 36(1)(viii) of Income tax [Read Judgement]

The Supreme Court has clarified the phrase ‘Derived from’ in Section 36(1)(viii) of the Income Tax Act, 1961. The bench noted that the it requires a direct, first-degree nexus with the business of providing long-term finance, and cannot be stretched to cover income streams that are merely incidental or attributable to the assessee’s broader operations.

The apex bench, while deciding an appeal filed by the National Cooperative Development Corporation (NCDC), the Court ruled that dividend income on redeemable preference shares, interest earned on short-term bank deposits, and service charges received for monitoring Sugar Development Fund loans do not satisfy the strict statutory requirement of being profits “derived from” long-term financing activity.

The Court noted that Parliament, through the Finance Act, 1995, had deliberately narrowed the scope of the deduction to prevent financial corporations from claiming benefits on diversified or ancillary income.

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It rejected NCDC’s argument that its activities formed a “single integrated business,” clarifying that fiscal incentives must be interpreted strictly and cannot be expanded through theories of business unity.

The bench of Justice Pamidighantam Sri Narasimha and Justice Atul S. Chandurkar, depending on the cases including Sterling Foods, Pandian Chemicals, Liberty India, and the Constitution Bench judgment in Bacha F. Guzdar, observed that the immediate and effective source of income must be the lending activity itself, not investments, agency functions, or temporary parking of funds.

The contested receipts failed the "first-degree nexus" requirement and were therefore not eligible for the deduction because none of them came from NCDC's direct deployment of long-term loans repayable with interest over five years.

“The phrase "derived from" whether used alone or as "derived from the business of" appears across multiple provisions of the Act, such as Section 80HHC and Section 80JJA. This Court has consistently held that this phrase requires a direct and proximate connection, or a "first-degree nexus," between the income and the specific activity. The addition of the words "the business of" simply clarifies which activity is the source; it does not dilute the requirement for a direct link. Any interpretation suggesting otherwise would upset settled law”, observed the court.

Additionally, the Court held that the present case is entirely different from Meghalaya Steels, which is a case relied on by the appellant, because Section 36(1)(viii) is a narrowly framed provision that allows deductions only for profits directly derived from the business of providing long-term finance.

Unlike Section 80-IB, which covers income from “any business,” the disputed receipts here neither reimburse business expenses nor arise from the corporation’s core lending activity.

Therefore, the court said that the broader reasoning in Meghalaya Steels cannot be applied to widen the scope of this deduction, given the strict statutory language and the fundamentally different nature of the income involved.

As a result, the Supreme Court rejected all of the NCDC's arguments and maintained the conclusions of the Assessing Officer, CIT(A), ITAT, and the Delhi High Court.

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