Income tax Deduction u/s 36(1)(viii) Limited to Profits ‘Derived From’ Long-Term Finance: Supreme Court says ‘No Deduction’ to Incidental or Ancillary income [Read Judgement]

The Supreme Court has ruled that the income-tax deduction under Section 36(1)(viii) of Income Tax Act, 1961 is available only on profits that are directly and strictly derived from the business of providing long-term finance, and not on incidental or ancillary income streams.

The National Cooperative Development Corporation (NCDC) filed an appeal before the supreme court aggrieving from the decision of all lower authorities including the High Court.

While rejecting the arguments of the appellant, the Court held that Parliament’s 1995 amendment changing the deduction base from “total income” to income derived from long-term finance was a deliberate attempt to “ring-fence” the benefit and restrict it to the corporation’s core lending activity.

The Court stated that the phrase “derived from” carries a narrow meaning in tax law and requires a first-degree nexus between the income and the lending business. Income that is merely “attributable to” or indirectly connected with the business cannot qualify.

In its detailed reasoning, the Court rejected NCDC’s argument that all its income streams should be treated as part of an “integrated business,” stating that fiscal incentives must be construed strictly. The Court noted that dividends from redeemable preference shares, interest earned on short-term bank deposits, and service charges for administering Sugar Development Fund loans do not satisfy the statutory test.

Each of these receipts, the Court held, originates from independent and distinct sources, investments, temporary parking of surplus funds, and agency services for the Government, not from the corporation’s own long-term lending operations.

Since Section 36(1)(viii) expressly defines “long-term finance” as loans or advances repayable over a period of five years or more, the deduction cannot be expanded to cover income streams that do not arise from lending the corporation’s own funds.

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Section 36(1)(viii) reads that “in respect of any special reserve created and maintained by a specified entity, an amount not exceeding twenty per cent of the profits derived from eligible business computed under the head "Profits and gains of business or profession" (before making any deduction under this clause) carried to such reserve account:

Provided that where the aggregate of the amounts carried to such reserve account from time to time exceeds twice the amount of the paid up share capital and of the general reserves of the specified entity, no allowance under this clause shall be made in respect of such excess.”

The apex court noted important precedents such as Sterling Foods, Pandian Chemicals, and the Constitution Bench ruling in Bacha F. Guzdar. It was observed that when the legislature uses the expression “derived from,” it intends to restrict the benefit to income that flows directly from the specified activity.

Even though some of NCDC’s disputed income streams were assessable as “business income,” the Court clarified that this classification does not automatically qualify them for the special deduction, which operates on a much narrower statutory plane.

The decision of the supreme court makes it clear that Section 36(1)(viii) is not a blanket concession for financial institutions but a targeted incentive limited to profits actually earned through long-term lending as defined in the Act.

JusticePamidighantam Sri Narasimha and Justice Atul S. Chandurkar, by upholding the findings of the Assessing Officer, CIT(A), ITAT, and the Delhi High Court, the Supreme Court dismissed the appeals and confirmed that the legislative intent behind the 1995 amendment must be honoured.

According to the court, only profits with a direct and proximate nexus to long-term finance will be eligible for the deduction and no other ancillary or incidental activities cannot be claimed.

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