Dividend Income Not Eligible for Deduction Under Section 36(1)(viii)

Case Details: National Cooperative Development Corporation vs. Assistant Commissioner of Income-tax - [2025] 181 taxmann.com 333 (SC)

Judiciary and Counsel Details

Pamidighantam Sri Narasimha & Atul S. Chandurkar, JJ.

Facts of the Case

The assessee, National Cooperative Development Corporation (NCDC), a statutory corporation engaged in providing long-term finance for agricultural and industrial development, claimed deduction under section 36(1)(viii) of the Income-tax Act, 1961 in respect of:

(i) dividend income on investments in shares,

(ii) interest earned on short-term bank deposits, and

(iii) service charges received for monitoring loans under the Sugar Development Fund.

The Assessing Officer, during the scrutiny assessment, disallowed the claim, holding that the receipts lacked a direct nexus with the business of providing long-term finance as required under section 36(1)(viii).

Aggrieved, the assessee preferred appeals before the CIT(A), which were dismissed. The disallowances were confirmed by the Income Tax Appellate Tribunal and thereafter by the High Court. Aggrieved by the High Court’s judgment, the assessee filed appeals before the Supreme Court.

Supreme Court Held

The Supreme Court held that the phrase “derived from” signifies a strict, first-degree nexus. It connotes a requirement of a direct, first-degree nexus between the income and the specified business activity. It is judicially settled that “derived from” is narrower than “attributable to”.

Assessee contended that the substance of redeemable preference shares is effective loans, as the fixed redemption schedule and dividend rate assimilate them to the nature of debt. However, the AO drew attention to the admitted factual position that these receipts are “investments in agricultural-based societies by way of contribution to share capital”.

AO submitted that under Section 85 of the Companies Act, 1956, preference shares unequivocally remain share capital and cannot be treated as loans.

The Supreme Court held that dividends are a return on investment dependent on the profitability of the investee company, and that this distinction is fundamental to the income’s genealogy. There is a fundamental distinction between a shareholder and a creditor. The basic characteristic of a loan is that the person advancing the money has the right to sue to recover the debt.

In stark contrast, a redeemable preference shareholder cannot sue for the money due on the shares or claim a return of the share money as a matter of right, except in the specific eventuality of winding up.

This is also the reason SC holds that the immediate source of dividend income is the investment in share capital, not the business of providing loans. Since the statute specifically mandates ‘interest on loans’, extending this fiscal benefit to ‘dividends on shares’ would defy the legislative intent. Therefore, the Supreme Court held that dividend income does not qualify as profits derived from the business of providing long-term finance.

List of Cases Reviewed

National Co-operative Development Corporation vs. Assistant Commissioner of Income-tax, Circle 13(1) [2011] 16 taxmann.com 251 (Delhi)/[2012] 204 Taxman 6 (Delhi)/[2013] 356 ITR 184 (Delhi) (para 35) Affirmed
Cambay Electric Supply Industrial Co. Ltd. v. CIT [1978] 113 ITR 84 (SC) (para 14)
Orissa State Warehousing Corpn. v. CIT [1999] 153 CTR 177/237 ITR 589/103 Taxman 623 (SC) (para 18)
Mrs. Bacha F. Guzdar v. CIT [1955] 27 ITR 1 (SC) (para 21)
National Co-operative Development Corporation v. CIT, Delhi-V [2020] 119 taxmann.com 137/427 ITR 288/274 Taxman 187 (SC) (para 24) Followed.
CIT v. Meghalaya Steels Ltd. [2016] 67 taxmann.com 158/284 CTR 321/383 ITR 217/238 Taxman 559 (SC) (para 17) Distinguished.

List of Cases Referred to

Pandian Chemicals Ltd. v. CIT [2003] 183 CTR 99/262 ITR 278/129 Taxman 539 (SC) (para 13)
CIT v. Sterling Foods [1999] 153 CTR 439/237 ITR 579/104 Taxman 204 (SC) (para 13)
CIT v. Meghalaya Steels Ltd. [2016] 67 taxmann.com 158/284 CTR 321/383 ITR 217/238 Taxman 559 (SC) (para 13)
Liberty India v. CIT [2009] 225 CTR 233/317 ITR 218/183 Taxman 349 (SC) (para 13)
Cambay Electric Supply Industrial Co. Ltd. v. CIT [1978] 113 ITR 84 (SC) (para 14)
Orissa State Warehousing Corpn. v. CIT [1999] 153 CTR 177/237 ITR 589/103 Taxman 623 (SC) (para 18)
Mrs Bacha F. Guzdar v. CIT [1955] 27 ITR 1 (SC) (para 21)
National Co-operative Development Corporation v. CIT, Delhi-V [2020] 119 taxmann.com 137/427 ITR 288/274 Taxman 187 (SC) (para 24)
National Co-operative Development Corporation v. Asstt. CIT, Circle 13(1) [2011] 16 taxmann.com 251/[2013] 356 ITR 184/[2012] 204 Taxman 6 (Delhi) (para 35).