All business Income not qualify for deduction u/s 36(1)(viii) unless derived from long-term finance

Even if a receipt is classified as Business Income u/s 28, it does not automatically qualify for the special deduction u/s 36(1)(viii) unless it is derived from the specific activity of long-term finance.

In a recent judgment, Hon’ble Supreme Court has held that under section 36(1)(viii) of the Income Tax Act, a vital judicial distinction exists between the general genus of “Business Income” and the specific species of “profits derived from the business of providing long-term finance.”

ABCAUS Case Law Citation:
4923 (2025) (12) abcaus.in SC

In the instant case the issue to be decided was as to whether the appellant assessee was entitled to deductions under Section 36(1)(viii) of the Income Tax Act, 1961 in respect of three specific heads of income, being, (i) Dividend income on investments in shares, (ii) Interest earned on short-term deposits and with banks, and (iii) Service charges received for monitoring Sugar Development Fund loans.

In other words, whether said receipts qualify as “profits derived from the business of providing long-term finance” for industrial or agricultural development, or whether they are merely attributable to business activities falling outside the strict scope of eligibility for the statutory deduction.

The appellant was a statutory cooperative corporation mandated to advance initiatives for the production, processing, and marketing of agricultural produce and notified commodities in accordance with cooperative principles.

First, the CIT(A), secondly ITAT and lastly the High Court had upheld the disallowances made by the Assessing Officer (AO) relying heavily on the legislative intent and the definition of “long-term finance” in the Explanation to Section 36(1)(viii) of the Act.

The Hon’ble Supreme Court noted that Explanation to the section 36(1)(viii) defines “long-term finance” to mean any loan or advance where the terms provide for repayment along with interest during a period of not less than five years.

The Hon’ble Supreme Court noted that before amendment of 1995, the provision allowed deductions based on the “total income” of the corporation. Parliament noticed that financial corporations were diversifying into activities unrelated to agricultural financing but were still claiming tax benefits on their entire profit. The amendment was introduced to fix this “mischief” by ensuring that the deduction is restricted only to profits that come directly from the core activity of providing long-term credit.

The Hon’ble Supreme Court opined that 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. The Apex 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.

The Hon’ble Supreme Court observed that in the light of the legal principles established by the judicial precedents set a strict threshold for eligibility. First, the phrase “derived from” must be interpreted much more narrowly than the phrase “attributable to”. Second, it requires a direct or immediate nexus with the specific business activity, for if the income is even a “step removed” from the business in question, that nexus is snapped. Third, the deduction is limited to income from “first degree” sources and explicitly keeps out “ancillary profits” of the undertaking. Finally, this Court refuses to accept the argument that appellants business should be treated as a “single, indivisible and integrated activity” in order to expand the scope of a specific deduction.

With respect to dividend income the Hon’ble Supreme Court held that dividends are a return on investment dependent on the profitability of the investee company, and this distinction is fundamental to the genealogy of the income. The immediate source of dividend income is the investment in share capital and 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, dividend income does not qualify as profits derived from business of providing long-term finance.

With respect to interest on short-term deposits in banks, the Hon’ble Supreme Court held that even if a receipt is classified as “Business Income” under Section 28, it does not automatically qualify for the special deduction unless it satisfies the strict rigor of being “derived from” the specific activity of long-term finance defined in the Explanation.

The Hon’ble Supreme Court noted that the legislative intent was to incentivize the specific act of providing long-term credit, not the passive investment of surplus capital. If we were to accept the appellant’s argument, it would create a perverse incentive for financial corporations to park funds in safe, short term investments and claim the 40% deduction, rather than fulfilling their statutory mandate of providing high-risk long-term credit to the agricultural sector. Consequently, interest earned from bank deposits fails this test as it is, at best, attributable to the business, but certainly not derived from the activity of providing long-term finance.

With respect to service Charge on Sugar Development Fund loans, the Hon’ble Supreme Court held that receipts in question were in the nature of service charges paid by the Government for the administrative tasks of monitoring and disbursement. The proximate source of this income was the agency agreement with the Government, not the lending activity itself. It could not be equated with “profits derived from the business of providing long-term finance,” which implies the deployment of the corporation’s own funds and the earning of interest thereon. Consequently, this income stream was rightly excluded from the deduction.

The Hon’ble Supreme Court held that upon a cumulative assessment of the statutory scheme and the judicial precedents the claim of the appellant-assessee was not correct in law.

The Hon’ble Supreme Court opined that Section 36(1)(viii) of the Act is not a general exemption granted to a statutory corporation for all its business activities, rather, it is a specific incentive attached strictly to the profits arising from a defined activity namely, the provision of long-term finance.

The Hon’ble Supreme Court opined that in the Explanation, the Legislature has explicitly excluded ancillary, incidental, or second-degree sources of income. The appellant’s contention that its functions constitute a “single, indivisible integrated activity” must yield to the specific statutory mandate. When a fiscal statute grants a benefit based on a specific source, the concept of an integrated business cannot be utilized to expand the scope of that benefit to cover distinct streams of income that do not strictly satisfy the statutory definition.

Accordingly, the appeal(s) were dismissed.

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