SC: U/s 37(1), Income Tax Act source of funds from which expenditure is made is not relevant

The Hon’ble Supreme Court, on 11th September 2020, in the matter of National Co-operative Development Corporation v. Commissioner of Income Tax, Delhi-Vpronounced that the expenditure incurred in the course of business and for the ‘purpose of business’, would naturally be an allowable deduction under Section 37(1) of the Income Tax Act. The source of funds from which the expenditure is made is not relevant.

The Hon’ble Supreme Court observed that:

Whether interest on loans or dividends would fall under the head of ‘Income from other sources’ under Section 56 of the Income Tax Act, 1961 or would it amount to income from ‘Profits and gains of business or profession’ under head ‘D’ of Section 14 of the Income Tax Act. In terms of Section 28 of the Income Tax Act such profits and gains of any business or profession under the head ‘D’ of Section 14 of the Income Tax Act would be chargeable to income tax if the income is relatable to profits and gains of business or profession carried out by the assessee at any time during the previous year [Clause (i) of Section 28 of the IT Act]. Section 56 of the Income Tax Act is in the nature of a residuary clause, i.e., if the income of every kind which is not to be excluded from total income under the Income Tax Act would be chargeable under this head if it is not chargeable under Section 14 heads ‘A’ to ‘E’. (Para 21)

To decide the question as to whether a particular source of income is business income, one would have to look to the notions of what is the business activity. The activity from which the income is derived must have a set purpose. (Para 23)

There can be an amount treated as a capital receipt while the same amount expended may be a revenue expenditure. (Para 26)

If an assessee carries on business, all that is required to be seen is whether any outlay constitutes an expenditure ‘for the purpose of business’ as used in Section 37(1) of the Income Tax Act. Once that requirement is satisfied, the expenditure incurred in the course of business and for the ‘purpose of business’, would naturally be an allowable deduction under Section 37(1) of the Income Tax Act. The source of funds from which the expenditure is made is not relevant. It is also not really relevant as to whether the expenditure is incurred out of the corpus funds or from the interest income earned. (Para 30)

Merely because the grants benefit a third party, it would not render the disbursement as ‘application of income’ and not expenditure. (Para 31)

If a portion of income arising out of a corpus held by the assessee consumed for the purposes of meeting some recurring expenditure arising out of an obligation imposed on the assessee by a contract or by statute or by own volition or by the law of the land and if the income before it reaches the hands of the assessee is already diverted away by a superior title the portion passed or liable to be passed on is not the income of the assessee. The test, thus, is what amounts to application of income and what is the diversion by overriding title. The principle, in a sense would apply, if the Act or the Rules framed thereunder or other binding directions bind the institution to spend the interest income on disbursal of grants. (Para 35)

The scheme of the Income Tax Act requires the determination of ‘real income’ on the basis of ordinary commercial principles of accountancy. To determine the ‘real income’, permissible expenses are required to be set off. (Para 38)

In the case of a business, the profits must be arrived at on ordinary commercial principles. The scheme of the Income Tax Act requires the determination of ‘real income’ on the basis of ordinary commercial principles of accountancy. To determine the ‘real income’, permissible expenses are required to be set off. (Para 38)

There is a clear distinction between deductions made for ascertaining real profits and thereafter distributions made out of profits. The distribution would be application of income. There is also a distinction between real profits ascertained on commercial principles and profits fixed by a statute for a specific purpose. Income tax is a tax on real income. (Para 38)

Copy of judgement: Judgement_11-Sep-2020

-Adv. Tushar Kaushik

Leave a Reply

Your email address will not be published. Required fields are marked *