Ring‑fencing Section 36(1)(viii): Strict “Derived From” Test for Long‑Term Finance Deductions in National Cooperative Development Corporation v. Assistant Commissioner of Income Tax

I. Introduction

The Supreme Court of India’s decision in National Cooperative Development Corporation v. Assistant Commissioner of Income Tax, 2025 INSC 1414, is a significant tax ruling on the scope of deductions under Section 36(1)(viii) of the Income Tax Act, 1961 (“the Act”). The Court has firmly “ring‑fenced” the deduction by insisting on a strict, first‑degree nexus between the eligible profits and the business of providing long‑term finance, as narrowly defined by statute after the Finance Act, 1995.

The appellant, the National Cooperative Development Corporation (NCDC), is a statutory corporation tasked with promoting and funding cooperative development in agriculture and allied sectors. It claimed a deduction under Section 36(1)(viii) in respect of three heads of income:

1. Dividend income from investments in redeemable preference shares;
2. Interest on short‑term deposits with banks; and
3. Service charges for monitoring loans made out of the Sugar Development Fund (“SDF”), where NCDC acted as a nodal agency for the Central Government.

The key legal issue was whether these receipts constituted “profits derived from the business of providing long‑term finance” so as to qualify for the special deduction available to approved financial corporations. The Supreme Court, affirming the Assessing Officer (AO), CIT(A), ITAT and the Delhi High Court, held that they did not.

In doing so, the Court:

• Re‑emphasised the narrow meaning of the expression “derived from” in fiscal statutes;
• Clarified that the 1995 amendment to Section 36(1)(viii) was intended to restrict, not expand, the deduction;
• Rejected the argument that NCDC’s activities constituted a “single, indivisible integrated business” for the purpose of this deduction; and
• Drew a sharp line between “business income” in general and the specific, incentivised category of profits derived from providing long‑term finance.

II. Summary of the Judgment

A. Parties and Procedural History

The appellant, NCDC, is a statutory corporation established to promote cooperative development in agriculture and related sectors. It provides finance, among other functions, and for the relevant assessment years, claimed a deduction under Section 36(1)(viii) in respect of the three categories of income mentioned above.

The Assessing Officer held that:

• Dividend on redeemable preference shares was return on share capital, not on long‑term loans;
• Interest on bank deposits arose from parking of surplus funds, not from the core activity of long‑term lending; and
• Service charges on SDF loans were agency fees for administering Government funds, not profits from deploying NCDC’s own long‑term finance.

These disallowances were upheld by:

• CIT(A) (order dated 15.11.2007);
• ITAT; and
• Delhi High Court (judgment dated 28.11.2011 in multiple ITAs, with further orders dated 10.04.2012 and 02.11.2012).

NCDC appealed to the Supreme Court. The Court heard arguments from counsel for both sides and ultimately dismissed all the appeals, affirming the restrictive interpretation of Section 36(1)(viii).

B. Core Holding

The Supreme Court held that:

• The 1995 amendment to Section 36(1)(viii) reflects a deliberate legislative intent to confine the deduction to profits directly and proximately derived from the business of providing long‑term finance.
• The phrase “derived from” requires a first‑degree nexus between the income and the defined activity of granting long‑term loans or advances (repayable over at least five years with interest).
• Income that is merely “attributable to” or incidental to the business, or that arises one step removed from the long‑term lending activity, does not qualify.
• Specifically:
  • Dividend on redeemable preference shares is income derived from an investment in share capital, not from long‑term finance by way of loans or advances.
  • Interest on short‑term bank deposits stems from the temporary parking of surplus funds and is, at best, attributable to the business, but not derived from the act of long‑term lending.
  • Service charges on SDF loans are agency fees for administering Government funds; the proximate source is the agency arrangement, not any long‑term finance provided by NCDC from its own resources.

Therefore, none of the three income streams were held to be “profits derived from the business of providing long‑term finance” and no deduction under Section 36(1)(viii) was available.

III. Statutory Context and Legislative Objective

A. Structure of Section 36(1)(viii)

Section 36(1)(viii) provides a deduction for specified financial corporations in respect of a special reserve created out of profits from long‑term financing. The key components as relevant here are:

• The assessee must be a financial corporation engaged in providing long‑term finance for specified developmental purposes (industrial, agricultural, infrastructure, etc.).
• The deduction is capped at 40% of the profits derived from such business of providing long‑term finance.
• Explanation (e) defines “long‑term finance” as “any loan or advance where the terms under which money are loaned or advanced provide for repayment along with interest thereof during a period of not less than five years”.

Thus, the deduction depends on three cumulative conditions:

1. The assessee must be an eligible financial corporation;
2. It must be engaged in the business of providing long‑term finance; and
3. The profits must be “derived from such business”, where “long‑term finance” is narrowly defined as loans/advances of at least five years with interest.

B. The 1995 Finance Act Amendment: From “Total Income” to “Profits Derived From”

Before the Finance Act, 1995, the deduction under Section 36(1)(viii) was computed with reference to “total income” of the corporation. Financial entities that had diversified into other activities were still claiming the deduction on their entire profits, including income unrelated to long‑term finance.

The Memorandum explaining the Finance Bill, 1995, quoted at length in the judgment, clearly identifies this as the “mischief” to be remedied. It states that:

• The deduction was being claimed even in respect of income from other activities or from sources outside the specified business;
• There was “no justification” for allowing the deduction with reference to such income; and
• It was therefore proposed to limit the deduction to income “derived from providing long term finance for the activities specified in Section 36(1)(viii)”, thereby taking out of the deduction income from other business activities or non‑business sources.

The Supreme Court relies heavily on this legislative history to hold that:

• The 1995 amendment reflects a conscious and deliberate move to tighten the scope of the deduction;
• The phrase “profits derived from such business of providing long‑term finance”, in conjunction with the definition of “long‑term finance”, must be read as a ring‑fencing mechanism that excludes ancillary, incidental or second‑degree sources of income;
• Any interpretation that effectively restores the pre‑amendment position (e.g. treating “all income of a statutory corporation” as eligible) would render the legislative change otiose.

This sets the stage for the Court’s stringent reading of the phrase “derived from”.

IV. Interpretation of “Derived From”: Precedents and Legal Reasoning

A. “Derived From” vs “Attributable To”: Cambay Electric and the Narrow Construction

The Court reiterates a well‑settled principle: the expression “derived from” is narrower than “attributable to”. This distinction was clearly drawn in Cambay Electric Supply Industrial Co. Ltd. v. CIT, (1978) 2 SCC 644, where:

• The Supreme Court noted that “attributable to” has a wider import than “derived from”;
• Had the legislature used “derived from” instead of “attributable to” in that context, the assessee’s claim would have faced a higher hurdle;
• The choice of words was held to be deliberate and indicative of legislative intent.

Applying this principle, the present judgment holds:

• Where the legislature uses “derived from”, it intends strict, proximate causation—the income must have a direct and immediate nexus with the specified activity;
• “Attributable to” would allow inclusion of more remote or indirect profits; “derived from” does not permit such breadth.

B. “First‑Degree Nexus” and Exclusion of Ancillary Profits: Sterling Foods, Pandian Chemicals, Liberty India

The Court aligns this case with a line of precedent interpreting similar “derived from” language in other deduction provisions:

• CIT v. Sterling Foods, (1999) 4 SCC 98 – profits from sale of import entitlements were held not to be “derived from” the industrial undertaking, as they were a step removed from the manufacturing activity.
• Pandian Chemicals Ltd. v. CIT, (2003) 5 SCC 590 – interest on deposits with the Electricity Board, though connected with the business, was held not to be “derived from” the industrial undertaking.
• Liberty India v. CIT, (2009) 9 SCC 328 – DEPB and duty drawback benefits were found not to be “profits derived from” the eligible business; they were instead post‑manufacture incentives, thus ancillary rather than core profits.

From these authorities, the Court extracts and applies the following principles:

1. The expression “derived from” requires a direct and proximate connection with the specified source.
2. Where income is even a “step removed” – i.e., if it flows from a different, though related, source – the link is broken for the purpose of such deductions.
3. Deductions using “derived from” language are confined to “first‑degree” income sources and expressly exclude ancillary, incidental or second‑degree profits.

The Court then applies these principles to Section 36(1)(viii), holding that the “first‑degree” source must be the act of granting long‑term loans or advances. If the immediate source of the income is something else (a share investment, a bank deposit, an agency contract), the “derived from” requirement is not met.

C. Distinguishing Meghalaya Steels: Subsidies vs Long‑Term Finance Profits

NCDC relied on CIT v. Meghalaya Steels Ltd., (2016) 6 SCC 747, where the Court had treated various government subsidies (transport, power, insurance) as profits “derived from” the industrial undertaking for the purpose of Section 80‑IB. The argument was that so long as income flows from the business and is taxable under Section 28, it should be treated as “derived from” that business.

The Supreme Court rejects this reliance for several reasons:

• Different statutory language: Section 80‑IB deals with profits from “any business” of an industrial undertaking; Section 36(1)(viii), by contrast, is confined to “profits derived from such business of providing long‑term finance”.
• Nature of the receipts: In Meghalaya Steels, the subsidies were reimbursements of actual operational costs of running the factory (transport, power, insurance) and thus had a direct impact on the profitability of the core business itself.
• No dilution of the “derived from” test: The Court notes that Meghalaya Steels did not relax the “derived from” standard; it merely applied that test to a specific fact pattern involving cost‑reimbursement subsidies.

In the present case:

• Section 36(1)(viii) is far narrower in both wording and design than Section 80‑IB;
• The disputed receipts (dividends, bank interest, service fees) are not reimbursements of running costs of long‑term finance; they arise from distinct economic activities;
• Hence, Meghalaya Steels cannot be used to enlarge the ambit of Section 36(1)(viii).

D. Rejection of “Single, Indivisible Integrated Activity”: Orissa State Warehousing

NCDC attempted to argue that all its activities—lending, investing, acting as nodal agency—formed a single, integrated business, and therefore all receipts should be treated as part of the same stream of profits for deduction purposes.

The Supreme Court rejects this “integrated activity” theory by relying on Orissa State Warehousing Corporation v. CIT, (1999) 4 SCC 197:

• In that case, interest income earned by a warehousing corporation was held not to be exempt under Section 10(29), despite arguments that it was part of its integrated warehousing business.
• The Court stressed that fiscal statutes must be interpreted strictly, based on the language actually used; courts must not rewrite or expand exemptions by invoking the idea of an integrated business.

Applying this reasoning, the present judgment holds:

• Section 36(1)(viii) is a specific, source‑based incentive—only profits from long‑term finance qualify;
• The fact that NCDC is a statutory corporation with a broad developmental mandate does not mean that all its income streams automatically fall within this provision;
• The “single, indivisible activity” argument cannot override the precise statutory formula based on the source and character of income.

E. Genus vs Species: “Business Income” vs Deductible Profits

A central conceptual contribution of the judgment is the distinction between:

• The broad category (genus) of “business income” under Section 28; and
• The specific (species) of “profits derived from the business of providing long‑term finance” that qualifies for deduction under Section 36(1)(viii).

The Court emphasises:

• An income may indeed be “business income” (and thus not “income from other sources”) yet still fail to satisfy the additional, stricter conditions of a special deduction provision such as Section 36(1)(viii).
• Being taxable under the head “Profits and gains of business or profession” is a necessary but not sufficient condition for the deduction.
• To qualify, the profits must be both:
  1. Business income; and
  2. Directly derived from the defined long‑term finance activity.

This distinction becomes especially important when the Court examines NCDC’s reliance on its earlier victory in National Co-operative Development Corporation v. CIT, (2021) 11 SCC 357.

F. The Earlier NCDC Case (2021) and Its Limited Relevance

NCDC cited the 2021 Supreme Court decision where interest on short‑term deposits of its surplus funds was characterised as business income rather than “income from other sources”, thus allowing it to claim corresponding business expenditure deductions under Section 37.

The Court explains why that decision is of limited relevance here:

• The issue in 2021 was classification of interest income (business vs other sources), not eligibility for a special deduction under Section 36(1)(viii).
• The assessment years in that case (1976–1984) predated the 1995 amendment that significantly tightened Section 36(1)(viii).
• That decision did not consider the post‑1995 requirement that profits be “derived from” long‑term finance as precisely defined.

The Court underscores that:

• Even though interest on short‑term deposits is business income, it does not automatically constitute “profits derived from the business of providing long‑term finance”;
• The 1995 amendment was precisely intended to prevent financial corporations from claiming broad, non‑core incomes under Section 36(1)(viii);
• It would be inconsistent with legislative intent to extend the special deduction to such passive, short‑term investment income merely because it qualifies as business income.

V. Application to the Three Disputed Income Streams

A. Dividend on Redeemable Preference Shares

1. NCDC’s Argument

NCDC argued that redeemable preference shares were, in substance, akin to loans:

• They carried a fixed dividend rate;
• They had a scheduled redemption, reflecting capital repayment; and
• Economically, they resembled long‑term debt instruments used to fund agricultural cooperatives.

On this basis, NCDC contended that dividend income on such investments should be treated as profits derived from long‑term finance.

2. Supreme Court’s Response

The Court rejects this argument by drawing a sharp distinction between:

• Loans or advances (debt), and
• Share capital (equity, including preference shares).

Key points:

• Under Section 85 of the Companies Act, 1956, preference shares form part of the share capital of a company; they are not loans.
• The Court relies on the Constitution Bench decision in Bacha F. Guzdar v. CIT, (1954) 2 SCC 563, which held:
  • Dividend is income derived from the shareholder’s contractual relationship with the company;
  • It is not derived from the underlying assets (such as agricultural land) or the nature of the company’s business;
  • The “immediate source” of dividend is the shareholding, not the business or property in which the company invests.
• The Court also notes that a creditor (lender) and a shareholder are fundamentally different:
  • A creditor has a right to sue for repayment of debt and enforce security;
  • A shareholder generally cannot sue for repayment of share capital, except in limited circumstances such as winding‑up;
  • Dividend is not interest on debt, but a distribution of profit on capital.

Consequently:

• The immediate source of dividend is the investment in share capital, not any long‑term loan;
• “Long‑term finance” in Section 36(1)(viii) is explicitly confined to loans or advances repayable with interest over at least five years;
• Extending this to dividends on shares would go against the plain statutory language and the legislatively defined scope of the incentive.

The Court therefore holds that dividend income on redeemable preference shares does not qualify as profits derived from the business of providing long‑term finance.

B. Interest on Short‑Term Bank Deposits

1. NCDC’s Argument

NCDC contended that:

• Its funds, pending deployment in long‑term loans, were temporarily parked in short‑term bank deposits;
• Earning interest on such parked funds was integral to and interlinked with its business of long‑term financing;
• The Supreme Court in the earlier 2021 NCDC decision had recognised such interest as business income and characterised its operations as a “single, indivisible integrated activity”.

On this basis, it argued that interest from these deposits should be treated as derived from the business of providing long‑term finance.

2. Supreme Court’s Response

The Court acknowledges that:

• Interest on short‑term deposits may indeed be business income (and not income from other sources); but
• The classification as business income does not automatically entitle it to the special deduction under Section 36(1)(viii).

Applying the strict “derived from” test:

• The immediate source of this income is the bank deposit itself, not the act of making long‑term loans or advances.
• This income arises from a passive investment of surplus funds, rather than from the core activity of extending long‑term credit.
• Therefore, the interest is at best “attributable to” or incidental to the business, but not derived from the provision of long‑term finance in the statutory sense.

Further, from a policy perspective:

• The legislative intent behind Section 36(1)(viii) is to incentivise high‑risk, long‑term development lending, not the conservative parking of surplus funds.
• If such passive income were covered, it would create a perverse incentive to prefer short‑term, low‑risk bank deposits while still enjoying the deduction meant for long‑term financing.

Accordingly, interest on short‑term bank deposits is held ineligible for deduction under Section 36(1)(viii).

C. Service Charges on Sugar Development Fund (SDF) Loans

1. NCDC’s Argument

For SDF loans, NCDC functioned as a nodal agency of the Central Government, receiving service charges for monitoring and administering loans advanced out of the Sugar Development Fund.

NCDC argued that:

• This function formed part of its statutory mandate of promoting cooperative and agricultural development;
• The SDF loans were, in effect, long‑term finance facilities that it helped to implement;
• Therefore, service charges earned in this context should be treated as profits derived from the business of providing long‑term finance.

2. Supreme Court’s Response

The Court focuses on the proximate source and the economic character of the income:

• The corpus of the SDF loans belonged entirely to the Government of India.
• NCDC did not deploy its own funds and bore no lending risk; it merely performed an administrative/agency function.
• The income in question consisted of service charges or agency fees paid by the Government for these administrative tasks.

On that basis:

• The immediate and proximate source of the income is the agency arrangement (contract with the Government), not the provision of long‑term finance from NCDC’s own resources.
• Section 36(1)(viii) presupposes that the financial corporation itself “provides” the long‑term finance, using its own capital and earning interest thereon.
• A pure agency commission, earned without deployment of the corporation’s own long‑term funds, falls outside the ring‑fenced scope of the deduction.

The Court therefore concludes that service charges on SDF loans are also not eligible for deduction under Section 36(1)(viii).

VI. Complex Concepts Simplified

A. “Derived From” vs “Attributable To”

In simple terms:

• “Derived from” = the income must come directly and immediately from the specified activity. Think of it as the first link in the chain.
• “Attributable to” = the income may arise from a wider set of related activities, including indirect or secondary effects. This allows for more remote links in the chain.

The Supreme Court holds that when Parliament uses “derived from”, courts must insist on a direct, first‑degree connection. If the income arises only after an extra step—such as investing surplus funds, entering into a separate agency arrangement, or holding shares in a company—then it is usually not “derived from” the original business for this kind of deduction.

B. “Ring‑Fencing” of Tax Incentives

“Ring‑fencing” means limiting a tax benefit to a clearly defined, narrow set of income or activities, and excluding everything else. Here:

• The deduction is ring‑fenced around:
  • Long‑term finance (loans/advances of at least five years, bearing interest);
  • For specified purposes (industrial, agricultural, infrastructure, etc.);
  • Profits directly derived from such financing.
• Income arising from:
  • Equity investments (dividends),
  • Short‑term deposits (interest),
  • Agency or service roles (fees),
  is kept outside the ring.

C. Genus vs Species: Why “Business Income” Is Not Enough

Think of all income under the head “Profits and gains of business or profession” as a large family (genus). Within that family are smaller, specially treated groups (species) that receive particular tax benefits.

• “Business income” = large category; many types of receipts qualify here.
• “Profits derived from the business of providing long‑term finance” = small, specially favoured subset; only certain business incomes qualify.

The Court makes clear that:

• Being part of the larger family (business income) is necessary but not sufficient for the special benefit;
• The receipt must also have the right source and character (first‑degree link to long‑term loans/advances) to fall into the favoured subset.

D. Loans vs Redeemable Preference Shares

While redeemable preference shares may economically resemble loans in some respects, in corporate law they are:

• Share capital, not debt;
• They confer shareholder status, not creditor status;
• Dividends depend on company profits and board decisions, unlike mandatory interest on loans;
• Redemption is typically subject to statutory and contractual conditions, and shareholders cannot usually force repayment as a creditor can.

For Section 36(1)(viii), “long‑term finance” is restricted to “loan or advance”. The Court declines to treat preference share investments as loans by “substance over form” when the statute itself uses precise, debt‑based language.

E. Nodal Agency vs Lender

When an entity acts as a nodal agency:

• It administers funds belonging to someone else (e.g., the Government),
• It may disburse, monitor, and collect repayments,
• It typically earns service charges or commissions.

This is different from being a lender:

• A lender deploys its own funds (or funds for which it bears risk),
• Earns interest,
• Assumes the risk of default.

Section 36(1)(viii) incentivises the latter (the lender role), not the former (agency role). The Court’s approach underscores that risk‑bearing and deployment of the corporation’s own long‑term capital are central to the deduction.

VII. Impact and Future Implications

A. For Financial Corporations and Development Institutions

This judgment has immediate consequences for:

• Statutory financial corporations and development institutions;
• Public sector financial entities engaged in long‑term development lending;
• Any entity claiming deduction under Section 36(1)(viii).

Key practical implications:

• They must segregate and track income streams with precision:
  • Interest on qualifying long‑term loans and advances; vs
  • Interest on short‑term deposits, dividends on investments, commissions, guarantees, fees, and other non‑core income.
• Only the first category—interest or other profits directly from long‑term lending—will typically qualify for the deduction.
• Accounting and tax reporting systems must be designed to differentiate between:
  • Profits derived from long‑term finance; and
  • Profits merely attributable to or connected with the broader financing business.

B. On Tax Planning and Structuring

The decision discourages attempts to expand the deduction through:

• Re‑labelling or re‑characterising investments (e.g., calling preference share investments “quasi‑loans”);
• Relying on the concept of a “single, integrated business” to pull diverse receipts under the umbrella of Section 36(1)(viii);
• Using temporary financial placements (short‑term deposits, money‑market instruments) as vehicles for enjoying long‑term finance benefits.

Tax planning strategies must now assume:

• A narrow, source‑specific reading of Section 36(1)(viii);
• Heightened scrutiny of whether a receipt is truly and directly connected to qualifying long‑term finance.

C. Doctrinal Significance

Beyond Section 36(1)(viii), the judgment reinforces several broader doctrinal points in Indian tax law:

• Consistency in the narrow interpretation of “derived from” across different provisions (80HHC, 80‑IB, etc.).
• Strict construction of fiscal incentives and exemptions: courts will not enlarge them beyond clear statutory language, especially by reference to purpose or integrated business theory.
• Recognition that legislative amendments matter: pre‑amendment case law (such as the earlier NCDC decision) cannot be mechanically applied where the statute has been consciously tightened.
• Endorsement of the genus–species approach: special deduction provisions operate within, but significantly narrower than, the broader head of business income.

D. Potential Litigation and Clarifications

In future assessment and appellate proceedings, key disputes are likely to revolve around:

• Characterisation of specific financial products: whether innovative or hybrid instruments qualify as “loans or advances” for long‑term finance;
• Boundary‑line income: fees (e.g., processing fees, restructuring fees, commitment charges) that may arguably arise directly from long‑term lending as opposed to being ancillary;
• Determining when an entity is acting as principal (lender) versus agent (nodal agency) for third‑party funds.

However, for the particular categories examined in this judgment—dividends on share capital, interest on short‑term deposits, and government agency fees—the law now appears well settled: they do not qualify for Section 36(1)(viii) deduction.

VIII. Conclusion

The Supreme Court’s decision in National Cooperative Development Corporation v. ACIT marks an important restatement and consolidation of principles governing tax incentives based on the expression “profits derived from”.

Central takeaways include:

• Section 36(1)(viii) is not a blanket concession for all profits of a statutory financial corporation. It is a carefully targeted incentive restricted to profits directly derived from qualifying long‑term finance.
• The 1995 amendment, supported by the Finance Bill Memorandum, was intended to ring‑fence this benefit, cutting out diversified and ancillary income streams.
• The phrase “derived from” demands a first‑degree, proximate nexus with the long‑term lending activity, as clarified in Cambay Electric, Sterling Foods, Pandian Chemicals, and Liberty India.
• Attempts to expand the deduction by:
  • Invoking the “integrated business” theory (Orissa State Warehousing),
  • Recharacterising share capital as quasi‑debt (Bacha F. Guzdar), or
  • Relying on pre‑amendment case law or different provisions (Meghalaya Steels, earlier NCDC case),
  were all firmly rejected.
• For the three specific heads of income at issue—dividends on redeemable preference shares, interest on short‑term bank deposits, and service charges for acting as a nodal agency under the Sugar Development Fund—the Court held that none are profits derived from the business of providing long‑term finance. The appeals were accordingly dismissed.

In the broader legal context, the judgment reinforces the trend towards precise, text‑driven interpretation of fiscal incentives and underscores that special deductions must be construed narrowly, true to both their language and their legislative history. For taxpayers and advisors, it highlights the need for careful source‑based analysis of income streams before claiming benefits under Section 36(1)(viii) and similar provisions.