2008 (12) TMI 27 - AAR - Income Tax

Swapping premium - applicant, PSU is registered as Non-Banking Financial Company by RBI to provide long-term finance to State Electricity Boards held that swapping premium is the profit derived from the business of providing long-term finance, hence merits allowance of the deduction u/s 36(1)(viii) - swapping premium can be termed as compensation for the breach of contract - disclosure of swapping premium in Balance Sheet as other income instead of business income is immaterial

Issues Involved:
1. Eligibility of the applicant for deduction under section 36(1)(viii) of the Income Tax Act.
2. Nature of the 'swapping premium' and its qualification for deduction under section 36(1)(viii).

Issue-wise Detailed Analysis:

1. Eligibility of the Applicant for Deduction under Section 36(1)(viii):

Background and Legislative History:
The applicant, a Government company, sought advance ruling on whether the swapping premium qualifies as profit derived from the business of providing long-term finance and if it is eligible for deduction under section 36(1)(viii). The section allows a deduction of up to 40% of profits derived from providing long-term finance for industrial, agricultural, or infrastructural development, provided it is carried to a special reserve.

Eligibility Criteria:
- The applicant is a public sector undertaking registered as a Non-Banking Financial Company by the Reserve Bank of India.
- The company's main objective is to provide long-term finance for electricity projects, contributing to industrial, agricultural, and infrastructural development.
- The applicant has consistently been allowed deductions under section 36(1)(viii) in the past, confirming its eligibility.

Assessment Year in Question:
For the assessment year 2004-05, the applicant claimed a deduction on Rs.170.58 crores received as swapping premium. The AO restricted the deduction, arguing that the swapping premium does not have a direct and immediate nexus with the business of providing long-term finance.

Legal Definitions and Interpretations:
- Section 36(1)(viii) defines eligible entities and the nature of long-term finance.
- The applicant qualifies as a financial corporation since it is a public company and a Government company under the Companies Act, 1956.
- The applicant's business of providing long-term finance for rural electrification aligns with the objectives of industrial and agricultural development.

Conclusion:
The applicant is an eligible entity for deduction under section 36(1)(viii) as it provides long-term finance for industrial and agricultural development, and its status as a financial corporation is undisputed.

2. Nature of the 'Swapping Premium' and Its Qualification for Deduction:

Applicant's Argument:
- The swapping premium is derived from the business of providing long-term finance.
- It is a result of rescheduling interest rates on existing long-term loans due to market conditions.
- The premium has a direct and immediate nexus with the business operations.

Revenue's Argument:
- The swapping premium is a one-time receipt for converting loans and does not have a direct nexus with long-term finance.
- It is considered as 'other income' and not income from lending operations.
- The premium is compensation for renegotiation, not derived directly from the business of long-term finance.

Judicial Precedents:
- The term 'derived from' requires a direct nexus between the income and the source.
- The Supreme Court's rulings in cases like CIT vs. Sterling Foods and CIT vs. Raja Bahadur Kamakhya Narain Singh emphasize the need for a direct connection between the income and the business operations.

Analysis:
- The swapping premium is essentially discounted interest, originating from the long-term finance initially advanced.
- It is a compensation for agreeing to lower interest rates, maintaining the direct nexus with the business of providing long-term finance.
- The business of providing long-term finance is the immediate and effective source of the swapping premium.

Conclusion:
The swapping premium qualifies as profit derived from the business of providing long-term finance and is eligible for deduction under section 36(1)(viii). The ruling answers both questions in the affirmative, allowing the applicant the claimed deduction.

Final Ruling:
The Authority for Advance Rulings ruled that the applicant is eligible for the deduction under section 36(1)(viii) for the swapping premium received, answering both questions in favor of the applicant.

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