R U L I N G (By Mr. Rao Ranvijay Singh)

Transcription

1 BEFORE THE AUTHORITY FOR ADVANCE RULINGS (INCOME TAX) NEW DELHI ========== Monday, the 19th Day of December, 2008 P R E S E N T Mr. Justice P.V.Reddi (Chairman) Mr. A Sinha (Member) Mr. Rao Ranvijay Singh (Member) A.A.R. NO. 758 OF 2007 Name & address of the applicant Commissioner concerned Present for the Applicant Present for the Department M/s.Rural Electrification Corporation Ltd. Core-4, Scope Complex, 7 Lodhi Road, New Delhi Commissioner of Income Tax-(LTU), New Delhi Mr.Pradeep Dinodia, FCA Mr. D.S.Ahluwalia, GM, REC Mr. Rakesh Sareen, DGM (Finance)REC Mr. Murlidharan, CM(F&A), REC Mr.Pravin Rawal, Dy.Commissioner of Income-Tax (L.T.U.) R U L I N G (By Mr. Rao Ranvijay Singh) The applicant, a Government company, has filed an application before us under section 245Q(1) of the Income Tax Act, 1961 (in short the Act) in the prescribed Form No.34E i.e. the form prescribed for specified categories of resident applicants under section 245N(b)(iii) of the Act and has sought advance ruling in respect of the following two questions: - 1

2 i. Whether the swapping premium amounting to Rs.170,58,24,000/- is profit derived from the business of providing long-term finance (computed under the head Profits & Gains of Business or Profession before making any deduction under this clause) in terms of section 36(1)(viii) of the Income Tax Act, 1961 ii. Whether specified percentage thereof is eligible for deduction u/s 36(1)(viii) of the Income Tax Act in view of the fulfillment of condition for carrying this sum to the special reserve. 2. Briefly stated, the applicant, M/s. Rural Electrification Corporation Limited, a public sector undertaking, is reportedly registered as a Non-Banking Financial Company by Reserve Bank of India. The main objective of the applicant company is to provide longterm finance primarily to State Electricity Boards for the purpose of transmission, distribution and generation of electricity so that the society at large is benefited on road to industrial, agricultural and infrastructural development. As stated, they (the applicant) have been filing income tax returns right from the beginning and the Revenue had, all along in the past, allowed the deduction under section 36(1)(viii) of the Act after coming to the conclusion that the applicant, being an eligible business enterprise, had conformed to the ingredients required for allowing the deduction referred to above. In fact, Section 36(1)(viii) of the Act lays down that the deduction is available upto 40% (forty percent) of the profits derived from the business of providing long-term finance for industrial or agricultural development or the development of infrastructural facility in India. Since the applicant derived income from advancing long-term finance for the industrial or agricultural development or for the development of infrastructural facility in consonance with the 2

3 specified objectives, deduction under section 36(1)(viii) of the Act was claimed and the same was being allowed by the Revenue after due scrutiny. 3. In the assessment year (the year in question), the applicant credited an amount of Rs crores as swapping premium received and claimed deduction thereon under section 36(1)(viii) of the Act being the profit derived from the business operations. Explaining the concept of swapping premium, the applicant submitted before the Assessing Officer (in short AO) that as per the objective of the company, long-term finance was made available to State Electricity Boards at fixed interest rates. Subsequently, there were requests from various State Electricity Boards to get the interest rates reduced in view of the steep fall in the interest rates. Realising the business need in the changed scenario of low interest cost regime, the applicant issued a guideline for swapping of outstanding loans by existing borrowers in the year The mode of swapping of loans was, as explained, done by computing the future cash flows of interest payment of the loan at the existing old rates for the unexpired tenure of loan and the future cash flows of the interest payment were recomputed at the current rate. The Net Present Value (NPV) of the differential was then computed and 50% of this was charged as premium from the State Electricity Boards to swap their old loans into new ones with lower interest rates. The applicant further stated that the swapping premium earned had a direct and immediate nexus with the applicant s business operations of providing long-term finance and as such qualified for the deduction under section 36(1)(viii) of the Act. 4. The AO considered the applicant s contentions in course of the assessment proceedings and allowed the restricted deduction under the aforesaid section. The AO observed that the phraseology profits derived from such business of providing long-term 3

4 finance has got a narrow and restricted connotation as laid down in certain judicial pronouncements and in the absence of direct and immediate nexus between the source and the premium earned, the AO concluded that the applicant forfeits the claim of allowance of deduction under the section 36(1)(viii) in respect of the swapping premium received. To comprehend fully the stand of the Revenue, it may not be out of place to give the following extract from the assessment order:- The explanation of the assessee is considered carefully and is found not acceptable. The immediate source of swapping premium is the scheme for converting the long-term finance given at a higher percentage of interest rate to a lower percentage of interest rate. The swapping premium is a one time receipt for converting the loan. The long-term finance provided by the assessee to its client has been only utilized for calculation of swapping premium. Though there is a business connection between the swapping premium and the long-term finance, it is considered that the nexus between swapping premium and long-term finance is only incidental. The nature of this transaction of swapping premium is substantially different from the nature of interest receivable for the long-term finance provided by the assessee. The swapping premium can not be said to be derived from longterm finance. The assessee itself has declared the swapping premium receipt as other income and not income from lending operations in its Balance Sheet ending on where it credits the income earned from long-term finance. 4

5 The Privy Council in the case of CIT Vs. Raja Bahadur Kamakhaya Narayan Singh (1948) 16 ITR 325, Hon ble Supreme Court in the case of Cambay Electric in 113 ITR 84 (SC), Hindustan Lever Ltd. reported in 239 ITR 297 (SC) and CIT Vs. Sterling Foods 237 ITR 539(SC) have defined the phrase derived from in a narrow and restrictive sense. In order to determine whether an income has been derived from a particular source, the Privy Council cautioned that the enquiry should be stopped as soon as the effective source is discovered. The other two case laws on the issue of defining derived from i.e. the case of Sterling Food and Hindustan Lever Ltd.(supra) the Hon ble Supreme Court has followed the principle laid down by the Privy Council in the above case. The income should have direct nexus with the loans given as long-term finance. Any income incidental to the business of long-term finance will not qualify for the deduction. Under the circumstances, there is no way to hold that handling, consultancy, processing and service charges and swapping premium can be said to be derived from funds loaned for long term period. Since the effective source of consultancy, management fees and service charges and swapping premium are different from interest on moneys given on loans, the deduction u/s 36(1)(viii) is calculated by excluding the above amount which do not have direct nexus with the long-term finance. The deduction u/s 36(1)(viii) allowable to the assessee is Rs.2,48,50,08,452/- worked out as per annexure with the assessment order as against Rs Crs. claimed by the assessee. However, as the assessee has made a Special Reserve of 5

6 Rs Crores only as per the requirement of the provisions of section 36(1)(viii) in the Balance Sheet as on , the deduction u/s 36(1)(viii) is restricted to Rs crores only. 5. The applicant s appeal against the AO s Order before the Commissioner of Incometax (Appeals) did not succeed and the appeal before the Income Tax Appellate Tribunal has been sought to be withdrawn. Meanwhile, the applicant has obtained the requisite permission from the Committee on Disputes, a body under the Cabinet Secretariat, Government of India, to pursue the matter before this Authority. 6. In the written submissions filed before us, the Revenue has reiterated the arguments given by the AO in the assessment proceeding as given above. The Revenue submits that the clients of the applicant, as a result of the lower interest rate scenario, would have entered into agreements with any other financier in the market at lower interest rate but for the risk of compensation payable to the applicant on account of breach of contract. The swapping premium thus tantamounts, as stated, to compensation charged for the breach of contract and it does not have any nexus with the applicant s business of long-term finance. In the backdrop of these facts, the applicant himself had, as submitted, shown the swapping premium receipt in the Balance sheet under the head Other income i.e. Income from other sources. As further contended, the swapping premium can also be termed as renegotiation fees charged by the applicant for revising the interest rate to the advantage of the clients and is thus not directly derived from the immediate source i.e. the business of long-term financing. The applicant does not also qualify as eligible business in consonance with the definition of Infrastructure facility as laid down in section 10(23G) of the Act read with section 36(1)(viii) as it stood on material 6

7 date, avers the Revenue. Further, the period of five years to be eligible for coming under the purview of long-term finance, within the meaning assigned to the term in section 36(1)(viii) of the Act, should be calculated from the date on which the interest rates have been altered because the alteration of fixed interest rate, as laid down in the loan agreement, amounts to renegotiating the entire agreement. According to the Revenue, the renegotiated agreement has to be seen as fresh agreement and the period of five years should be counted therefrom. 7. Rebutting the above contentions, the learned counsel for the applicant has emphasized the fact that the swapping premium received by the applicant is part and parcel of its business operations of long-term financing and accordingly merits allowance of deduction under section 36(1)(viii) of the Act. What the applicant has done is only setting or re-scheduling of the interest rate fixed at the time of advancing the long-term finance and, in fact, the original advance / loan has not been tampered with, argues the learned counsel. Buyers of the loan remaining the same and the nature of transactions also remaining the same i.e. long-term loans; the swapping premium earned has got immediate/direct nexus with the long-term loans given. 8. In reply to the contention that the applicant itself had shown the swapping premium as Other Income in the Balance Sheet, the learned counsel for the applicant submitted that the entries made in the books of accounts are, as legally settled, not determinative of the correct nature of income or expenditure. As regards Revenue s reliance on the section 10(23G) to deny the eligibility status to the applicant, it has been contended that the reference to section 10(23G) in the section 36(1)(viii) of the Act has been made only for the limited purpose of defining Infrastructure facilities so as to enlarge the scope of the 7

8 impugned section i.e. section 36(1)(viii) of the Act and the initial requirement of providing long-term finance for the industrial and agricultural development, as contained in the section, remained unchanged. The applicant has been, as initially required, approved by the Central Government as being eligible for deduction under section 36(1)(viii) of the Act because it has been giving loans for the industrial development in the country by advancing loans for Power Projects. The Revenue has never doubted the eligibility criteria for the deduction and as such, to take refuge in section 10(23G) seems to be far-fetched, the learned counsel submitted. Also, the setting or rescheduling of the fixed rate of interest does not, by any stretch of imagination, tantamount either to compensation charged by the applicant for breach of contract or renegotiation of the original agreements with the clients. The counsel for the applicant further contends that it is not proper to count five year period required for Long-term finance from the altered date of the rescheduled interest because the long-term finance was given in the beginning itself and the same has remained intact. 9. To appreciate the rival submissions it would be appropriate to quote the relevant sections i.e. section 36(1)(viii) & Section 10(23G) of the Act which stood in the following terms during the relevant Assessment Year ( ):- Section 36(1)(viii) : as it stood in the Statute during the Assessment Year In respect of any special reserve created and maintained by a financial corporation which is engaged in providing long-term finance for industrial or agricultural development or development of infrastructure facility in India or by a public company formed and registered in India with the main object of carrying on the business of providing long-term finance for construction or purchase of houses in 8

9 India for residential purposes, an amount not exceeding forty per cent of the profits derived from such business of providing long-term finance (computed under the head Profits and gains of business or profession before making any deduction under this clause) carried to such reserve account: Provided that where the aggregate of the amounts carried to such reserve account from time to time exceeds twice the amount of the paid-up share capital and of the general reserves of the corporation or, as the case may be, the company, no allowance under this clause shall be made in respect of such excess. Explanation. In this clause - (a) financial corporation shall include a public company and a Government company; (b) public company shall have the meaning assigned to it in section 3 of the Companies Act, 1956 (1 of 1956); (c) Government company shall have the meaning assigned to it in section 617 of the Companies Act, 1956 (1 of 1956);] (d) Infrastructure facility shall have the meaning assigned to it in clause (23G) of section 10; (e) long-term finance means any loan or advance where the terms under which moneys are loaned or advanced provide for repayment along with interest thereof during a period of not less than five years. xxx xxx xxx Section 10(23G):any income by way of dividends, other than dividends referred to in section 115-O, interest or long-term capital gains of an infrastructure capital fund 9

10 or an infrastructure capital company or a co-operative bank from investments made on or after the 1 st day of June,1998 by way of shares or long-term finance in any enterprise or undertaking wholly engaged in the business referred to in sub-section (4) of section 80-1A (a) or a housing project referred to in sub-section (10) of section 80-1B and which has been approved by the Central Government on an application made by it in accordance with the rules made in this behalf and which satisfies the prescribed conditions. xxx xxx xxx Section 80-IA(4) This section applies to (i) any enterprise carrying on the business [of (i) developing or (ii) operating and maintaining or (iii) developing, operating and maintaining] any infrastructure facility which fulfils all the following conditions, (a) namely :- (a) it is owned by a company registered in India or by a consortium of such companies; (b) it has entered into an agreement with the Central Government or a State Government or a local authority or any other statutory body for (i) developing or (ii) operating and maintaining or (iii) developing, operating and maintaining a new infrastructure facility; (c) it has started or starts operating and maintaining the infrastructure facility on or after the 1 st day of April, 1995: (a) emphasis supplied. 10

11 Provided that where an infrastructure facility is transferred on or after the 1 st day of April, 1999 by an enterprise which developed such infrastructure facility (hereafter referred to in this section as the transferor enterprise) to another enterprise (hereafter in this section referred to as the transferee enterprise) for the purpose of operating and maintaining the infrastructure facility on its behalf in accordance with the agreement with the Central Government, State Government, local authority or statutory body, the provisions of this section shall apply to the transferee enterprise as if it were the enterprise to which this clause applies and the deduction from profits and gains would be available to such transferee enterprise for the unexpired period during which the transferor enterprise would have been entitled to the deduction, if the transfer had not taken place. [Explanation For the purposes of this clause, infrastructure facility means (a) - (a) a road including toll road, a bridge or a rail system; (b) a highway project including housing or other activities being an integral part of the highway project; (c) a water supply project, water treatment system, irrigation project, sanitation and sewerage system or solid waste management system; (d) a port, airport, inland waterway or inland port;] (a) emphasis supplied. 11

12 It may be mentioned that infrastructural facility was earlier defined in clause (c) to Expln. 1 to Section 10(23G) as follows:- (c) infrastructure facility means- (i) a road, highway, bridge, airport, port rail system, a water supply project, irrigation project, water treatment system, solid waste management system, sanitation and sewerage system or any other public facility of a similar nature as may be notified by the Board in this behalf in the Official Gazette and which fulfils the conditions specified in clause (i) of sub-section (4) of section 80-1A ; (ii) an industrial undertaking which (a) is set up in any part of India for the generation or generation and distribution of power if it begins to generate power at any time during the period beginning on the 1 st day of April, 1993 and ending on the 31 st day of March 2003; (b) starts transmission or distribution by laying a network of new transmission or distribution lines at any time during the period beginning on the 1 st day of April, 1999 and ending on the 31 st day of March, 2003; xxx xxx xxx However, Clause (c) was omitted by Finance Act,2001 w.e.f In the backdrop of the above extract we may also recall the legislative history of the section 36(1)(viii) of the Act which has undergone various changes/amendments with the 12

13 passage of time. It is seen that this provision i.e. section 36(1)(viii) of the Act corresponded to section 10(2)(xiva) of the 1922 Act which, as on 31 st March, 1962, was in the following terms:- (xiva) in respect of any special reserve created by a financial corporation which is engaged in providing long term finance for industrial development in India (a), an amount not exceeding ten per cent of the total income carried to such reserve account: Provided that the corporation is for the time being approved by the Central Government for the purposes of this clause: Provided further that where the aggregate of the amounts carried to such reserve account from time to time exceeds the paid-up share capital (excluding the amounts capitalized from reserves) of the corporation no allowance under this clause shall be made in respect of such excess: The above provision of the 1922 Act, was re-enacted in identical terms in section 36(1)(viii) by the 1961 Act. However, the Finance Act (13 of 1966) substituted a new clause with effect from 1 st April, 1966 in the following terms:- 36(1)(viii) In respect of any special reserve created by a financial corporation which is engaged in providing long-term finance for industrial development in India, an amount not exceeding- (a) in the case of a financial corporation whose paid-up share capital does not exceed three crores of rupees, twenty-five per cent, (a) emphasis supplied 13

14 (b) in the case of any other financial corporation, ten per cent of the total income carried to such reserve account; Till the amendment by the Finance Act (2) of 1971, there were some changes in the procedural or phrasal aspects of the section and the objective of providing long-term finance by a financial corporation for industrial development remained untouched. Subsequently, the Finance Act, 1971 substituted the existing words for industrial development in India by the words for Industrial or agricultural development (a) to give fillip to the development of agriculture as well. In pursuance of the Finance Act (20) of 1974, there was change in the quantum of the deduction to be allowed in the following terms:- (a) for the portion beginning with the words an amount not exceeding and ending with the words ten per cent, the following were substituted, namely: an amount not exceeding (a) in the case of a Financial Corporation or a Joint Financial Corporation established under the State Financial Corporation Act, 1951 (63 of 1951), or an institution deemed under section 46 of that Act to be a Financial Corporation established by the State Government for the State within the meaning of that Act, forty per cent, (b) in the case of any other financial corporation. (i) where the paid-up share capital of the corporation does not exceed three crores of rupees, twenty five per cent; (ii) where the paid-up share capital of the corporation exceeds three crores of rupees, ten per cent. (a) emphasis supplied 14

15 By the Finance Act (21) of 1979, the provisions of section 36(1)(viii) have also been extended to public companies formed and registered in India with the main object of carrying on the business of providing long-term finance for the construction or purchase of residential houses in India, in the following terms:- agricultural development in India or by a public company formed and registered in India with the main object of carrying on the business of providing long-term finance for construction or purchase of houses in India for residential purposes (a), an amount not exceeding forty per cent of the total income (computed before making any deduction under Chapter VIA) carried to such reserve account: In addition to the deduction being available, for industrial or agricultural development, the Finance Act, 1995 w.e.f also added or development of infrastructure facility in India (a) and it was stated therein that the term infrastructure facility shall have the meaning assigned to it as in section 80-1A of the Act. Later on by the Finance Act, 1997, it was amended to the effect that infrastructure facility shall have the meaning assigned to it as in section 10(23G) of the Act (since omitted by the Finance Act, 2007 w.e.f ). In line with the policy of simplification, the Finance Act 1999 w.e.f dispensed with the requirement of the approval by the Central Government in respect of the financial corporations for the purpose of the deduction. Now, Section 36(1)(viii) of the Act has been streamlined and w.e.f. 1 st April, 2008 it has extended itself to (i) a financial corporation specified in section 4A of the companies Act, 1956 (ii) a financial corporation which is a public sector company (iii) a banking company (iv) a co-operative bank other than a (a) emphasis supplied. 15

16 primary agricultural credit society or a primary co-operative or agricultural and rural cooperative bank (v) a housing finance company; and (vi) any other financial corporation including a public company. The main business of these eligible entities is still to provide long-term finance for industrial or agricultural development or development of infrastructure facility in India or for construction or purchase of houses for residential purposes. However, the quantum of deduction has now been restricted to twenty per cent as against that of forty percent. 11. What stands out from the above analysis of the legislative history is that the eligible entity all throughout for the deduction under the impugned section has been a financial corporation which has created and maintained a special reserve. Further, the entity should be engaged in the business of providing long-term finance for industrial or agricultural development or for the development of infrastructure facilities in India. To sum up, the deduction is available to:- (i) a financial corporation (which includes a public company and a government company) engaged in providing long-term finance for industrial or agricultural development or development of specified infrastructure facility in India, or (ii) a public company formed and registered in India with the main object of carrying on the business of providing long term finance for construction or purchase of houses in India for residential purposes in respect of the amount credited to the special reserve. (iii) The loan or advance given should be in the nature of long-term finance as defined in the section. 16

17 (iv) The deduction is restricted to a specified percentage of the taxable profit derived from the business of providing long-term finance. (v) The deduction at the rate of specified percentage as above is merited only when such profit is carried to a special reserve which is not only created but maintained too. (vi) The approval of the Central Government for an eligible entity was necessary upto 31 st March, Based on the preceding discussion, we have first to examine whether the applicant is an eligible entity for the deduction under section 36(1)(viii) of the Act. The eligible entity has been stated to be a financial corporation which includes, as per the definition in the Section, a public company and a Government Company. As per the Explanation appended to Section 36(1)(viii) of the Act, Public Company will have the meaning assigned to it in section 3 of the Companies Act, 1956 and section 3 of the Companies Act stands in the following terms:- 5 [(iv) public company means a company which (a) is not a private company; (b) has a minimum paid-up capital of five lakh rupees or such higher paid-up capital, as may be prescribed; (c) is a private company which is a subsidiary of a company which is not a private company;] 5 Clause (iv) substituted by the Companies (Amendment) Act, 2000 (53 of 2000), s. 3 (w.e.f ), prior to its substitution it stood as under: (iv) Public company means a company which is not a private company. 17

18 Further, as per Explanation (c) to section 36(1)(viii) of the Act, Government Company shall have the meaning assigned to it in section 617 of the Companies Act, 1956 which stands in the following terms:- S.617. Definition of Government Company For the purposes of this Act Government company means any company in which not less than fifty one per cent of the 1 [paid-up share capital] is held by the Central Government, or by any State Government or Governments, or partly by the Central Government, and partly by one or more State Governments, and includes a company which is a subsidiary of a Government Company as thus defined. 13. When analysed on the basis of the essential ingredients of a public company or a Government company as given above, it emerges that the applicant is a public company incorporated under the Companies Act 1956 in which 100% (hundred percent) sharecapital was held by the Central Government during the year in question. However, pursuant to an initial public offer of Rs crore in February 2008, the share holding of the Government of India has been reduced from 100% to 81.82%. Thus, even now more than 50% (fifty percent) share is held by the Central Government. The paid up share capital of the applicant is to the tune of Rs crores. As such, the applicant is a Government Company and a public company as well. That being so, the applicant is an eligible entity i.e. a financial corporation as laid down in the section 36(1)(viii) of the Act. 14. Next point to be examined is whether the applicant fulfills the criteria of being engaged in business of providing long-term finance for industrial or agricultural development or for the development of infrastructure facility in India. As the legislative history bears out, the common thread that survives, right from the inception of the impugned section, is that of the objective of providing long-term finance for the industrial 1 Subs. By s. 198, ibid, for Share Capital. 18

19 development and other objectives such as for agricultural development or for development of infrastructure facilities have been added with the passage of time. It is no denying the fact that the scheme of deduction, as enshrined in the section, has existed primarily to boost up industrial, agricultural and infrastructural development in India. The applicant, it is an admitted fact, is engaged in the business of providing long-term finance to its clients for rural electrification which paves the way for industrial development, agricultural development and infrastructural development. It is an accepted fact that the availability of electricity contributes significantly to the overall development of the country including that of the development of industry, agriculture and infrastructure. The provision of electricity is essential for modernization and growth of agriculture and also caters to the requirements of industry including small and medium industries, agro-industries, Khadi and village industries etc. The applicant has been providing finance for the industrial and agricultural development in India and keeping these very goals in view the Government of India granted approval to the applicant for the deduction under section 36(1)(viii) of the Act vide order bearing No.147(4)/71-TPL dated 23 rd March, 1971 which is reproduced as under:- F.NO.147(4)/71-TPL GOVERNMENT OF INDIA MINISTRY OF FINANCE (Department of Revenue and Insurance) New Delhi, 23 rd March, ORDER Subject: Income-tax Act, 1961 Section 36(1)(viii) approval by Govt. of a financial Corporation for the purpose of In exercise of the powers conferred by clause (viii) of sub-section (1) of section 36 of the Income-tax Act, 1961 (43 of l1961), the Central Government hereby approves the Rural Electrification Corporation Ltd., New Delhi as a financial Corporation for the purposes of the said clause with effect from 1 st April, Sd/ S.P.Chaudhury Under Secretary to the Govt. of India 19

20 15. The applicant is no doubt a financial corporation engaged in providing the long-term finance for the development of industry and agriculture in India as discussed above because electrification is the sheet anchor of such development. Approved by the Central Government of India as being eligible for the deduction under section 36(1)(viii) of the Act the applicant s eligibility status has not been doubted by the Revenue in course of the assessment proceedings. 16. However, in course of arguments, it has been contended by the Revenue that the applicant is not engaged in the business of providing long-term finance for the development of infrastructure facilities as defined in section 10(23G) read with section 80 1-A(4) and therefore it forfeits the claim of being an eligible entity for the allowance of deduction under section 36(1)(viii) of the Act. As against this contention, the counsel for the applicant submits that the applicant is also engaged in the business of providing long term finance for infrastructure development as it is understood in ordinary parlance. Though it is seemingly doubtful whether the applicant falls within the four corners of the definition of Infrastructure facilities as per section 10(23G) read with section 80 1-A(4) we need not go into this question further because the applicant, as per the discussion given in the preceding paras, can be said to be engaged in providing long-term finance for the industrial and agricultural development in India. 17. It is also an accepted fact that the long-term loans financed by the applicant to its clients in the beginning has not been tampered with on the event of re-scheduling of the interest and no fresh loan agreements have also been drawn. Clause (e) of the Explanation to the section 36(1)(viii) defines the long-term finance as any loan or advance where the terms under which moneys are loaned or advanced provide for repayment 20

21 along with interest thereof during a period not less than five years. In the instant case, the loans have been advanced on a fixed rate of interest in the beginning for five years and these loan amounts have not undergone any change, so the period of five years will be counted from the date of advancing the initial loan and not from the date of rescheduling the interest rates. The contention of the Revenue, on this score, does not sound convincing. 18. Engaged in the business of generation, distribution or transmission of power, the applicant accordingly satisfies the requirements of being an eligible entity as laid down in Section 36(1)(viii) of the Act and the Revenue s reliance on the Section 10(23G) of the Act, as referred to above, is far-fetched and misplaced. 19. Before we take up the Revenue s contention that swapping premium is not directly derived from the business of long-term finance, the following extracts from at least two important judicial decisions as relied upon by the Revenue, will be quite relevant:- (i) CIT vs. Sterling Foods(supra) The word derive is usually followed by the word from, and it means: get, to trace from a source; arise from, originate in; show the origin or formation of. The source of import entitlements could not be said to be the industrial undertaking of the assessee. The source of the import entitlements could only be said to be the Export Promotion Scheme of the Central Government whereunder the export entitlements became available. There must be, for the application of the words derived from, a direct nexus between the profits and gains and the industrial undertaking. In the instant case, the nexus was not direct but only incidental. The industrial undertaking exported processed sea foods. By reason of such export, the 21

22 Export Promotion Scheme applied. Thereunder, the assessee was entitled to import entitlements, which it could sell. The sale consideration therefrom could not be held to constitute a profit and gain derived from the assessee s industrial undertaking. The receipts from the sale of import entitlements could not be included in the income of the assessee for the purpose of computing the relief under section 80HH of the Income-tax Act, (ii) CIT vs. Raja Bahadur Kamakhya Narain Singh(supra) The word derived is not a term of art. Its use in the definition indeed demands an inquiry into the genealogy of the product. But the inquiry should stop as soon as the effective source is discovered. In the genealogical tree of the interest, land indeed appears in the second degree, but the immediate and effective source is rent, which has suffered the accident of non-payment. And rent is not land within the meaning of the definition. 20. The essence of the above extracts given from the judgements by the Apex Court is that there should be direct nexus, not incidental one, between the income earned and the source of income. When we apply the above principles laid down by the Apex Court to the facts of the instant case, we find that the swapping premium is nothing but discounted interest and has originated in the long-term finance initially advanced. The premium is actually traced to the original source and is not a step removed from the business of providing long-term finance. No fresh agreements for advancing long-term finance have been entered into and one time measure taken for re-scheduling the interest has been actuated by business expediency. We find that as per letter D.O.NO.Bud/1029/ dated , the Government of Nagaland made a request as under:- 22

23 As a part of our effort, we are approaching REC with a request to agree for reduction in the interest rate on the loans availed by us to the lowest rate possible. Similar request was also made by Tamil Nadu State Electricity Board and also from other State Governments. Pursuant to these requests, the applicant agreed to re-scheduling the earlier interest rate on the loans already given. In other words, the swapping premium is simply a compensation received for agreeing to a lesser amount of interest as against higher fixed rate of interest initially fixed. We find that the business of providing long-term finance is immediate and effective source of the swapping premium received. As against the facts of the present case, it emerges that the facts in the case laws relied upon by the Revenue were quite different. In the Sterling s case and Hindustan Lever s case (supra) the receipts of income were from the sale of import entitlements and did not have any direct nexus with the main business operations of the Industrial undertakings, whereas in the case of the applicant the swapping premium receipt is, as discussed above, directly derived from the main business operations. Even in the case of Raja Bahadur Kamakhya Narain Singh (supra) interest income received from the arrears of rent did not have any immediate nexus with the agricultural land. As such, this decision is also clearly distinguishable on facts. 21. Similarly, by no stretch of imagination, the swapping premium can be termed as compensation for the breach of contract because neither party has breached the terms of the contract. The disclosure of the swapping premium in the Balance Sheet as other income instead of business income is also immaterial in the light of the finding of the Apex Court that entries in the books of accounts are not determinative of the true character of 23

24 the receipt. The following observation of the Apex Court in the case of Sutlej Cotton Mills Ltd. 116 I.T.R. 1 can be usefully recalled:- It is now well settled that the way in which entries are made by an assessee in his books of account is not determinative of the question whether the assessee has earned any profit or suffered any loss. The assessee may, by making entries which are not in conformity with the proper principles of accountancy, conceal profit or show loss and the entries made by him cannot, therefore, be regarded as conclusive one way or the other. What is necessary to be considered is the true nature of the transaction and whether in fact it has resulted in profit or loss to the assessee. 22. In the light of the discussion above, we are of the view that the applicant merits allowance of the deduction under section 36(1)(viii) of the Act in respect of the swapping premium received. 23. Accordingly, the ruling is given, answering both the questions in affirmative, as contended by the applicant. Sd/- Sd/- Sd/- (RAO RANVIJAY SINGH) (JUSTICE P.V.REDDI) (A.SINHA) MEMBER CHAIRMAN MEMBER Pronounced in the open Court on 23 rd day of December,2008 by Hon ble Chairman and Member(R). (Sanjay Puri) Commissioner of Income-tax(AAR-IT) F.No. AAR/758/2007/ Dated. (A) This copy is certified to be a true copy of the advance ruling and is sent to: 1. The applicant. 2. The Commissioner of Income-tax(LTU), New Delhi.. 3. The Joint Secretary (FT&TR-I), M/Finance, CBDT, North Block, New Delhi. 4. The Joint Secretary (FT&TR-II), M/Finance, CBDT, North Block, New Delhi 5. Guard file. (B) In view of the provisions contained in Section 245S of the Act, this ruling should not be given for publication without obtaining prior permission of the Authority. ( Batsala Jha Yadav) Addl. Commissioner of Income-tax(AAR-IT) 24