The Hindu Business Line : Conflict between `heads'

The relative importance of heads of income in the Income-Tax Act 1961 (the Act) is slowly losing significance mainly on account of the fact that the overall tax rates have stabilised at 30 per cent. However, capital gains as a distinct head continues to retain its independent character on account of the lower rate and the special exemptions.

More often than not conflict arises as to whether a particular source of income would fall under the specific head of `income' or `income from other sources'. This conflict assumes importance since business income enjoys the advantage of various deductions, which is not available for income from other sources.

Section 36(1)(viii) of the Act requires a special reserve to be created and deduction up to 40 per cent of the profits derived from such business is available for designated activities.

One such activity relates to long-term finance for construction and purchase of houses in India. An interesting issue in the computation of Section 36(1)(viii) has developed which is unique to the housing finance industry.

STATUTORY INVESTMENTS

Housing finance companies are governed by National Housing Banks (NHB) Directions and are required to maintain minimum Statutory Liquidity Reserves (SLR) on the deposits invested by such companies. These investments are usually made in government securities and bank deposits.

The yield on these investments is lower compared to return on deploying funds in the main business but the Directions require this liquidity reserve to be maintained to provide the required safety to the depositors.

The issue for consideration is whether the interest of such securities/bank deposits would constitute `business income' or `income from other sources' and whether such income would also be entitled to deduction under Section 36(1)(viii) of the Act.

It is in this context that the head of income becomes crucial to decide the matter. Once such income is categorised as "other sources" the question of Section 36(1)(viii) deduction will not arise. The key question is whether interest arising from statutory investments mandated by a quasi regulator is business income or income from other sources?

INDUSTRY STANDPOINT

Industry has rightly argued before the tax authorities that the SLR is dictated by the NHB Directions and is not maintained voluntarily by the companies. If the amounts were not so deposited in comparatively low-yielding investments, they would have been deployed in business, which will by way of right be treated as business income and entitled to deduction under Section 36(1)(viii).

Any investment in accordance with directions/law is in lieu of carrying on business and income arising there from has to be categorized as business income. This matter came up in an appeal recently in Chennai and CIT Appeals in ITA No 242/05-06 as held that the deduction under Section 36(1)(viii) is available for income arising from SLR investments also.

Courts have held in a different context that interest on bank deposits cannot be assessed, as other sources but have to be assessed as business income in the following cases: CIT vs Madras Refineries Ltd (1997 228 ITR 354; Mad); Snam Progetti Spa vs. Addl. CIT (1981; 132 ITR 70; Del); Tamilnadu Daily Development Corpn. vs. CIT (1995; 216 ITR 535;Mad).

COMPUTING CONFLICTS

Conflicts also arise in the manner computing deductions placed under Chapter VIA of the Act and any deduction such as Section 36(1)(viii), which is restricted only to business income. Several court decisions have in the context of Chapter VIA, particularly in dealing with issues such as Section 80HHC, 80IA, etc., have restricted the quantum of deduction taking into account the concept of total income.

In the case of Section 36(1)(viii), the ratio of these decisions will not apply. The housing finance industry should rightly take a consistent stand that interest on statutory investments in entitled to Section 36(1)(viii) deduction.

While the Department would still try to argue on the basis of distinct heads of income, the appellate orders would come to the rescue of assessee on the matter, which is of considerable importance to the housing finance companies.

It is appropriate that the CBDT clarifies the issue to settle the dispute stating clearly that income from statutory investments is also entitled to deduction under Section 36(1)(viii) of the Act.

(The author is a Chennai-based chartered accountant.)