2016 (6) TMI 1504 - AT - Income Tax

Deduction u/s 80P(2)(a)(i) on interest income received from the various Cooperative Banks and other Banks - HELD THAT - As we find that the issue involved is covered in favour of the assessee by a catena of decisions from ITAT as well as a decision of jurisdictional High Court. In this regard we may gainfully refer in the case of Solapur Nagri Audyogic Sahakari Bank Ltd 2009 (6) TMI 15 - BOMBAY HIGH COURT held there being no dispute that the funds in the voluntary reserves which were utilised for investment in KVP/OVP by the cooperative banks were the funds generated from the banking business we hold that in all these cases the Tribunal was justified in holding that the interest income received by the co-operative banks from the investments in KVP/IVP made out of the funds in the voluntary reserves were eligible for deduction u/s 80P(2)(a)(i). The above case law fully supports the assessee s case. Here also surplus funds not immediately required for day to day banking were kept in Bank deposits. The income earned there from thus would be income from banking business eligible for deduction u/s 80P(2)(a)(i). Decided against revenue.

Summary

The core legal questions considered in this appeal pertain to the correct tax treatment of interest income earned by a cooperative society from investments made out of surplus or operational funds. Specifically, the issues are:

1. Whether the interest income of Rs. 82,60,109/- earned by the assessee from bank deposits and mutual funds is taxable as business income attributable to its credit facility business or as income from other sources.

2. Whether the assessee is entitled to deduction under section 80P(2)(a)(i) of the Income-tax Act, 1961, which exempts certain income of cooperative societies engaged in banking or credit activities.

3. Whether the decision of the Hon'ble Supreme Court in The Totgar's Co-op. Sale Society Ltd. case, which held that interest income on surplus funds invested outside business purposes is taxable as income from other sources, is applicable to the facts of the present case.

Issue-wise Detailed Analysis

Issue 1 & 2: Taxability and Deductibility of Interest Income under Section 80P(2)(a)(i)

The relevant legal framework centers on section 80P(2)(a)(i) of the Income-tax Act, which provides exemption to cooperative societies engaged in the business of banking or providing credit facilities to their members, for income derived from such activities. The key question is whether the interest income earned on investments made from surplus or operational funds qualifies as income from the business and hence eligible for exemption.

The Assessing Officer (AO) held that the interest income earned from investments in bank deposits and mutual funds out of surplus funds was not eligible for exemption under section 80P(2)(a)(i) and taxed it under income from other sources. The AO's reasoning was that such income was not attributable to the business of providing credit facilities.

The learned CIT(Appeals) reversed this view, relying on a series of precedents including decisions from the ITAT and the jurisdictional High Court. The CIT(A) held that the interest income earned on investments made from surplus funds, which were not immediately required for business purposes, still qualifies as income from the business of providing credit facilities, as these funds originated from the business operations.

The Tribunal referred to the jurisdictional High Court decision in CIT vs. Solapur Nagri Audyogic Sahakari Bank Ltd., where the Court considered whether interest income from investments in Kisan Vikas Patra (KVP) and Indira Vikas Patra (IVP) made out of voluntary reserves of cooperative banks was exempt under section 80P(2)(a)(i). The Court held that since the funds invested were generated from the banking business and held in voluntary reserves, the interest income was indeed income from the banking business and eligible for exemption.

This principle was applied analogously to the present case, where the cooperative society maintained operational funds and invested surplus funds in bank deposits. The Tribunal emphasized that such investments were made to maintain liquidity and meet contingencies, which is an integral part of prudent business management in credit societies.

Further support was drawn from the ITAT Nagpur Bench decision in MSEB Engineers Co-Op. Credit Society Ltd., which dealt with similar facts and held that interest income on short-term deposits maintained as liquid funds for business contingencies qualified for exemption under section 80P(2)(a)(i).

The Tribunal distinguished these facts from those in The Totgar's Co-op. Sale Society Ltd. case by highlighting that in the Totgar's case, the surplus funds arose from marketing activities and were not immediately required for business purposes, whereas in the present case, the funds were operational and integral to the credit business, with no surplus funds lying idle.

The Tribunal also noted that the assessee maintained an overdraft facility, indicating active business operations and the necessity of maintaining liquid funds. This operational context was crucial in concluding that the interest income was business income eligible for exemption.

Issue 3: Applicability of The Totgar's Co-op. Sale Society Ltd. Decision

The Totgar's case held that interest income on surplus funds invested outside the business was taxable as income from other sources under section 56, not as business income under section 28, and hence not eligible for exemption under section 80P(2)(a)(i). The Revenue contended that this decision was squarely applicable to the present facts.

The Tribunal carefully analyzed the facts and distinguished the present case from Totgar's. It noted that in Totgar's, the surplus funds arose from marketing activities and were admitted to be surplus and not required for immediate business use. The interest income on such surplus was rightly held to be income from other sources.

Conversely, in the present case, the funds were operational, used for providing credit facilities, and the investments were made to maintain liquidity for business contingencies. The Tribunal concluded that the ratio in Totgar's does not apply since there were no surplus funds lying idle; all funds were utilized for business purposes.

Accordingly, the Tribunal held that the interest income should be treated as business income eligible for exemption under section 80P(2)(a)(i), rejecting the Revenue's reliance on Totgar's.

Treatment of Competing Arguments

The Revenue's argument that the interest income was from surplus funds not related to business activities and hence taxable under income from other sources was countered by the assessee's evidence showing the funds were operational and necessary for business liquidity. The Tribunal found the assessee's position supported by the balance sheet and the overdraft facility, indicating active business use of funds.

The Tribunal also relied on a consistent line of judicial precedents favoring the assessee's position, including decisions by the jurisdictional High Court and coordinate benches of the ITAT, which had been affirmed by the High Court, thereby strengthening the legal basis for exemption.

Conclusions

The Tribunal concluded that the interest income earned by the cooperative society on investments made from operational funds qualifies as income from the business of providing credit facilities and is eligible for deduction under section 80P(2)(a)(i) of the Income-tax Act. The Tribunal reversed the AO's order and upheld the CIT(Appeals) decision granting exemption.

Significant Holdings

The Tribunal's crucial legal reasoning includes the following verbatim excerpt:

"In overall consideration of all the aspects, we are of the considered view that the ratio laid down by the Hon'ble Supreme Court in the case of Totgars Co-op. Sale Society Ltd. cannot in any way come to the rescue of either the Ld.CIT(A) or the Revenue. In view of the above facts, we are of the firm view that the learned CIT(A) was not justified in coming to a conclusion that the sum of Rs.9,40,639/- was to be taxed u/s.56 of the Act. It is ordered accordingly."

And further:

"Here also surplus funds not immediately required for day to day banking were kept in Bank deposits. The income earned there from thus would be income from banking business eligible for deduction u/s 80P(2)(a)(i)."

Core principles established include:

• The nature of the funds (operational vs. surplus) and their use in the business are critical in determining the tax treatment of interest income.
• Interest income earned on investments made from operational funds maintained for liquidity and contingencies is business income eligible for exemption under section 80P(2)(a)(i).
• The Supreme Court decision in Totgar's is applicable only when surplus funds unrelated to immediate business needs are invested, and not where funds are integral to business operations.

Final determinations:

• The interest income of Rs. 82,60,109/- earned by the cooperative society is business income attributable to its credit facility business.
• The assessee is entitled to deduction under section 80P(2)(a)(i) on such interest income.
• The Revenue's appeal is dismissed, and the orders of the CIT(Appeals) are upheld.