2025 (4) TMI 938 - AT - Income Tax

Deduction u/s 80P - denial of claim as assessee is carrying on the activity in violation of provisions of cooperative society and thereby the concept of mutuality is missing - CIT(A) disallowed the deduction of interest income earned from surplus funds invested in banks and government securities - HELD THAT - We find that this statutory requirement imposes a legal obligation on the assessee society to maintain such deposits thereby restricting its ability to freely use or withdraw these funds for its business operations without prior approval from the Registrar of Co- operative Societies. Given this statutory compulsion we find that the interest income arising from these deposits cannot be equated with interest income derived from surplus funds voluntarily parked in banks for earning a return. Therefore we hold that the interest income earned from such statutory deposits should be considered as operational income derived in the course of the assessee s business and consequently qualifies for deduction u/s 80P(2)(a)(i). We in the interest of justice and fair play are inclined to set aside the issue to the file of the AO with direction to compute the required quantum of amount needs to be deposited as per statutory requirement and allow the claim of the deduction under section 80P(2)(a)(i) of corresponding interest income. We are also inclined to consider the alternative plea raised by the assessee. In the event that the AO found that the any amount of investment over and above the required statutory limit and classify the interest income from such deposits as Income from Other Sources then it is imperative that the corresponding cost incurred in earning such income must be deducted while computing taxable income. It is a well-established principle of taxation that only net income should be brought to tax and any expenditure directly attributable to the earning of such income should be allowed as a deduction. Therefore we direct the AO to grant a proportionate deduction of the corresponding cost if any while assessing the interest income under the head Income from Other Sources. We hold that the assessee is entitled to deduction u/s 80P(2)(a)(i) on the interest income earned from deposits made in compliance with statutory requirements. AO is directed to re-examine the taxability of such interest income in accordance with this finding as per law and grant appropriate relief to the assessee. Appeal of the assessee is allowed for statistical purposes.

Summary

1. ISSUES PRESENTED and CONSIDERED

The core legal questions considered by the Tribunal were:

• Whether the assessee cooperative society is entitled to claim deduction under section 80P(2)(a)(i) of the Income Tax Act in respect of interest income earned from deposits made with the District Co-operative Bank, Vijayapura, which are mandated by statutory provisions of the Karnataka State Co-operative Societies Act, 1959.
• Whether the interest income earned from such statutory deposits should be treated as business income eligible for deduction under section 80P(2)(a)(i) or as income from other sources and thus taxable accordingly.
• Whether the concept of mutuality is preserved when the cooperative society accepts deposits and advances loans to associate or nominal members, and whether such transactions qualify for deduction under section 80P(2)(a)(i).
• Whether the disallowance of deduction on the ground of violation of cooperative society laws and absence of mutuality is justified.
• Whether in the event any interest income is treated as income from other sources, the corresponding expenses incurred to earn such income should be allowed as deductions.

2. ISSUE-WISE DETAILED ANALYSIS

Issue 1: Eligibility of Deduction under Section 80P(2)(a)(i) for Interest Income on Statutory Deposits

Relevant Legal Framework and Precedents: Section 80P(2)(a)(i) of the Income Tax Act provides deduction to cooperative societies in respect of income derived from the business of banking or providing credit facilities to its members. The Karnataka State Co-operative Societies Act, 1959, particularly sections 57(2) and 58, mandates that cooperative societies set aside 25% of their net profit as reserve funds, which must be invested in specified institutions, including District Co-operative Banks.

Judicial precedents considered included the Supreme Court decision in CIT vs. Karnataka State Cooperative Apex Bank (251 ITR 194), which held that income derived from funds mandatorily placed with banks as part of carrying on the banking business qualifies as business income eligible for deduction under section 80P(2)(a)(i). The Tribunal also relied on the coordinate bench decisions such as Kalika Parameswari Co-operative Society Ltd vs. ITO and Bharat Co-operative Credit Society vs. ITO, which recognized interest income from statutory deposits as business income entitled to deduction under section 80P(2)(a)(i).

Court's Interpretation and Reasoning: The Tribunal noted that the deposits in question were not voluntary investments but statutory obligations under the Karnataka State Co-operative Societies Act, 1959. Since the society cannot withdraw or utilize these funds freely without approval from the Registrar, the interest income earned thereon is integrally linked to the business of the society. The Tribunal distinguished this from interest income earned from surplus funds voluntarily parked for earning returns, which is not eligible for deduction under section 80P.

The Tribunal observed: "The placement of such funds being imperative for the purposes of carrying on the banking business, the income derived therefrom would be income from the assessee's business." This aligns with the principle that income arising out of statutory compulsion to invest funds as part of business operations should be treated as business income.

Key Evidence and Findings: The statutory provisions mandating reserve fund creation and investment, the nature of deposits with the District Co-operative Bank, and the absence of free disposal over these funds were crucial. The Tribunal also noted the absence of detailed quantification of the amount required to be deposited as per the Act, which necessitated remand to the Assessing Officer (AO) for determination.

Application of Law to Facts: The Tribunal applied the legal principle that income arising from mandatory statutory deposits forms part of the business income of the cooperative society. It directed the AO to verify the quantum of mandatory deposits and allow deduction under section 80P(2)(a)(i) accordingly.

Treatment of Competing Arguments: The Revenue argued that interest income from deposits should be treated as income from other sources, following the Supreme Court decision in Totgars Cooperative Sale Society Ltd. vs. ITO. However, the Tribunal distinguished that case on facts, emphasizing the statutory compulsion in the present case. The assessee's argument that the deposits were statutory and not voluntary investments was accepted. The Tribunal also accepted the alternative plea that if any interest income is treated as income from other sources, corresponding expenses should be allowed.

Conclusion: Interest income earned from statutory deposits mandated by the Karnataka State Co-operative Societies Act qualifies as business income eligible for deduction under section 80P(2)(a)(i). The matter was remanded to the AO for quantification and verification of the statutory deposit amount.

Issue 2: Mutuality and Eligibility of Deduction for Transactions with Associate/Nominal Members

Relevant Legal Framework and Precedents: Section 80P(2)(a)(i) allows deduction for income derived from providing credit facilities to members of the cooperative society. The concept of mutuality requires that the cooperative's activities be confined to its members. The Supreme Court decision in Citizen Co-operative Ltd vs. ACIT (84 taxmann.com 114) was relied upon by the AO to deny deduction where loans were advanced to the general public posing as associate members, thereby breaching mutuality.

The Tribunal also referred to the Supreme Court ruling in Mavilayi Service Cooperative Bank Ltd. vs. CIT (123 taxmann.com 161), which clarified that if nominal or associate members are recognized under the relevant State Cooperative Societies Act as members, income from loans to such members qualifies for deduction.

Court's Interpretation and Reasoning: The Tribunal found that under the Karnataka Cooperative Societies Act, associate and nominal members are legally recognized as members. Therefore, loans advanced to such members do not violate mutuality. The AO's finding that the society was accepting deposits and advancing loans to members of the general public disguised as associate members was not supported by evidence. The Tribunal held that the deduction under section 80P(2)(a)(i) cannot be denied on the ground of absence of mutuality where the society operates within the statutory framework.

Key Evidence and Findings: The statutory definition of members under the Karnataka Cooperative Societies Act, the nature of associate and nominal members, and the absence of approval for admitting members outside the statutory framework were examined. The Tribunal accepted the assessee's submission that it did not engage with the general public beyond statutory members.

Application of Law to Facts: The Tribunal applied the principle that income derived from transactions with recognized members, including associate and nominal members, qualifies for deduction under section 80P(2)(a)(i). The AO's disallowance was set aside.

Treatment of Competing Arguments: The AO and Revenue contended that the society violated cooperative laws by admitting non-regular members and that mutuality was absent. The Tribunal rejected these arguments based on statutory recognition of associate members and the absence of evidence of transactions with the general public.

Conclusion: The society's transactions with associate and nominal members are within the statutory framework and preserve mutuality, entitling the society to deduction under section 80P(2)(a)(i).

Issue 3: Treatment of Interest Income Earned from Investments in Banks and Government Securities

Relevant Legal Framework and Precedents: The Supreme Court decision in Totgars Cooperative Sale Society Ltd. vs. ITO (322 ITR 283) held that interest income from investments in banks and government securities does not constitute operational income under section 80P(2)(a) and is taxable as income from other sources.

Court's Interpretation and Reasoning: The CIT(A) disallowed deduction on such interest income, following the Supreme Court ruling. The Tribunal upheld this approach but clarified that where such income is treated as income from other sources, corresponding expenses must be allowed as deductions to arrive at net taxable income.

Key Evidence and Findings: The nature of the investments and the source of interest income were examined. The statutory compulsion did not extend to such investments, differentiating them from mandatory deposits.

Application of Law to Facts: The Tribunal applied the established principle that income from investments not integrally connected to the business is taxable under income from other sources.

Treatment of Competing Arguments: The assessee argued that such interest income should be treated as business income if investments are statutory; however, the Tribunal distinguished the facts and upheld the denial of deduction.

Conclusion: Interest income from investments in banks and government securities not mandated by statute is taxable under income from other sources, with allowance for corresponding expenses.

Issue 4: Allowance of Corresponding Expenses against Interest Income Treated as Income from Other Sources

Relevant Legal Framework and Precedents: It is a well-established principle in taxation that only net income is taxable, and expenses incurred to earn income must be allowed as deductions.

Court's Interpretation and Reasoning: The Tribunal accepted the assessee's alternative plea that if any interest income is treated as income from other sources, the AO must allow deduction of corresponding expenses incurred to earn such income.

Key Evidence and Findings: No specific expenses were quantified, but the principle was recognized.

Application of Law to Facts: The AO was directed to allow proportionate deduction of expenses while assessing interest income under income from other sources.

Treatment of Competing Arguments: The Revenue did not dispute this principle.

Conclusion: Corresponding expenses related to interest income treated as income from other sources must be allowed as deductions.

3. SIGNIFICANT HOLDINGS

"The placement of such funds being imperative for the purposes of carrying on the banking business, the income derived therefrom would be income from the assessee's business."

"If the investments are out of compulsion under the Act and relevant Rules, necessarily it is part of assessee's business activity entailing the benefit of section 80P(2)(a)(i) of the Act."

"Income derived from transactions with associate and nominal members recognized under the State Cooperative Societies Act qualifies for deduction under section 80P(2)(a)(i), preserving the concept of mutuality."

"Interest income from investments in banks and government securities not mandated by statute is taxable under income from other sources, but corresponding expenses must be allowed."

"Only net income should be brought to tax, and any expenditure directly attributable to the earning of such income should be allowed as a deduction."

The Tribunal concluded that the assessee cooperative society is entitled to claim deduction under section 80P(2)(a)(i) on interest income earned from deposits made in compliance with statutory requirements of the Karnataka State Co-operative Societies Act, 1959. The AO was directed to verify the quantum of such statutory deposits and allow the deduction accordingly. The denial of deduction on the ground of absence of mutuality was rejected, recognizing associate and nominal members as statutory members. Interest income from other investments was held taxable under income from other sources with allowance for corresponding expenses. The appeals were allowed for statistical purposes with remand to the AO for computation and verification consistent with the Tribunal's directions.