2010 (2) TMI 3 - SC - Income Tax

Copoerative socicity deduction u/s 80P(2)(a)(i) - Assessee(s) is a cooperative credit society. During the relevant assessment years in question it had surplus funds which the assessee(s) invested in short-term deposits with the Banks and in Government securities. On such investments interests accrued to the assessee(s). Assessee(s) provides credit facilities to its members and also markets the agricultural produce of its members. The substantial question of law which arises in this batch of civil appeals is - Whether such interest income would qualify for deduction as business income under Section 80P(2)(a)(i) of the Income Tax Act 1961 held that - Therefore to that extent such interest income cannot be said to be attributable either to the activity mentioned in Section 80P(2)(a)(i) of the Act or in Section 80P(2)(a)(iii) of the Act. Therefore looking to the facts and circumstances of this case we are of the view that the Assessing Officer was right in taxing the interest income indicated above under Section 56 of the Act. - To say that the source of income is not relevant for deciding the applicability of Section 80P of the Act would not be correct

Summary

1. ISSUES PRESENTED and CONSIDERED

The core legal questions considered by the Court are:

(a) Whether the interest income earned by a cooperative credit society on surplus funds invested in short-term bank deposits and government securities qualifies as business income under Section 80P(2)(a)(i) of the Income Tax Act, 1961, thereby entitling the society to deduction under this provision?

(b) Whether such interest income should be taxed under the head "Income from business" (Section 28) or under "Income from other sources" (Section 56) of the Income Tax Act?

(c) Whether the source or head of the income is relevant for determining eligibility for deduction under Section 80P(2)(a)(i) of the Act?

(d) Whether the re-opening of assessment under Section 148 of the Act was valid, particularly regarding the timing and approval of the notice issuance?

(e) Whether the interest income taxed under Section 56 without allowing deductions under Section 57 (for cost of funds and proportionate administrative expenses) was correct?

2. ISSUE-WISE DETAILED ANALYSIS

(a) Classification of Interest Income and Eligibility for Deduction under Section 80P(2)(a)(i)

Relevant Legal Framework and Precedents: Section 80P of the Income Tax Act provides deductions in respect of income of cooperative societies engaged in specified activities, including providing credit facilities to members and marketing agricultural produce. The deduction applies to "the whole of the amount of profits and gains of business" attributable to such activities. The definition of "income" under Section 2(24)(i) includes profits and gains, encompassing business profits.

Court's Interpretation and Reasoning: The Court emphasized that the interest income in question arises not from credit facilities extended to members but from surplus funds invested in short-term deposits and securities, which were not immediately required for business purposes. The Court held that such interest income does not constitute "profits and gains of business" attributable to the specified activities under Section 80P(2)(a)(i).

The Court noted that the surplus funds invested were retained sale proceeds payable to members and shown as liabilities in the balance sheet. Therefore, the interest earned on such investments is not attributable to the cooperative society's core business activities but is income from investments.

Key Evidence and Findings: The balance sheets and asset-liability charts indicated that the funds generating the interest income were surplus and not used directly in business operations. The Assessing Officer and the Tribunal had consistently treated such interest income under "Income from other sources" (Section 56).

Application of Law to Facts: Applying the statutory language, the Court concluded that the interest income on surplus funds invested as an ordinary investor does not qualify as business income under Section 80P(2)(a)(i). Consequently, such income is taxable under Section 56 and not eligible for deduction under Section 80P.

Treatment of Competing Arguments: The assessee argued that the investment of surplus funds was a business activity by a prudent businessman and that a statutory obligation under the Karnataka Cooperative Societies Act required investment in specified securities, making the interest income business income. The Court rejected these contentions, distinguishing the statutory contexts and emphasizing the plain language of Section 80P(2)(a)(i).

Conclusions: The Court held that interest income on surplus funds invested in short-term deposits and securities is not business income attributable to the cooperative society's specified activities and is therefore taxable under Section 56 without deduction under Section 80P(2)(a)(i).

(b) Relevance of Source or Head of Income for Deduction under Section 80P(2)(a)(i)

Relevant Legal Framework and Precedents: The assessee contended that the source or head of income is irrelevant for deduction under Section 80P(2)(a)(i), relying on comparisons with other provisions such as Explanation (baa) to Section 80HHC, Section 80HHD(3), and Section 80HHE(5), where the language explicitly refers to "profits of the business" computed under the head "Profits and gains of business".

Court's Interpretation and Reasoning: The Court distinguished Section 80P from these other provisions, noting that Section 80P(2)(a)(i) expressly uses the phrase "profits and gains of business" attributable to specified activities, implying that the income must be operational business income. The Court emphasized that where Parliament intended to exclude or include income based on its source or head, it did so expressly, and such clarity is absent in Section 80P.

Key Evidence and Findings: The Court observed that the interest income in question was not from the core business activities but from investments of surplus funds, which are liabilities to members. The Court found that the cited judgments supporting the assessee's contention involved cooperative banks engaged in banking business, which is distinct from the present case.

Application of Law to Facts: The Court applied the statutory language strictly, concluding that the deduction under Section 80P(2)(a)(i) is limited to business profits attributable to the cooperative society's eligible activities, and the source or head of income is relevant in this determination.

Treatment of Competing Arguments: The Court rejected the argument that the interest income should be deemed business income merely because the investment was statutorily mandated or prudently made. It held that the nature and source of income must be considered.

Conclusions: The Court concluded that the source or head of income is relevant and that Section 80P(2)(a)(i) does not allow deduction for interest income falling under "Income from other sources".

(c) Validity of Re-opening Assessment under Section 148

Relevant Legal Framework and Precedents: Section 148 requires prior approval from a specified authority before issuing a notice for re-opening assessment. The timing of such approval relative to the notice issuance is critical.

Court's Interpretation and Reasoning: The assessee argued that the notice under Section 148 was served before the approval was communicated, rendering the notice invalid. The Court noted that the Tribunal found that sanction was granted prior to the notice issuance, although the communication of such sanction occurred later.

The Court emphasized the distinction between the grant of sanction and its communication, noting that no prescribed form is required for sanction. The Tribunal's finding of fact that approval existed prior to the notice was accepted.

Key Evidence and Findings: Correspondence between officers prior to the notice issuance indicated that approval was effectively granted before the notice. The Tribunal's factual finding was final and binding.

Application of Law to Facts: The Court held that the re-opening notice was valid as the sanction existed before the notice, notwithstanding the timing of formal communication.

Treatment of Competing Arguments: The Court rejected the assessee's contention based on procedural technicality, emphasizing the substance over form in sanction approval.

Conclusions: The Court upheld the validity of the re-opening notice under Section 148.

(d) Taxation of Interest Income under Section 56 without Deduction under Section 57

Relevant Legal Framework: Section 56 governs taxation of income from other sources, while Section 57 allows deductions for expenses incurred in earning such income.

Court's Interpretation and Reasoning: The Court identified a question left unanswered by the lower authorities and the Tribunal: whether the interest income taxed under Section 56 without allowing deductions under Section 57 (for cost of funds and administrative expenses) was correct.

Key Evidence and Findings: The Court noted the absence of consideration of this issue in the record and the need for proper interpretation of Sections 56 and 57 in context.

Application of Law to Facts: The Court did not decide this question but remitted it to the High Court for consideration in accordance with law.

Conclusions: The issue is remanded for further adjudication.

3. SIGNIFICANT HOLDINGS

"Such interest income would come in the category of 'Income from other sources', hence, such interest income would be taxable under Section 56 of the Act, as rightly held by the Assessing Officer."

"The words 'the whole of the amount of profits and gains of business' emphasise that the income in respect of which deduction is sought must constitute the operational income and not the other income which accrues to the Society."

"The Assessing Officer was right in taxing the interest income ... under Section 56 of the Act."

"To say that the source of income is not relevant for deciding the applicability of Section 80P of the Act would not be correct because we need to give weightage to the words 'the whole of the amount of profits and gains of business' attributable to one of the activities specified in Section 80P(2)(a) of the Act."

"The Tribunal has recorded a finding of fact that there was a detailed correspondence between the concerned officers prior to 31st May, 2001, in the context of re-opening of assessment. It may also be mentioned that there is a vital difference between grant of sanction and communication of such sanction."

"Approval/sanction for re-opening of assessment in terms of Section 148 of the Act read with Section 151 existed even prior to 31st May, 2001."

Core principles established include:

• Interest income on surplus funds invested by a cooperative credit society, not immediately required for business purposes, is income from other sources and not business income.
• Deduction under Section 80P(2)(a)(i) is available only for profits and gains of business attributable to specified activities, not for income from investments of surplus funds.
• The source or head of income is relevant in determining eligibility for deduction under Section 80P.
• Re-opening of assessment under Section 148 requires prior sanction, and the timing of sanction vis-`a-vis notice issuance is a question of fact.
• Questions regarding allowance of deductions under Section 57 against income taxed under Section 56 require separate consideration and were remitted for further adjudication.

Final determinations on each issue are that the interest income on surplus funds invested in short-term deposits and securities is taxable under Section 56, not eligible for deduction under Section 80P(2)(a)(i), and the re-opening of assessment was valid. The question regarding deductions under Section 57 remains open and remitted for further consideration.