Court Upholds Tax Treatment of Co-op Society's Interest Income, Remands for Reassessment

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Case Name:

Principal Commissioner of Income Tax vs. Electro Urban Co-operative Credit Society Ltd. (High Court of Calcutta)

ITAT 329 of 2018

Date: 5th March 2020

Key Takeaways:

1. The court applied the Totgar's case principle to co-operative societies engaged in banking.

2. Interest income from investments not directly related to member activities may be taxable under "Income from Other Sources."

3. The court emphasized the importance of considering statutory requirements for reserve funds when assessing deductions.

4. The case highlights the complex interplay between co-operative society laws and income tax regulations.

Issue: 

Was the Supreme Court's decision in Totgar's Co-operative Sale Society Ltd. vs. ITO applicable to co-operative societies carrying on the business of banking or providing credit facilities to its members?

Facts:

1. Electro Urban Co-operative Credit Society Ltd. is a co-operative society engaged in banking and providing credit facilities to its members.

2. The society earned interest income from various investments.

3. The Assessing Officer allowed deduction under Section 80P(2)(d) (of Income Tax Act, 1961) for interest received from co-operative banks but added the remaining interest to the total income under "Income from Other Sources."

4. The case went through appeals, reaching the High Court.

5. The assessment year in question is 2012-13.

Arguments:

Appellant (Revenue):

- Argued that the Totgar's case should apply to co-operative societies engaged in banking.

- Contended that interest income from investments not directly related to member activities should be taxed as "Income from Other Sources."

Respondent (Co-operative Society):

- Claimed that all interest income should be considered as profits and gains of the co-operative society's banking business.

- Argued that investments were made as per statutory requirements and existing bye-laws.

- Contended that the entire interest income should be eligible for deduction under Section 80P (of Income Tax Act, 1961).

Key Legal Precedents:

1. Totgar's Co-operative Sale Society Ltd. vs. ITO (2010) 322 ITR 283 (SC): Established that interest income from investments of funds not immediately required for business purposes should be taxed under "Income from Other Sources."

2. CIT vs. South Eastern Railways Employees Cooperative Credit Society Limited [2017] 390 ITR 524 (Cal):

Applied the Totgar's principle to co-operative societies engaged in banking, but also considered statutory requirements for reserve funds.

Judgement:

1. The court answered the question in the affirmative, favoring the Revenue's position.

2. It held that the Totgar's case principle applies to co-operative societies engaged in banking.

3. However, the court remanded the matter to the Assessing Officer with specific directions:

  a. To work out the interest earned on the reserve fund, if invested, and allow deduction for it.

  b. This deduction should be in addition to the deduction already allowed under Section 80P(2)(d) (of Income Tax Act, 1961).

4. The court clarified that the previous deduction under Section 80P(2)(d) (of Income Tax Act, 1961) was correctly allowed and should not imply disallowance of other income based on the nature of investments.

FAQs:

Q1: What is the significance of this judgment for co-operative societies?

A1: It clarifies that interest income from investments not directly related to member activities may be taxable, even for co-operative societies engaged in banking.

Q2: Does this mean all interest income of co-operative societies is taxable?

A2: No, the judgment recognizes that some interest income, particularly from statutorily required reserve funds, may still be eligible for deduction.

Q3: What should co-operative societies do in light of this judgment?

A3: They should carefully review their investment practices and ensure proper segregation of funds to maximize eligible deductions while complying with tax laws.

Q4: How does this judgment balance co-operative society laws and tax regulations?

A4: It recognizes the statutory requirements for reserve funds under co-operative society laws while applying tax principles established in the Totgar's case.

Q5: What's the practical impact of remanding the case to the Assessing Officer?

A5: It allows for a more nuanced assessment of the society's income, potentially resulting in a fairer tax treatment that considers both statutory requirements and tax principles.

Revenue has appealed against order dated 17th November, 2017 passed by Income Tax Appellate Tribunal “D” Bench, Kolkata in ITA 144/Kol/2016 pertaining to assessment year 2012-13. The substantial question of law, on which the appeal was admitted, is set out below:-

“Was Totgar’s (supra) made applicable to Co-operative Societies carrying on the business of banking or providing credit facilities to its members, by South Eastern Railway Employees Co-operative Credit Society Ltd. (supra)?” Mr. Bhowmick, learned advocate appears on behalf of appellant- revenue and submits, declaration of law in Totgar’s Co-operative Sale Society Ltd. vs ITO reported in (2010) 322 ITR 283 (SC) was on the question whether interest on deposits/securities, which strictly speaking accrues to the members’ account, could be taxed as business income under section 28 (of Income Tax Act, 1961)? Supreme Court said, such interest income would come in the category of income from other sources. Hence, such interest income would be taxable under section 56 (of Income Tax Act, 1961). In that connection section 80P (of Income Tax Act, 1961) was analyzed and appellant, being a co-operative sale society, was held against as follows:

“As stated above, in this case, interest held as ineligible for deduction under section 80P(2)(a)(i) (of Income Tax Act, 1961) is not in respect of interest received from members. In this case, we are only concerned with interest which accrues on funds not required immediately by the assessee(s) for its business purposes and which have been only invested in specified securities as “investment”. Further, as stated above, the assessee(s) markets the agricultural produce of its members. It retains the sale proceeds in many cases. It is this “retained amount” which was payable to its members, from whom produce was bought, which was invested in short-term deposits/securities. Such an amount, which was retained by the assessee-society, was a liability and it was shown in the balance- sheet on the liabilities-side. 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 Income Tax Act, 1961) or in section 80P(2)(a)(iii) (of Income Tax Act, 1961). 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 Income Tax Act, 1961).”

He submits, Totgar’s (supra) was made applicable to an assessee such as respondent by a Division Bench of this Court, to which one of us was party (Arindam Sinha, J.), in CIT vs. South Eastern Railways Employees Cooperative Credit Society Limited reported in [2017]390 ITR 524 (Cal). Appeal of revenue is covered by the decision and the question should be answered accordingly.

Mr. Majumder, learned senior advocate, Additional Advocate- General appears on behalf of assessee-respondent. He submits, his client is an existing cooperative society, on whom deeming provision in section 6 (of Income Tax Act, 1961) of West Bengal Co-operative Societies Act, 2006 operates. He relies on sections 79 and 82 therein for provisions relating to firstly, investment of funds by his client and secondly, on mandate to transfer, in every cooperative year, not less than 10% of its net profit to a reserve fund. Corresponding enabling procedure is as per rule 119 (of Income Tax Rules, 1962) in West Bengal Co-operative Societies Rules, 2011. His client made investments as permitted by the Act, Rules and its existing bye-laws, the latter not being inconsistent with the provisions in the Act of 2006. Interest on these investments are profits and gains of his client, being a cooperative society, carrying on business of banking and providing credit facilities to its members. As such, the whole amount of profits and gains achieved from interest earnings on such investments, is to be deducted in computing the total income.

Furthermore, he draws attention to the assessment order dated 25th February, 2015. He submits, the Assessing Officer appears to have disallowed major part of the interest income from being deducted, going on the nature of investments. This would be apparent from the deduction allowed by him. He relies on following in the assessment order to make his point.

“However, as per section 80P(2)(d) (of Income Tax Act, 1961) any income by way of interest or dividends derived by the co-operative society from its investments with any other co-operative society will be allowed as deduction. Hence, interest received only from co- operative bank amounting to Rs.90,21,660.91 is allowed as deduction u/s 80P(2)(d) (of Income Tax Act, 1961) and remaining interest received of Rs. 2,43,97,796.35 is added to the total income of the assessee under the head Income from Other Source.”

He submits in fairness, the Tribunal upheld the order of CIT (Appeal) upon reliance of a case, which could not be tracked on the reference given in impugned order. Without prejudice to above contentions Mr. Majumder submits further, if Court answers the question in favour of revenue, then directions made in South Eastern Railways Employees Co-operative Credit Society Limited (supra) must necessarily be made in this appeal as well.

In South Eastern Railways Employees Co-operative Credit Society Limited (supra), one contention advanced on behalf of assessee therein was that it being a multi-State cooperative society, duly registered, was bound by mandate in section 63 (of Income Tax Act, 1961) of Multi-State Co- operative Societies Act, 2002, regarding disposal of net profits. 25% thereof in any year is to be transferred to the reserve fund. Investment of funds is permitted under section 64 (of Income Tax Act, 1961). The reserve fund was invested and interest income on the fund therefore must be taken to be as profit and gain of business attributable to banking and providing credit facilities to its members. The Division Bench took note of this argument in holding that the entire interest income, therefore, could not be disallowed. The question in that appeal is reproduced below:-

“Whether in the facts and circumstances of the case, the Income-tax appellate Tribunal by allowing deduction on income earned by the assessee from investment in banks and other financial institutions has rendered the provisions of section 80P(2)(a)(i) (of Income Tax Act, 1961) nugatory as the said section of the Act allows deduction to a co-operative society engaged in carrying on business of banking or providing credit facilities to its members?” The question was answered in the affirmative and in favour of revenue in the manner as will appear below.

“In that view of the matter, the question raised for decision is answered in the affirmative and in favour of the Revenue to the extent as indicated above. The appeal is allowed. The matter is, however, remanded to the Assessing Officer (a) to work out the interest earned under sections 63 (of Income Tax Act, 1961) and 64 of the Multi-State Co- operative Societies Act, 2002 and to allow benefit under section 80P (of Income Tax Act, 1961) and (b) to ascertain the interest paid to the members for the purpose of earning the sums of Rs. 99 lakhs and 1.2 crores on account of interest from investments. Such interest shall be deducted from the expenses of eligible business. Consequent increased amount of profits of eligible business as discussed above shall be the amount of deduction available to the assessee under section 80P (of Income Tax Act, 1961).”

We find that revenue’s case is covered by South Eastern Railways Employees Co-operative Credit Society Limited (supra). The Act of 2006 and Rules thereunder mandate 10% of net profit in every cooperative year to be transferred to a reserve fund. Interest income on rest of the net profit of respondent appears to be similar income or to be similarly treated as interest income on investment of sale of agricultural produce of the assessee in Totgar’s (supra), that assessee being one coming within sub-clause (a)(iv) under sub-section (2) in section 80P (of Income Tax Act, 1961). Assessee being a credit society similar to assessee South Eastern Railways Employees Co-operative Credit Society Limited, Totgar’s (supra) would apply to its such income. It follows that the question in this appeal is to be answered in the affirmative, in favour of revenue and we so answer it.

Substantial question of law was formulated and answered in South Eastern Railways Employees Co-operative Credit Society Limited (supra). Substantial question of law, on which this appeal was admitted, has been answered. That does not automatically require same directions, as made in South Eastern Railways Employees Co-operative Credit Society Limited (supra), to be made here as well. Sub-section (7) in section 260A (of Income Tax Act, 1961) makes applicable provisions of Code of Civil Procedure, 1908, relating to appeals to the High Court, as far as may be, applied in the case of appeals under the section. Rule 33 (of Income Tax Rules, 1962) in Order 41 provides for appellate Court’s power to pass any decree and make any order as the case may require. The directions were made in South Eastern Railways Employees Co-operative Credit Society Limited (supra) and directions to be made here, are in exercise of such power.

Having answered the question as we have, we direct the matter be remanded to the Assessing Officer, to work out interest earned on the reserve fund, if invested and allow deduction therefor in addition to the deduction already allowed in applying section 80P(2)(d) (of Income Tax Act, 1961), as in the assessment order. Said deduction was correctly allowed and allowing of only it cannot be taken to imply, reason to have disallowed the other income was by going on manner of such investments.

The appeal is disposed of.

(Arindam Sinha, J.) (Shekhar B. Saraf, J.)