Reserve-fund investment income is not exempt banking income unless securities form part of circulating capital in ordinary operations.

Interest earned by a co-operative bank on reserve-fund investments in Government and approved securities is not treated as income attributable to banking business under section 80P(2)(a)(i) unless the securities form part of the bank's circulating capital or stock-in-trade and are freely deployable in ordinary banking operations. The character of the income depends on the nature of the investment under banking law, not merely on its source. Absence of sanction from the Registrar under the Co-operative Societies law does not by itself convert the income into non-banking income, but reserve-fund investments remained outside the exemption on the facts considered.

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Issues: (i) Whether interest income earned by a co-operative bank from investment of reserve funds in Government securities and similar approved securities was exempt as income attributable to banking business under section 80P(2)(a)(i) of the Income-tax Act, 1961. (ii) Whether absence of sanction from the Registrar under the Rajasthan Co-operative Societies Act changed the character of the investment income from banking to non-banking income.

Issue (i): Whether interest income earned by a co-operative bank from investment of reserve funds in Government securities and similar approved securities was exempt as income attributable to banking business under section 80P(2)(a)(i) of the Income-tax Act, 1961.

Analysis: The investment of reserve funds was examined in the light of the Banking Regulation Act, 1949, the Reserve Bank of India Act, 1934, and the Rajasthan Co-operative Societies Act and Rules. The decisive consideration was whether the funds invested constituted circulating capital or stock-in-trade of the bank. The Court applied the principle that interest on securities can qualify for exemption only where the securities are held as part of the bank's banking operations and remain part of its circulating capital. Reserve-fund investments, which are not freely withdrawable and are available only in limited contingencies, do not answer that description.

Conclusion: The income from investment of reserve funds was not exempt under section 80P(2)(a)(i) and was against the assessee.

Issue (ii): Whether absence of sanction from the Registrar under the Rajasthan Co-operative Societies Act changed the character of the investment income from banking to non-banking income.

Analysis: The Court held that mere absence of Registrar's permission for a particular mode of investment did not by itself alter the intrinsic character of income. However, that question did not assist the assessee because, on the facts and the governing banking law, reserve-fund investments were not treated as banking business in the relevant sense. The references concerning other funds were left open only to the extent their nature and source required factual examination by the Tribunal.

Conclusion: The absence of Registrar's sanction did not by itself determine the character of the income, but the assessee still failed on the principal exemption issue.

Final Conclusion: Interest earned from reserve-fund investments of a co-operative bank, in the circumstances found, did not qualify as exempt banking income, and the references were answered for the Revenue.

Ratio Decidendi: Interest on securities derived from reserve funds is not exempt as income attributable to banking business unless the securities form part of the bank's circulating capital or stock-in-trade and are freely deployable in the ordinary course of banking operations.

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