Banking income attribution test governs exemption for incidental receipts, but earmarked security interest remains taxable

Interest on securities earmarked against reserve and provident funds was held not to arise from the co-operative bank's business activity, so it did not qualify for exemption under section 81 of the Income-tax Act, 1961. By contrast, income from commission, exchange and miscellaneous receipts attributable to banking activity was treated as income from banking business and remained exempt under section 81. The controlling test applied was whether the receipt was attributable to an activity normally forming part of banking business; incidental receipts so connected were deductible, while earmarked security interest was not.

---

---

Issues: (i) Whether interest on securities earmarked against reserve and provident funds was income from business and exempt under section 81 of the Income-tax Act, 1961. (ii) Whether income from commission, exchange and miscellaneous sources in the hands of the assessee co-operative bank was income from banking business and exempt under section 81 of the Income-tax Act, 1961.

Issue (i): Whether interest on securities earmarked against reserve and provident funds was income from business and exempt under section 81 of the Income-tax Act, 1961.

Analysis: The issue was covered by the earlier binding decision of the same court, and the interest earned on securities set apart against reserve and provident funds was treated as not arising from the assessee's business activity for the purpose of the exemption.

Conclusion: The answer is against the assessee. Such interest was not exempt under section 81 of the Income-tax Act, 1961.

Issue (ii): Whether income from commission, exchange and miscellaneous sources in the hands of the assessee co-operative bank was income from banking business and exempt under section 81 of the Income-tax Act, 1961.

Analysis: The exemption depended on whether the receipts were attributable to an activity normally forming part of the business of banking carried on by a co-operative society. The court followed its earlier view that income from commission, exchange and similar incidental receipts attributable to banking activity falls within the deductible business income, and the Banking Regulation Act did not displace that conclusion for the purpose of the exemption claimed.

Conclusion: The answer is against the Revenue. The income from commission, exchange and miscellaneous sources was exempt under section 81 of the Income-tax Act, 1961.

Final Conclusion: The reference was answered by holding that the claim failed on the interest on securities issue, but succeeded on the commission, exchange and miscellaneous income issues, leaving the parties to bear their own costs.

Ratio Decidendi: For exemption of a co-operative society's banking receipts, the controlling test is whether the income is attributable to an activity normally forming part of banking business; incidental receipts so attributable qualify for deduction, while interest on securities earmarked against reserve and provident funds does not.

---