Assessee wins appeal against revision order under section 263 for section 80P(2)(d) deduction on cooperative bank interest income

ITAT Rajkot allowed the assessee's appeal against PCIT's revision order u/s 263 regarding deduction u/s 80P(2)(d) for interest income from cooperative bank fixed deposits. The tribunal held that the AO had conducted adequate inquiry u/s 142(1), examined submitted documents, and taken a plausible view sustainable in law. The Gujarat HC judgment in Katlery Karayana case cited by PCIT was inapplicable to the assessee's circumstances. Following SC precedent in Malabar Industries, the tribunal found the AO's order was neither erroneous nor prejudicial to revenue interests, making PCIT's assumption of revisional jurisdiction null and void.

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1. ISSUES PRESENTED and CONSIDERED

The core legal questions considered in this appeal are:

(i) Whether the order passed by the Assessing Officer (AO) under section 143(3) of the Income-tax Act, 1961, for AY 2018-19, allowing deduction under section 80P(2)(d) of the Act in respect of interest and dividend income earned from a Co-operative Bank, is erroneous and prejudicial to the interest of revenue, thereby justifying exercise of revisional jurisdiction under section 263 of the Act by the Principal Commissioner of Income-tax (PCIT)Rs.

(ii) Whether interest income earned by a Co-operative Society from fixed deposits with a Co-operative Bank qualifies for deduction under section 80P(2)(d) of the Income-tax ActRs.

(iii) Whether the AO conducted adequate inquiries and applied correct legal principles while allowing the deduction under section 80P(2)(d) of the ActRs.

(iv) The applicability and binding nature of various judicial precedents, including decisions of the Hon'ble Gujarat High Court and Supreme Court, on the issue of eligibility of deduction under section 80P(2)(d) in respect of interest income from Co-operative Banks.

2. ISSUE-WISE DETAILED ANALYSIS

Issue (i) & (iii): Whether the AO's order was erroneous and prejudicial to the interest of revenue and whether proper inquiries were madeRs.

Legal Framework and Precedents: Section 263 of the Income-tax Act empowers the PCIT to revise an order passed by the AO if it is erroneous and prejudicial to the interest of revenue. Explanation 2 to section 263 expands the scope by declaring an order to be erroneous if it is passed without making inquiries or verification which should have been made, or if it is passed allowing relief without inquiry, or not in accordance with judicial decisions.

The Supreme Court in Malabar Industries Ltd. vs. CIT has laid down twin conditions for exercise of revisional jurisdiction under section 263: the AO's order must be erroneous and prejudicial to the interest of revenue. An order is erroneous if it is based on incorrect facts, incorrect application of law, violation of natural justice, lack of application of mind or failure to investigate the issue. However, if the AO has taken a plausible view sustainable in law, the order cannot be held erroneous.

Court's Interpretation and Reasoning: The PCIT held that the AO's order was erroneous and prejudicial because the AO allowed deduction under section 80P(2)(d) on interest income from fixed deposits with a Co-operative Bank without proper inquiry and in contravention of the judgment of the Hon'ble Gujarat High Court in Katlary Kariyana Merchant Sahkari Sarafi Mandali Ltd., which held such interest income ineligible for deduction.

However, the Tribunal examined the assessment record and noted that the AO had issued a notice under section 142(1) of the Act, specifically calling for details and documentary evidence regarding the eligibility of deduction under section 80P(2)(d). The assessee submitted detailed replies and documents, which were duly considered by the AO before passing the assessment order.

The Tribunal observed that mere issuance of notice and examination of replies by the AO is not sufficient; the AO's order must also be sustainable in law. The Tribunal found that the AO had taken a plausible view based on binding judicial precedents favorable to the assessee (discussed below), and thus the AO's order could not be termed erroneous or prejudicial.

Application of Law to Facts: Since the AO had conducted inquiry and applied judicial precedents supporting the assessee's claim, the order was not passed without application of mind or without inquiry. The AO's view was plausible and sustainable in law, precluding interference under section 263.

Treatment of Competing Arguments: The PCIT relied heavily on the Katlary Kariyana judgment and considered the AO's failure to follow it as a mistake apparent on record. The Revenue's representative argued that the AO's order was unsustainable and the PCIT rightly exercised jurisdiction. The assessee contended that the AO had examined the issue and taken a plausible view based on binding precedents. The Tribunal agreed with the assessee, distinguishing the Katlary Kariyana judgment as not applicable to the facts and noting that the AO's order was supported by earlier binding decisions.

Conclusion: The AO's order was not erroneous or prejudicial to the interest of revenue, and the PCIT's exercise of jurisdiction under section 263 was unjustified.

Issue (ii): Whether interest income earned by a Co-operative Society from fixed deposits with a Co-operative Bank qualifies for deduction under section 80P(2)(d)Rs.

Legal Framework: Section 80P(2)(d) allows deduction in respect of income by way of interest or dividends derived by a co-operative society from its investments with any other co-operative society. The Finance Act, 2006 introduced section 80P(4), excluding co-operative banks (other than primary agricultural credit societies or primary co-operative agricultural and rural development banks) from the benefits under section 80P.

Judicial precedents have interpreted the scope of section 80P(2)(d) and the principle of mutuality, which underpins the exemption. The Supreme Court in CIT vs. Kumbakonam Mutual Benefit Fund Ltd. and M/s Bangalore Club vs. CIT held that interest earned from investments with entities not satisfying mutuality principles, such as co-operative banks functioning like commercial banks, is not eligible for deduction under section 80P.

The Hon'ble Gujarat High Court in Katlary Kariyana (2022) held that interest income from fixed deposits with co-operative banks is not eligible for deduction under section 80P(2)(d), as co-operative banks are distinct from co-operative societies and function like commercial banks.

However, earlier decisions of the Gujarat High Court, including Sabarkantha District Co-operative Milk Producers Union Ltd. and Surat Vankar Sahakari Sangh Ltd., held that interest income from co-operative banks is eligible for deduction under section 80P(2)(d). These precedents were not expressly overruled by Katlary Kariyana.

Court's Interpretation and Reasoning: The Tribunal noted that the definition of "co-operative society" in section 2(19) of the Act does not exclude co-operative banks. A co-operative bank is initially a co-operative society that obtains RBI license to conduct banking business. The Katlary Kariyana judgment was rendered in the context of section 194A and assessment reopening under section 147, and is thus distinguishable and not binding for the present case.

The Tribunal observed that the AO relied on the earlier binding decisions of the Gujarat High Court which allowed deduction for interest income from co-operative banks, and these decisions have not been overruled or distinguished by a larger bench. The Tribunal also noted that the Supreme Court decision in Totagars Co-operative Sale Society Ltd. relates to section 80P(2)(a)(i) and not section 80P(2)(d), and therefore is distinguishable.

Application of Law to Facts: The interest income from fixed deposits with the Amreli Jilla Madhyasth Sahakari Bank Ltd. (a co-operative bank) was shown as income and deduction was claimed under section 80P(2)(d). The AO accepted this claim based on binding precedents. The PCIT's contrary view based on Katlary Kariyana was found not applicable to the facts and legal context.

Treatment of Competing Arguments: The Revenue relied on Katlary Kariyana and subsequent ITAT decisions supporting it. The assessee relied on earlier Gujarat High Court decisions and other High Court and Tribunal decisions favoring deduction under section 80P(2)(d) for interest from co-operative banks. The Tribunal preferred the earlier binding precedents and distinguished Katlary Kariyana.

Conclusion: Interest income earned by the assessee from fixed deposits with the co-operative bank qualifies for deduction under section 80P(2)(d) of the Act.

3. SIGNIFICANT HOLDINGS

"The twin conditions needs to be satisfied before exercising revisional jurisdiction u/s 263 of the Act by the CIT. The twin conditions are that the order of the Assessing Officer must be erroneous and so far as prejudicial to the interest of the Revenue. In the following circumstances, the order of the AO can be held to be erroneous order, that is (i) if the Assessing Officer's order was passed on incorrect assumption of fact; or (ii) incorrect application of law; or (iii) Assessing Officer's order is in violation of the principle of natural justice; or (iv) if the order is passed by the Assessing Officer without application of mind; (v) if the AO has not investigated the issue before him; then the order passed by the Assessing Officer can be termed as erroneous order. When the Assessing Officer adopted one of the courses permissible in law and it has resulted in loss to the revenue, or where two views are possible and the Assessing Officer has taken one view with which the CIT does not agree, it cannot be treated as an erroneous order prejudicial to the interest of the revenue unless the view taken by the Assessing Officer is unsustainable in law."

"The judgment of the Hon'ble Gujarat High Court in the case of Katlary Karayana Merchant Sahkari Sarafi Mandali Ltd. is in the context of a specific definition mentioned in section 194A of the Act and in the context of reopening of assessment u/s 147/148 of the Act. It is distinguishable and not binding precedent on the assessee for the issue under consideration."

"The earlier decisions of the Hon'ble Gujarat High Court in the cases of Sabarkantha District Co-operative Milk Producers Union Ltd. and Surat Vankar Sahakari Sangh Ltd. which held that interest income from co-operative banks is eligible for deduction under section 80P(2)(d) have not been overruled or distinguished by a larger bench and are binding precedents applicable to the assessee."

"The principle of judicial discipline requires following binding decisions of the jurisdictional High Court, but the AO's order is sustainable in law when based on binding precedents, even if the PCIT takes a different view."

"The order passed by the PCIT under section 263 of the Act is ab initio void and is quashed as the AO's order is neither erroneous nor prejudicial to the interest of revenue."

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