2024 (6) TMI 1500 - AT - Income Tax

Registered co-operative entitled to deduction under section 80P(2)(i); statutory deposit interest deductible, non-statutory interest taxable under section 56.

Kavradi Co-operative Agricultural Bank Versus ITO Ward-2 Udupi

ITAT held that the assessee, being a registered co-operative under the Karnataka Act, cannot be denied deduction u/s 80P or be disqualified as a ... Deduction u/s 80P - denial of deduction as assessee had violated the provisions of the Karnataka Co-operative Societies Act by having more number of nominal and associate members than prescribed u/s 18 - HELD THAT:- AO cannot disallow the claim of deduction and also disqualify the assessee as a Coop society for the reason that the assessee is dealing with the nominal members when there is no prohibition under the Act. The only condition prescribed under the Act is that the assessee should be a registered Coop. Society under the provisions of the Coop Societies Act. Admittedly the assessee is registered under the Karnataka Act and therefore the deduction can not be denied by citing other reasons. We find that the issue is fully covered by the judgement of case of Mavilayi Service Co-operative Bank Ltd. [2021 (1) TMI 488 - SUPREME COURT] We therefore, find that there is no merit in the arguments made by the ld. D.R. and held that the order of the ld. AO is against the provisions of the Act and also against the judgement rendered by the Hon’ble Supreme Court. Disallowance of the interest income received from Co-operative banks - Argument made by the A.R. that the deposits were made pursuant to the statutory obligation contained in the Karnataka Act and Rules - HELD THAT:-Assessee themselves admitted that the total statutory deposit and the balance deposits is not as per the statute. Therefore, the interest income generated from the statutory deposits are eligible for deduction u/s 80P(2)(i) of the Act. The balance non statutory deposits interest income should be taxed u/s 56 of the Act after granting deductions of cost of funds and administrative and other related expenses. Thus remitting the issue to the jurisdictional AO to examine whether the interest income received on investments with co-operative bank is out of compulsion under the provisions of the Karnataka Co-operative Societies Act and if so, the same may be considered under business income and the assessee is entitled for relief u/s 80P(2)(a)(i) after quantifying the correct income. In so for as the interest income received from other commercial banks the ld AO is directed to verify if there is any statutory compulsion, otherwise the same should be treated as income from other sources and the assessee is entitled for the cost of funds. Whether the provision made for the interest expenses is eligible for deduction u/s 80P? - We perused the provision and the other financial statements filed by the assessee and found that the assessee made provisions for interest expenses on an accrual basis which is in accordance with the accounting policies as prescribed under Karnataka Co-operative Societies Act. Rule 22 of the Karnataka Co-operative Societies Rules specifies that interest income should be accounted for on an actual receipts basis while interest expenses should be recognized on an accrual basis. Therefore, the assessee, a registered society registered under the Karnataka Act, have to follow Rule 22 of the Karnataka Co-op. Societies Rules and therefore the method of accounting is in accordance with the Karnataka Rules and therefore the AO’s allegation that they are employing hybrid system of accounting one for the interest income and the other for the interest expenses is not correct. We therefore held that the disallowance of the Provision for Net Interest Expenses is not correct. We therefore, find that this issue is in favour of the assessee and we allow the appeal of the assessee in so far as the provision made for the interest expenses are concerned. ISSUES PRESENTED AND CONSIDERED 1. Whether deduction under section 80P(2)(a)(i) can be disallowed on the ground that the cooperative society has more nominal or associate members than permitted under section 18 of the Karnataka Co-operative Societies Act. 2. Whether interest income earned on deposits with co-operative banks and other scheduled/commercial banks is eligible for deduction under section 80P(2)(a)(i) where such deposits are made pursuant to statutory compulsion under the Karnataka Co-operative Societies Act and Rules. 3. Whether provisions made for interest expenses (accrued interest) are deductible under section 80P where interest income is accounted on receipt basis and interest expense on accrual basis pursuant to Rule 22 of the Karnataka Co-operative Societies Rules. ISSUE-WISE DETAILED ANALYSIS Issue 1 - Disallowance of section 80P(2)(a)(i) deduction based on alleged breach of membership limits under Karnataka Co-operative Societies Act Legal framework: Section 80P(2)(a)(i) grants deduction in respect of income of a co-operative society carrying on the business of providing credit facilities, subject to the society being a registered co-operative under the relevant State Act; the Karnataka Co-operative Societies Act prescribes limits for nominal/associate membership (associate members not to exceed 15% of total membership). Precedent treatment: The Court applied and followed the Supreme Court judgment in Mavilayi Service Co-operative Bank Ltd. v. CIT which addresses entitlement to section 80P benefits and the conditions for cooperative status; coordinate decisions of the Tribunal dealing with similar issues were cited and followed where applicable. Interpretation and reasoning: The Court examined the statutory provision and the society's membership statement and found the associate/nominal members within the 15% threshold prescribed by the Karnataka Act. The assessing officer lacked jurisdiction to adjudicate alleged violations of the State Act as a ground to deny tax deduction; enforcement and remedial action for breaches of the State Act lie with the Registrar of Co-operative Societies. The only condition for section 80P entitlement is registration under the State Act, which was undisputedly satisfied. Ratio vs. Obiter: Ratio - an assessing officer cannot disqualify a registered co-operative society from section 80P deduction by alleging breaches of the State Co-operative Act (membership composition) where registration exists and the statutory threshold is not breached. Obiter - general observations on jurisdiction of Registrar vs. AO for enforcement of State Act (supporting the ratio). Conclusion: Disallowance of the deduction on the membership-composition ground was unsustainable; the AO's order was set aside on this issue in line with the Supreme Court authority. Issue 2 - Eligibility of interest income from deposits with co-operative banks and commercial banks for deduction under section 80P(2)(a)(i) Legal framework: Section 80P(2)(a)(i) permits deduction for income of a co-operative society from its credit business; classification of interest income as business income (eligible for section 80P) depends on whether deposits/investments were made in the ordinary course of the society's business or pursuant to statutory compulsion under the State Co-operative Act and Rules. Non-compulsory deposits may constitute income from other sources (section 56) subject to allowable deductions like cost of funds. Precedent treatment: The Court relied on coordinate Bench decisions which held that interest earned on investments made 'out of compulsion' under the Karnataka Co-operative Societies Act/Rules (e.g., statutory mandatory deposits with Central Co-operative Bank) may be treated as business income and be eligible for section 80P deduction; those decisions were followed and applied to the facts. Interpretation and reasoning: The Tribunal parsed the assessee's own tabulation showing statutory deposits (Rs.3,03,00,221) and non-statutory balances (Rs.97,44,751). Interest attributable to statutory deposits (made pursuant to a statutory obligation) is to be treated as business income and thus eligible for deduction under section 80P(2)(a)(i). Interest on non-statutory deposits lacks the element of compulsion and should be taxed under section 56 after allowing appropriate cost of funds and administrative expenses. Given disputed factual quantification and the need for verification of whether specific deposits were made under statutory compulsion, the matter was remitted to the assessing officer for fresh examination and quantification after affording opportunity to the assessee. Ratio vs. Obiter: Ratio - interest income on deposits made under statutory compulsion pursuant to the State Co-operative Act/Rules can be treated as business income and is eligible for deduction under section 80P(2)(a)(i); interest on non-statutory deposits is taxable under section 56 subject to allowable cost allocations. Obiter - detailed guidance on treatment and quantification procedures pending AO verification. Conclusion: The Tribunal set aside the AO's blanket disallowance and remitted the quantification and classification of interest income (statutory vs. non-statutory) to the AO to decide in accordance with law after hearing the assessee. Issue 3 - Deductibility of provisions for interest expenses where accounting treats interest income on receipt basis and interest expense on accrual basis (Rule 22) Legal framework: Rule 22 of the Karnataka Co-operative Societies Rules prescribes that interest income shall be accounted on actual receipt basis while interest expenses may be recognized on accrual basis; mercantile (accrual) system and consistent accounting policies are relevant for deductibility. Precedent treatment: The Tribunal relied on coordinate Bench rulings (e.g., Sumangala Credit Co-operative Society v. ITO) holding that provisions for interest expenses made consistently under the mercantile system, and in conformity with State Rules, are allowable; such provisions are not to be treated as unascertained liabilities or disallowed on the ground of alleged hybrid accounting when the State Rules prescribe differing bases for income and expense recognition. Interpretation and reasoning: The assessee followed Rule 22 in accounting interest income on receipt and recognizing interest expense on accrual basis; this method was consistent with the Karnataka Co-operative Societies Rules and applied uniformly. The AO's characterization of this method as an impermissible hybrid system was rejected. The provision for interest expense represented a regular, ascertainable accrual in accordance with prescribed accounting policy and thus constituted an allowable deduction under section 80P. Ratio vs. Obiter: Ratio - provisions for interest expense recognized on accrual basis pursuant to Rule 22 and consistent accounting practice are deductible; AO cannot disallow such provisions merely because interest income is recognized on receipt basis as required by the State Rules. Obiter - remarks on mutuality and unascertained liabilities were referenced in support of the ratio. Conclusion: The disallowance of the provision for net interest expenses was reversed and the deduction allowed. Disposition and directions The Court partly allowed the appeal: (a) set aside the disallowance based on alleged membership-composition violations; (b) allowed deduction for provisions for interest expenses; and (c) remitted classification and quantification of interest income from co-operative and commercial banks to the assessing officer to determine whether specific deposits were made under statutory compulsion and to apply section 80P(2)(a)(i) or section 56 treatment accordingly, after giving the assessee an opportunity of being heard.