1996 (1) TMI 8 - SC - Income Tax

Section 81 exempts income from cooperative society banking but taxes non-banking activities and earmarked investment interest

SC held that section 81 exempts income from a co-operative society's banking or credit business, but income from activities not constituting normal ... Entitlement to the benefit of section 81 - interest earned on securities earmarked against reserves and interest earned on provident fund deposits - Co-operative society registered under the Madhya Pradesh Co-operative Societies (Amalgamation) Act, 1957 ('the Act') - HELD THAT:- There can be no doubt that the object of section 81 was to encourage co-operative movement in the country by providing tax exemption to those co-operatives engaged in activities set out in clauses (a) to (f) thereof. One such activity is the carrying on of the business of banking or providing credit facilities to its members by a co-operative society. The section, therefore, provides that income-tax shall not be payable by a co-operative society in respect of the profits and gains of business carried on by it, if it arises from the business of banking or providing credit facilities for its members. However, if such a co-operative society also engages itself in activities other than the business of banking or providing credit facilities the profits derived from such business shall not be exempt from tax if it exceeds rupees fifteen thousand. It is, therefore, obvious that the entire income derived by a co-operative society from the business of banking or providing credit facilities to its members is exempt from income-tax, but if that society also engages itself in any other activity and earns-profit therefrom, the income so derived becomes liable to assessment and payment of income-tax, if it exceeds the ceiling amount. The normal banking activity is to receive deposits and utilise such deposits by advancing loans, etc., to borrowers. Since the rate at which interest is paid to depositors is lower than the rate charged from borrowers, the difference in the rates generates income for the banks. The banks may have to maintain certain reserves to meet with emergencies, e.g., a spurt in withdrawals by depositors for diverse reasons. Investments which permit withdrawals at short notice would, therefore, be a part of the requirement of banking business and interest accruing on such investments would be outside the tax net. It is clearly understood in banking parlance that circulating capital is that which is put into circulation or turned over to earn profits. Government securities coming out of the reserve fund which cannot be easily encashed and which can be utilised only when the contingencies mentioned therein arise cannot be considered to be circulating capital or stock-in-trade. It is more or less in the nature of a fixed asset of the society, being out of circulation for an indefinite period. It is, so to say, at arm's length from the normal banking business, to be utilised on the happening of certain events, events which may virtually bring a cessation of the business. If that be the purpose and object of setting apart the funds in the form of the Government securities and the like, it cannot be reasonably contended that the funds placed in cold storage continue to constitute the bank's stock-in-trade or circulating capital. Learned counsel for the Revenue was, therefore, right in contending that the case law cited at the Bar by learned counsel for the assessee cannot come to the rescue of the assessee. According to us, what the proviso seeks to convey is that even if a co-operative society is engaged only in the business of banking, but part of its activity is not attributable, to engagement in such activity, income derived from that part of activity would become taxable. And as held above, the income derived from the investment in Government securities placed with the State Bank of India/ Reserve Bank of India cannot be regarded as an essential part of its banking activity inasmuch as the same does not form part of its stock-in-trade or working/circulating capital. Therefore, we see no force in Mr. Salve's premises. For the above reasons, we see no merit in these appeals and dismiss the same with costs. Issues Involved:1. Whether the income from interest accruing on Government securities earmarked for reserve fund/provident fund qualifies for exemption under section 81 of the Income-tax Act.2. Whether the interest on provident fund deposits is exempt from tax.Detailed Analysis:1. Interest on Government Securities and Section 81 Exemption:The primary issue was whether the interest earned on Government securities earmarked for reserve fund/provident fund can be considered income derived from the business of banking under section 81 of the Income-tax Act, 1961, to qualify for tax exemption. Section 81 provides that income tax shall not be payable by a co-operative society in respect of the profits and gains of business carried on by it, specifically if it is engaged in banking or providing credit facilities to its members. However, the proviso states that if a co-operative society is also engaged in other activities, the exemption does not apply to profits from such activities exceeding fifteen thousand rupees.The court clarified that not every income of a society carrying on banking business is exempt from tax; only the income from banking business is exempt. The assessee, an apex body controlling all District Co-operative Banks, argued that its entire income was from banking business and thus exempt under section 81. However, the Income-tax Officer and higher authorities rejected this claim.The court examined whether the interest earned on Government securities placed with the State Bank of India or the Reserve Bank could qualify for exemption. The M.P. Government's Instructions mandated that the reserve fund of the apex bank be fully invested in Government securities and not utilized as working capital. The court noted that the reserve fund investments could not be withdrawn without the Registrar's permission, indicating they were not part of the bank's circulating or working capital. Consequently, the interest earned on these securities did not qualify for exemption under section 81 as it did not form part of the bank's stock-in-trade or circulating capital.2. Interest on Provident Fund Deposits:The second issue was whether the interest on provident fund deposits was exempt from tax. The interest on provident fund deposits was included in the profit and loss account of the bank. The Tribunal noted that even the assessee's counsel found it difficult to justify the claim, acknowledging that the interest should not have been included in the profit and loss account since it belonged to the provident fund, with the bank merely holding those deposits as trustees. The Tribunal held that since the interest was included in the profit and loss account of the assessee and shown as earnings, it was liable to tax. The Tribunal's approach was justified as the foundational facts were not established, and the assessee's counsel did not press the contention further.Conclusion:The court concluded that the object of section 81 was to encourage the co-operative movement by providing tax exemption to co-operatives engaged in specified activities, including banking. However, the exemption applied only to income derived from the business of banking or providing credit facilities to members. The court held that the interest on Government securities relating to the reserve fund did not qualify for exemption under section 81 as it did not constitute the bank's circulating capital or stock-in-trade. The interest on provident fund deposits was also taxable as it was included in the profit and loss account and did not form part of the bank's circulating capital.The appeals were dismissed with costs, affirming that the income from Government securities and provident fund deposits did not qualify for tax exemption under section 81 of the Income-tax Act.