Reserve-fund investment interest of a co-operative bank falls outside banking income, but disallowance must be on net interest after expenses.

Interest earned on reserve-fund investments by a co-operative bank was treated as income from non-trading assets, because the funds were subject to statutory control and were not part of circulating capital or stock-in-trade. On that footing, the Tribunal held that such interest did not qualify for exemption under section 80P(2)(a)(i), and the disallowance was upheld. However, when computing the amount denied exemption, the Tribunal accepted that proportionate administrative expenses attributable to earning the interest had to be deducted, so the disallowance was confined to net interest income. The assessee obtained only partial relief on this alternative computational issue.

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Issues: (i) Whether interest earned on investments made out of reserve funds of a co-operative bank qualified for exemption under section 80P(2)(a)(i) of the Income-tax Act. (ii) Whether, while disallowing the exemption on such interest, proportionate administrative expenses had to be deducted to arrive at the net amount.

Issue (i): Whether interest earned on investments made out of reserve funds of a co-operative bank qualified for exemption under section 80P(2)(a)(i) of the Income-tax Act.

Analysis: The reserve funds were governed by the Gujarat Co-operative Societies Act, 1961 and the Rules framed thereunder, under which investment of such funds was subject to statutory control and regulatory oversight. The Tribunal applied the principle that income from funds kept in long-term investments, including Government securities, debentures and fixed deposits, is not income from banking business when the funds are not part of circulating capital or stock-in-trade. It distinguished the authorities relied upon by the assessee and treated the later interest income as arising from non-trading assets outside the normal banking operations.

Conclusion: The interest income from investments to the extent of reserve funds did not qualify for exemption under section 80P(2)(a)(i) and the disallowance was upheld, against the assessee.

Issue (ii): Whether, while disallowing the exemption on such interest, proportionate administrative expenses had to be deducted to arrive at the net amount.

Analysis: The Tribunal accepted the assessee's alternative plea that the disallowance should be confined to net interest income, because the interest attributable to reserve-fund investments could not be isolated without allocating the corresponding administrative expenses incurred in earning it. It therefore directed that proportionate expenses be deducted before computing the amount on which exemption was denied.

Conclusion: Proportionate administrative expenses were required to be deducted, in favour of the assessee.

Final Conclusion: The exemption claim on interest from reserve-fund investments was rejected, but the disallowance had to be worked out on a net basis after deducting proportionate expenses, resulting in a partial relief.

Ratio Decidendi: Interest on reserve-fund investments is not attributable to banking business where the funds are not part of circulating capital or stock-in-trade, and any disallowance on such income must be computed on the net interest after allowing proportionate s of earning it.

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