Co-op society partly succeeds; 80P(2)(a)(i) and 80P(2)(d) deductions allowed, 80P(4) inapplicable, AO to verify interest

ITAT allowed the assessee-co-operative society's appeal in part and issued directions to the AO. It held that interest on investments made with banks to comply with mandatory provisions of the Karnataka Co-operative Societies Act may qualify for deduction u/s 80P(2)(a)(i), subject to AO's verification that such investments were statutorily compelled. If any portion of interest is held taxable under "Income from Other Sources," corresponding allowable expenses must be granted. Further, ITAT held the assessee is not hit by s.80P(4) and is eligible for deduction u/s 80P(2)(d) on interest from co-operative banks, with AO to verify the quantum.

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1. ISSUES PRESENTED AND CONSIDERED

1.1 Whether interest income earned from investments with banks/co-operative banks, allegedly made under statutory compulsion under the Karnataka State Co-operative Societies Act, 1959 and Rules, qualifies as "business income" eligible for deduction under Section 80P(2)(a)(i) of the Income-tax Act, 1961.

1.2 Whether interest income earned by a co-operative society from deposits/investments with co-operative banks is eligible for deduction under Section 80P(2)(d), and whether such claim is affected by the exclusion in Section 80P(4).

1.3 Whether, in the event interest income (or any part thereof) is held not eligible for deduction under Section 80P(2)(a)(i), the assessee is entitled to deduction of corresponding expenditure while computing income under the head "Income from Other Sources".

1.4 Effect of non-pressing of certain general and natural justice grounds of appeal before the Tribunal.

1.5 Nature of the ground challenging levy of interest and its treatment as consequential.

1.6 Maintainability at this stage of the ground challenging initiation of penalty proceedings under Section 270A(2).

2. ISSUE-WISE DETAILED ANALYSIS

Issue 1 - Deduction under Section 80P(2)(a)(i) on interest from investments with banks/co-operative banks made under statutory compulsion

Interpretation and reasoning

2.1 The assessee contended that interest income of a substantial amount was earned from investments with co-operative banks and other banks made out of compulsion to comply with the Karnataka State Co-operative Societies Act, 1959 and the applicable Rules; hence such interest was incidental to its main business of providing credit facilities to members and constituted "business income" eligible for deduction under Section 80P(2)(a)(i).

2.2 The Tribunal relied on its earlier decision in Primary Agricultural Credit Co-operative Society Ltd. v. ITO (ITA No. 1006/Bang/2023), which in turn had followed the approach in Canara Bank Staff Credit Co-operative Societies Ltd. In these decisions, it was held that where investments with co-operative banks are made out of statutory compulsion under the Karnataka Co-operative Societies Act and Rules, the resultant interest income is to be treated as "income from business" eligible for deduction under Section 80P(2)(a)(i).

2.3 Following that precedent, the Tribunal held that the correct approach is first to verify whether the investments generating the interest income were indeed made to meet statutory requirements and, if so, to treat the interest therefrom as business income entitled to deduction under Section 80P(2)(a)(i).

Conclusions

2.4 The Assessing Officer is directed to verify the nature of the investments on which interest income has been received from banks. If it is found that the investments were made to comply with the Karnataka State Co-operative Societies Act, 1959 and the Rules framed thereunder, the interest income from such investments shall be treated as business income and deduction under Section 80P(2)(a)(i) shall be allowed.

Issue 2 - Deduction of expenditure if interest is taxed as "Income from Other Sources"

Interpretation and reasoning

2.5 The Tribunal addressed the contingency that some portion of the interest income may not be eligible for deduction under Section 80P(2)(a)(i) after verification.

2.6 It held that, in such a situation, the Assessing Officer must compute income under the appropriate head and grant deduction for corresponding expenses as permissible under the Act while treating such interest as "Income from Other Sources".

Conclusions

2.7 If, upon verification, any part of the interest income is held to be not eligible for deduction under Section 80P(2)(a)(i), the Assessing Officer shall allow deduction of corresponding expenditure as per the provisions of the Act while computing such income under the head "Income from Other Sources".

Issue 3 - Deduction under Section 80P(2)(d) on interest from co-operative banks and scope of Section 80P(4)

Legal framework as discussed

2.8 The Tribunal considered Section 80P(2)(d), which grants deduction to a co-operative society in respect of "any income by way of interest or dividend" derived from investments with any other co-operative society, and Section 80P(4), which excludes certain co-operative banks functioning at par with commercial banks from the benefit of Section 80P.

2.9 Reliance was placed on the decision of the Supreme Court in Mavilayi Service Co-operative Bank Ltd. v. CIT, wherein it was held that:

(a) For eligibility under Section 80P, the recipient must be a "co-operative society" as defined in Section 2(19), i.e., a society registered under the Co-operative Societies Act, 1912 or any State law for registration of co-operative societies; and

(b) Section 80P(4) was intended to exclude only those co-operative banks which function like commercial banks (lending to the public at large) from the benefit of Section 80P, and it does not apply where the recipient co-operative society itself does not hold a banking licence to lend to the public.

2.10 The Tribunal also referred to decisions including State Bank of India v. CIT and Pr. CIT v. Totagars Co-operative Sale Society to highlight that Section 80P(2)(d) uses the expression "any income by way of interest or dividend", without restricting it to "profits and gains of business", thereby indicating that the head of income (business income or income from other sources) is not determinative for the purpose of this clause.

Interpretation and reasoning

2.11 It was found as an admitted position that the assessee is registered as a co-operative society under the Karnataka State Co-operative Societies Act, 1959 and does not hold a banking licence issued by the Reserve Bank of India.

2.12 Based on Mavilayi, the Tribunal held that the assessee, being a co-operative society without an RBI banking licence, is not hit by Section 80P(4), and therefore continues to be eligible to claim deduction under Section 80P.

2.13 The Tribunal further held that for deduction under Section 80P(2)(d), what is relevant is that interest/dividend income is derived by a co-operative society from investments with another co-operative society, which may function as a co-operative bank. The characterisation of such income under different heads (business income or income from other sources) is immaterial given the language "any income by way of interest or dividend".

Conclusions

2.14 The assessee, being a co-operative society registered under the Karnataka State Co-operative Societies Act, 1959 and not holding a banking licence from RBI, is not excluded by Section 80P(4) and is eligible for deduction under Section 80P(2)(d).

2.15 The assessee's claim for deduction under Section 80P(2)(d) in respect of interest income earned from co-operative banks is allowed. The Assessing Officer is directed to verify the quantum of such interest income from co-operative banks and grant deduction accordingly.

Issue 4 - Effect of non-pressing of general and natural justice grounds

Interpretation and reasoning

2.16 General grounds challenging the order as being opposed to law and on facts, as well as the ground alleging violation of principles of natural justice by the appellate authority, were not argued before the Tribunal.

Conclusions

2.17 In the absence of any arguments advanced, these grounds were treated as not pressed and were dismissed.

Issue 5 - Ground on levy of interest (including under Section 234B) as consequential

Interpretation and reasoning

2.18 The ground challenging liability to interest was considered to arise only as a consequence of the ultimate determination of taxable income.

Conclusions

2.19 The ground relating to levy and computation of interest was disposed of as being consequential in nature, to be governed by the outcome of the assessment as modified in accordance with the Tribunal's directions.

Issue 6 - Challenge to initiation of penalty proceedings under Section 270A(2)

Interpretation and reasoning

2.20 The Tribunal noted that penalty proceedings are distinct and separate from assessment proceedings.

2.21 The ground of appeal was directed only against the initiation of penalty, not against any final penalty order.

Conclusions

2.22 The ground challenging initiation of penalty proceedings under Section 270A(2) was held to be premature and was dismissed.

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