Tax deduction exemption classification upheld as rational, while co-operative bank exemption position remained governed by the earlier explanatory note.

The proviso inserted in Section 194A(3) of the Income-tax Act, 1961, was upheld as a valid classification because it lawfully limited the tax-deduction exemption for co-operative societies by turnover and interest thresholds, and the challenge based on arbitrariness failed. Co-operative banks were held not to derive their exemption position from the new proviso, since the CBDT explanatory note to the Finance Act, 2015 continued to govern the practical exemption for time deposits credited to co-operative society depositors. No interference was warranted with the clarification protecting transactions covered by interim orders, as those transactions had been acted upon during the pendency of the writ petitions. The appeals were dismissed.

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Issues: (i) whether the proviso inserted in Section 194A(3) of the Income-tax Act, 1961, creating thresholds for co-operative societies, was unconstitutional as an arbitrary classification; (ii) whether co-operative banks and urban banks were excluded from the effect of the proviso and were instead governed by the CBDT explanatory note to the Finance Act, 2015; and (iii) whether the clarification protecting transactions covered by interim orders from adverse consequences was liable to be interfered with.

Issue (i): whether the proviso inserted in Section 194A(3) of the Income-tax Act, 1961, creating thresholds for co-operative societies, was unconstitutional as an arbitrary classification.

Analysis: Section 194A(1) mandates deduction of tax at source, while Section 194A(3) creates exemptions for specified co-operative societies. The impugned proviso, introduced by the Finance Act, 2020, did not withdraw the legislative power to grant or curtail exemptions, but only limited the exemption to societies below the prescribed turnover and interest thresholds. The classification was held to rest on a rational basis tied to the size and nature of the societies and did not offend the constitutional scheme.

Conclusion: The challenge to the constitutional validity of the proviso failed and the provision was upheld in favour of the Revenue.

Issue (ii): whether co-operative banks and urban banks were excluded from the effect of the proviso and were instead governed by the CBDT explanatory note to the Finance Act, 2015.

Analysis: On the plain text of Section 194A(3)(v), co-operative banks are not within the statutory exemption for deduction of tax at source in respect of payments to their member-societies. However, the CBDT explanatory note clarified that the existing exemption for interest paid by a co-operative society to another co-operative society would continue to apply to co-operative banks for time deposits credited to co-operative society depositors. The proviso introduced in 2020 was directed to the remaining categories of co-operative societies and did not govern the exemption position of co-operative banks, which derived from the earlier explanatory note.

Conclusion: The proviso was held to have no bearing on the exemption position of co-operative banks, but the appeals nevertheless failed because the statutory challenge to the proviso itself was rejected.

Issue (iii): whether the clarification protecting transactions covered by interim orders from adverse consequences was liable to be interfered with.

Analysis: The interim orders had restrained deduction of tax at source during the pendency of the writ petitions, and the parties had acted in obedience to those orders. In view of the practical impossibility of undoing the consequences after the relevant assessment years had passed, the confirmation of the interim protection for transactions effected under those orders was treated as justified and consistent with the administration of justice.

Conclusion: No interference was called for with the clarification made in respect of transactions covered by the interim orders.

Final Conclusion: The impugned proviso was upheld, the contentions of the appellants were rejected, and the connected appeals were dismissed while preserving the limited protection granted for transactions undertaken under the subsisting interim orders.

Ratio Decidendi: The Legislature may lawfully restrict a statutory tax exemption by a rational classification, and a CBDT explanatory note may govern the practical exemption position of co-operative banks where the text of the provision does not itself confer that benefit.

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