TaxTMI 
TaxTMI 
2026 (6) TMI 1380
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....ssessee, a society, registered under The Karnataka Souharda Sahakari Act, 1997, claimed to be carrying on the business of banking or providing credit facilities to its members. In the return of income for the year relevant A.Y. 2017-18, the assessee declared total income at NIL after claiming deduction under section 80P(2)(a)(i) of the Act for a sum of Rs. 56,07,438/- only. 3. During the assessment, the AO observed that during the year, the assessee has 3 class of members i.e. A Class, C Class & D Class members. As per the byelaws of the society, "A" class members are permanent/regular members enjoying all the rights and privileges. On the other hand, "C & D" class members do not have voting rights, share of profit, do not hold share certificates, do not have access to books of accounts and right of participation in administration. They can only make deposits and avail the loan. The numbers of members of each class stand as under: - A Class - 863 - C Class - 978 - D Class - 230 3.1 Based on these facts the AO alleged that the assessee has non-members in the form of "C & D" class members which are 1.5 time more than the regular members (A Class). Hen....
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.... also catering 3 types of members viz "A, C & D" Class. The C & D class member are only allowed to make deposits and avail loans without participating in the profit and other function of the society like A class members. Hence, the business carried out with those members is like financing business and not the business in the nature of cooperative principle. Therefore, there is clear violation of principle of mutuality. According to the AO, in a cooperative society, there must be complete identity between the contributors and participators. The members who contribute to the common fund must also be entitled to participate in the surplus and affairs of the society. In the present case, the AO found that the assessee accepted deposits from nominal members and advanced loans to them for earning maximum returns, but such nominal members were not given equal rights in the society. Therefore, the AO held that the assessee was not functioning on the principle of mutuality, which is the basic foundation of a co-operative movement. 3.5 The AO held that as per section 18 of the Karnataka Co-operative Societies Act, 1959, as amended w.e.f. 06.09.2014, nominal members should not exceed 15% o....
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.... 5. Being aggrieved by the order of the learned CIT(A), the assessee is in appeal before us. 6. The learned AR before us submitted that the assessee is a cooperative society registered under the Karnataka Souharda Sahakari Act, 1997 and engaged in providing credit facilities only to its members. It was contended that A-Class, C-Class and D-Class members are recognized members under the State Act and, therefore, transactions with them cannot be treated as dealings with non-members. The learned AR submitted that the AO wrongly applied the decision in Citizen Cooperative Society Ltd. without appreciating the judgment of the Hon'ble Supreme Court in Mavilayi Service Co-operative Bank Ltd. It was further submitted that associate members were within the permissible limit prescribed under the State law. 7. On the other hand, the learned DR supported the orders of the lower authorities and submitted that the assessee was carrying on substantial business with C-Class and D-Class members who did not enjoy equal rights with regular members. It was contended that such members had no voting rights, no participation in management and no right to share profits and, therefore, could not be t....
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....that when the Income-tax Act does not define the word "member", the meaning of the word has to be taken from the concerned co-operative law under which the society is registered. The Hon'ble Supreme Court also explained and distinguished its earlier decision in Citizen Co-operative Society Ltd. and held that the said decision cannot be applied mechanically to every case where the society has nominal members. 8.3 In the present case, the assessee is registered under the Karnataka Souharda Sahakari Act / Karnataka co-operative law. State law recognizes nominal and associate members as members of society. Once the State Act recognizes such people as members, the Income-Tax Authorities cannot treat them as complete strangers or general public only because they do not have all rights equal to regular members. The Act itself does not require that every member must have identical rights in the society. Section 80P(2)(a)(i) of the Act only requires that the business of banking or providing credit facilities should be carried on with members. It does not say that such members must have voting rights, right to participate in management, or right to share profits. Therefore, the reasoning ....
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....ning this aspect. The lower authorities have only proceeded on the numerical comparison between regular members and nominal or associate members. They have not examined when such members were admitted, whether they were existing members prior to the amendment, whether there was any fresh admission beyond the prescribed limit after the amendment, and whether the State co-operative authority had treated the assessee as having violated the State Act. 8.7 In our considered view, the decision in Citizen Co-operative Society Ltd. cannot be applied in a mechanical manner. That decision was rendered on its own peculiar facts, where the assessee was found to have carved out a category of nominal members and carried on finance business in violation of the co-operative law applicable to it. The subsequent judgment of the Hon'ble Supreme Court in Mavilayi Service Co-operative Bank Ltd. has clarified that the word "member" has to be understood with reference to the concerned State Act and that the ratio of Citizen Co-operative Society Ltd. cannot be expanded to deny deduction to every co-operative society having nominal members. Therefore, the blanket denial of deduction made by the AO and c....
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....d that such a hybrid system is not permissible under the Income-tax Act, 1961. According to the AO, the assessee can follow either the cash system or the mercantile system of accounting, but it cannot follow both systems selectively for income and expenditure. The AO further observed that the assessee had claimed provision for interest for F.Y. 2016-17 at Rs. 45,27,514 and for F.Y. 2015-16 at Rs. 37,90,709. The excess provision debited came to Rs. 7,36,805 only. 10.2 The assessee explained that it was maintaining books as per the Karnataka Souharda Sahakari Act, 1997, Rules and audit guidelines issued by the Director of Co-operative Audit, Karnataka. It was submitted that as per such system, the assessee was required to provide for outstanding interest payable on members' deposits, whereas unrealized interest on loans was not accounted for. 10.3 The AO rejected the explanation. He held that if the assessee wanted to claim interest provision on accrual basis, then it should also have accounted for interest receipts on accrual basis. Since the assessee had not done so, the AO held that the excess provision of interest of Rs. 7,36,805/- was not allowable and brought the same to ....
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.... not arise from any independent or non-business source. It is only an adjustment made to the business profit of the assessee from its activity of providing credit facilities to its members. 14.1 Once the provision for interest is disallowed, the consequence is that the business income of the assessee gets enhanced to that extent. Such enhanced income continues to retain the same character as income derived from the business of providing credit facilities to members. The disallowance does not change the nature of income. It only increases the taxable profit as computed by the AO. Therefore, if the assessee is otherwise eligible for deduction u/s 80P(2)(a)(i) of the Act in respect of its income from providing credit facilities to its members, then such deduction cannot be denied merely because the income has increased on account of disallowance of expenditure. 14.2 In our considered view, the principle is clear that where an addition or disallowance results in enhancement of eligible business profit, the deduction admissible on such eligible profit has to be allowed on the enhanced figure, unless the addition relates to an income which is outside the eligible activity. In the p....