COMMISSIONER OF INCOME TAX vs. RATNAGIRI DISTRICT CENTRAL CO-OPERATIVE BANK LTD.

HIGH COURT OF BOMBAY

S.H. Kapadia & V.C. Daga, JJ.

IT Ref. No. 474 of 1997

10th September, 2001

(2001) 69 CCH 0857 MumHC

(2002) 174 CTR 0116 : (2002) 254 ITR 0697 : (2002) 120 TAXMAN 0077

Legislation Referred to

S 80P(2)(a)(i), 260A

Case pertains to

Asst. Year –

Decision in favour of:

Assessee

Deduction under s. 80P(2)(a)(i) Business of banking Interest on Indira Vikas Patra If the income is derived from the business of banking, then only it will fall within the exemption, but if it arises from and out of the business with third party as in case of investment of surplus assets, the exemption is not available Investment made to generate income must form part of circulating capital or stock-in-trade of the bank Business must have a direct or proximate connection with or nexus to the earnings in order to attract the provisions of s. 80P(2)(a)(i) Facts available on record suggest that interest income was attributable to assessee’s business and the investment in Indira Vikas Patras were made from fund generated from the banking business Interest income derived from Indira Vikas Partras was clearly from and out of banking business and, therefore, entitled to exemption under s. 80P(2)(a)(i) No substantial question of law arises

Held :

If the income is derived by a co-operative society (bank) from the business of banking, then only it will fall within the exemption, but if it arises from and out of the business with third party as in case of investment of surplus assets, the exemption is not available because investment of fluid assets is not a part of business of banking. The income must be attributable to banking facility. The investment made to generate income must form part of circulating capital or stock-in-trade of the (co-operative) bank. The business must have a direct or proximate connection with or nexus to the earnings in order to attract the provisions of s. 80P(2)(a)(i). It follows that each investment has to be examined, considered and decided on its own merits applying the above norms derived from the various precedents. In order to apply these principles, investigation of facts and definite findings is necessary. The investments made in IVPs no doubt had an effect of withdrawing funds from the banking business. Mere withdrawal of funds is not sufficient. It must be proved that the withdrawal of funds have resulted in permanent deprivation of funds for banking activity. It ought to have been examined as to whether such investments had an effect of temporary withdrawal of the funds or the investments made in IVP could be brought back to the banking business. In absence of detailed enquiry in the nature of available surplus and investments thereof, it is difficult to go along with the submissions made by the Revenue. No enquiry in this behalf was made by any of the authorities below. It was obligatory on the part of the fact-finding authorities below to make enquiry and record finding of fact in this behalf. No such attempt was made by either of the authorities below in this regard. Therefore, the Court has to decide these matters on the facts found and available on record. The facts found and available on record do suggest that the interest income was attributable to the assessees’ business income and the investment made in IVPs are investments made from the fund generated from the banking business. It has a direct and proximate connection with or nexus to the earning from banking business in order to attract provisions of s. 80P(2)(a)(i). In the facts and circumstances, findings recorded in favour of the assessees and against the Revenue are upheld.

(Paras 24 to 28)

Conclusion :

Interest income derived from Indira Vikas Patras by assessee-societies engaged in banking business was clearly from and out of banking business and, therefore, entitled to exemption under s. 80P(2)(a)(i).

In favour of :

Assessee

Cases referred:

Bihar State Co-operative Bank Ltd. vs. CIT (1960) 39 ITR 114 (SC) : TC 26R.636

Cambay Electric Supply Industrial Co. Ltd. vs. CIT 1978 CTR (SC) 50 : (1978) 113 ITR 84 (SC) : TC 25R.306

CIT vs. Bangalore District Co-op. Central Bank Ltd. (1998) 148 CTR (SC) 226 : (1998) 233 ITR 282 (SC) : TC S26.2714

Gujarat State Co-op. Bank Ltd. vs. CIT (2001) 167 CTR (Guj) 34

M.P. Co-operative Bank Ltd. vs. Addl. CIT (1996) 134 CTR (SC) 92 : (1996) 218 ITR 438 (SC) : TC S26.2715

M.P. State Co-operative Bank Ltd. vs. Addl. CIT (1979) 8 CTR (MP) 361 : (1979) 119 ITR 327 (MP) : TC 26R.707

Counsel appeared:

R.V. Desai with J.P. Deodhar & P.S. Jetly i/b. H.D. Rathod, for the Appellant : S.N. Inamdar with P.Y. Vaidya, V.H. Patil with Ms. Jyoti Dialani & S.M. Lala, K.B. Bhujle & B.R. Naik with P.R. Naik, for the Respondents

V.C. DAGA, J.

*Also CIT vs. Sampada Sahakari Bank Ltd. (IT Appeal No. 7 of 1999); CIT vs. Pen Co-op. Urban Bank Ltd. (IT Appeal Nos. 679 & 680 of 2000); CIT vs. Sangli Urban Co-op. Bank Ltd. (IT Appeal No. 700 of 2000); CIT vs. Goregaon Co-op. Urban Bank Ltd. (IT Appeal No. 717 of 2000) & CIT vs. Sindhudura Distt. Central Co-op. Urban Bank Ltd. (IT Appeal No. 737 of 2000).

Judgment

The common issue raised in the present cases by the Revenue centres around the question as to whether the interest accrued on the investment made in Indira Vikas Patra (‘IVP’) is an income arising out of banking business eligible for exemption under s. 80P(2)(a)(i) of the IT Act, 1961 (‘the Act’).

2. The parties are different but the issue involved is identical and so a single judgment will dispose of all the appeals including one reference.

The facts

3. We need not trace the history of the litigation from deck to deck but may conclude the chronology for the present purpose by stating that the respondents (‘assessees’) are co-operative societies engaged in the banking business. The said assessees, in the relevant assessment years, mentioned in the respective impugned orders, claimed deductions under s. 80P(2)(a)(i) of the Act, on the income earned by way of interest on the Government securities. The AO, in all the respective cases, held that the income from IVP, not being income earned from banking business, was not exempted under the above section. On appeal, the appellate authority, in some cases, allowed the appeals holding that the income earned was not out of non-banking business, but in some cases confirmed the order of the AO. The Income-tax Appellate Tribunal (“Tribunal” for short) dismissed all the appeals preferred by the Revenue and allowed the appeals preferred by the assessees. Consequently, the Tribunal accepted the contention of the assessees in all the cases that interest income was attributable to the assessees’ business income. The aggrieved Revenue has preferred these appeals.

Rival submissions

4. The learned counsel for the Revenue contended that it was necessary that the income would have been earned from the actual conduct of the business of banking. What is required under s. 80P is that the activity from which the income is earned must have a direct and proximate nexus with the income earned. He further contended that the income earned out of the investment of the surplus funds not required for banking business could not be said to be income earned from banking business warranting exemption under s. 80P(2)(a)(i).
5. The learned counsel for the Revenue further contended that the investment in IVPs could not be held as banking business. The reliance was placed on the decision of three-Judge Bench of the Supreme Court in the case of Bihar State Co-operative Bank Ltd. vs. CIT (1960) 39 ITR 114 (SC) : TC 26R.636, wherein it was held by the Court that it was a normal mode of carrying of business to invest monies in such a manner that they are readily available. The Court also held that the surplus fund, if invested in long-term deposits, could not be held as stock-in-trade of the bank. Relying on this observation, the learned counsel for the Revenue contended that the IVP does not have easy liquidity. It is not encashable before the maturity, as such, prayed for reversal of the order passed by the Tribunal.
6. The learned counsel appearing for the Revenue further placed strong reliance on another judgment of the apex Court in the case of M.P. Co-operative Bank Ltd. vs. Addl. CIT (1996) 134 CTR (SC) 92 : (1996) 218 ITR 438 (SC) : TC S26.2715 and contended that the normal banking activities are to receive deposits and utilise such deposits by advancing loans to the borrowers. Since the rate at which interest is paid to the depositors is lower than the rate charged from borrowers, the difference in the rate generates income for the banks. The banks may have to maintain certain reserves to meet with emergencies, e.g., spurt in withdrawal by depositors for diverse reasons. Investments which permit withdrawal 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. On this premise, he urged that considering the facts of the case in hand, it cannot be said that the investment in IVP has easy liquidity. It can only be encashed on maturity. Therefore, he contended that the IVP cannot be treated as stock-in-trade, and, consequently, the interest earned therefrom could not be treated as income earned from banking business.
7. The learned counsel for the Revenue also contended that investment of surplus fund of the co-operative bank in excess of banking reserves in long-term deposits with other banks could not be considered as banking activities and, therefore, interest earned on such deposits is not entitled to deduction under s. 80P(2)(a)(i) of the Act. In sum and substance, the submission is that the investment in the security like IVP is not easily encashable, consequently, such investment is taken out of banking business. The income earned from such investment cannot be said to be income earned from the banking business.
8. Per contra, the learned counsel for the assessee contended that it was obligatory on the part of the AO to first determine as to whether the investments made in IVP were from surplus funds, not needed for banking activities. Since, no facts in this behalf were investigated by any of the authorities below, this Court should not dwell upon this aspect of the matter for want of adequate material and categorical finding in this behalf. He further tried to point out that the funds received by way of various deposits from the customers were used for acquiring IVPs. He claimed that during the relevant period, the assessee has paid total interest amounting to Rs. 88,65,500 on deposits worth Rs. 746.96 lakhs and it is further claimed that it was the fund received from these deposits which was used for acquiring the IVPs. He further sought to support his contention from the very fact that no payment of interest on the borrowed funds has been reflected in the account books is sufficient indication to indicate that the deposits received during the course of banking business were used for acquiring IVPs. He further pointed out that even otherwise the funds available with the assessee-bank on the given date when the IVPs were acquired consisted different receipts. The available funds, on any given date, were of the following nature :

(i) repayment of the principal amounts of loan to the assessee by the customers;

(ii) interest on loans of the above nature;

(iii) deposits in current account;

(iv) deposits on saving account;

(v) subscription towards recurring accounts;

(vi) deposits made in FDR for varying periods from one year to five years; and

(vii) security deposits, etc.

9. It was further contended on behalf of the assessee that the interest earned on investment in IVPs would be the income earned by the bank from its circulating capital and in any case in the normal course of banking business could not, therefore, be brought to tax. It was contended that the IVPs form part of the bank’s stock-in-trade and any income earned thereon would be outside the tax net.
10. The learned counsel for the assessee further urged that if the funds were withdrawn from the banking business, then the interest earned on such investment would not qualify for exemption but if the funds were taken out for temporary investment and if brought back depending upon requirement of the banking business, then in that event, such investment would certainly qualify for exemption.
11. In order to demonstrate easy liquidity, he further pointed out that as a fact the State Bank of India was pleased to sanction the overdraft limit of Rs. 65 lakhs against IVPs valued at Rs. 85 lakhs to one of the assessees, namely, Sindhudurg Co-op. Bank Ltd. and the said assessee has been actually utilising the said overdraft facility. In support of his contention, he produced on record letter dt. 10th Oct., 1990 written by the State Bank of India to the said assessee. Placing strong reliance on this piece of evidence, the learned counsel for the assessee argued that the securities like IVPs can easily be transformed into liquid cash and the liquidity generated therefrom could easily be utilised to meet the requirement of the banking business. Such liquidity can always be used as circulating capital meant for banking business. Therefore, he submitted that these securities could be treated as stock-in-trade and/or circulating capital. In his submission, the interest earned thereon and shown as forming part of the income of the bank can qualify for exemption. He, therefore, prayed for dismissal of the appeal with costs.

Statutory provisions

12. Before examining the arguments in support of the contention, it is necessary to have a look on the scheme of the Act and the law on the subject. Sec. 80P deals with deduction in respect of income of co-operative societies :

“80P Deduction in respect of income of co-operative societies.—(1) xxx xxx

(2) The sums referred to in sub-s. (1) shall be the following, namely :

(a) in the case of a co-operative society engaged in—

(i) carrying on the business of banking or providing credit facilities to its members, or”

13. There is no dispute that all the assessees are co-operative societies carrying on business of banking and are governed by the provisions of the Maharashtra Co-operative Societies Act, 1960 (‘Co-operative Societies Act’ for short). The relevant provisions thereof are as under :

The Co-operative Societies Act has an interpretation section for defining the meaning of many words used therein. Sec. 2 thereof defines various terminologies used in the Act, ‘unless context otherwise requires’:

“2. Definitions.—In this Act, unless the context otherwise requires,—

xxx xxx

(10) ‘co-operative bank’ means a society which is doing the business of banking as defined in cl. (b) of sub-s. (1) of s. 5 of the Banking Companies Act, 1949 and includes any society which is functioning or is to function as an Agriculture and Rural Development Bank under Chapter XI.

xxx xxx

(31) ‘working capital’ means funds at the disposal of a society inclusive of paid-up share capital, funds built out of profits, and money raised by borrowing and by other means.”

14. Sec, 70 deals with investment of funds. The State of Maharashtra in exercise of powers conferred under s. 70(e) of the Co-operative Societies Act, has issued order dt. 21st Jan., 1987 permitting all the co-operative societies to invest their funds in IVP on the conditions mentioned therein in the following terms :

“By virtue of the provisions of s. 70(e) of the Maharashtra Co-operative Societies Act, 1960, r/w r. 55 of the Maharashtra Co-operative Societies Rules, 1961 the Government of Maharashtra is hereby pleased to permit all the co-operative societies for investing/depositing their funds in Indira Vikas Patra on the following terms and conditions :

(1) that the payments for purchase of the Vikas Patra by the society should be made only by cheques.

(2) once the society purchases the Vikas Patra, it should be duly stamped so that there is no scope for misappropriation or misapplication of the same.

(3) the provisions of rr. 55(1), (2) and (3) should be complied with by the society, for this purpose the respective society, intending to invest in Indira Vikas Patra should approach the appropriate authorities for necessary sanctions, etc.

(4) the Commissioner for Co-operation and Registrar of Co-operative Societies for every quarter should submit the progress report regarding the total investments in Indira Vikas Patra by various co-operatives.”

15. The Dy. Governor of the Reserve Bank of India, vide his letter dt. 5th Oct., 1989, addressed to the Principal Secretary, Finance Department, Government of Maharashtra, has extended no objection to the co-operative banks and/or such other institutions in the State of Maharashtra for making investment in IVPs.
16. The co-operative banks are also required to follow the mandate of the Banking Regulation Act, 1949. Therefore, it is also necessary to take survey of the relevant provisions of the said legislation. Sec. 5(b) thereof defines the word ‘banking’ as under :

“5. Interpretation.—In this Act, unless there is anything repugnant in the subject or context,—

(a) xxx xxx

(b) ‘banking’ means the accepting, for the purpose of lending or investment, of deposits of money from the public, repayable on demand or otherwise, and withdrawal by cheque, draft, order or otherwise.

xxx xxx”

Sec. 6 of the said legislation defines business of banking. The relevant extract of s. 6(1)(a) is reproduced hereinbelow :

“6. Forms of business in which banking companies may engage.—(1) In addition to the business of banking, a banking company may engage in any one or more of the following forms of business, namely :—

(a) the borrowing, raising, or taking up of money; the lending or advancing of money either upon or without security; the drawing, making, accepting, discounting, buying, selling, collecting and dealing in bills of exchange, hundees, promissory notes, coupons, drafts, bills of lading, railway receipts, warrants, debentures, certificates, scrips and other instruments, and securities whether transferable or negotiable or not; the granting and issuing of letters of credit, traveller’s cheques and circular notes; the buying, selling and dealing in bullion and species; the buying and selling of foreign exchange including foreign bank notes; the acquiring, holding, issuing on commission, underwriting and dealing in stock, funds, shares, debentures, debenture stock, bonds, obligations, securities and investments of all kinds; the purchasing and selling of bonds, scrips or other forms of securities on behalf of constituents or others, the negotiating of loans and advances; the receiving of all kinds of bonds, scrips or valuables on deposits or for safe custody or otherwise; the providing of safe deposit vaults; the collecting and transmitting of money and securities;

xxx xxx”

The issue

17. The substantive issue, on the basis of foregoing facts and survey of various legislations including the provision of s. 80P of the Act which arise in this appeal is :

“Whether, on the facts and in the circumstances of the case, the Tribunal was justified in law in holding the interest accrued on the investments on Indira Vikas Patra (IVP) as income of banking business under s. 80P(2)(a)(i) of the Act?”

Judicial precedent

18. Before proceeding to consider the issue raised in these proceedings, let us examine the judicial approach to the issue in question. The learned counsel for the Revenue placed reliance on the decision of the apex Court in the case of M.P. Co-operative Bank Ltd. (supra), wherein the decision of the Madhya Pradesh High Court in M.P. State Co-operative Bank Ltd. vs. Addl. CIT (1979) 8 CTR (MP) 361 : (1979) 119 ITR 327 (MP) : TC 26R.707 was affirmed. The apex Court held that the circulating capital was that which was put into circulation or turned over to earn profits and the Government securities coming out of the reserve fund which could not be easily encashed and could be utilised only when the contingencies mentioned could not be considered to be circulating capital or stock-in-trade. It was, therefore, ruled by the apex Court while interpreting s. 81, that the interest on Government securities of State Bank of India and Reserve Bank of India could not qualify for exemption under s. 81 (now s. 80P) of the Act.
19. The Revenue also placed reliance on the judgment of the Gujarat High Court in the case of Gujarat State Co-op. Bank Ltd. vs. CIT (2001) 167 CTR (Guj) 34, wherein it was held that the investment of the surplus funds of the co-operative bank including those permitted by s. 67(2), r/w s. 71 of the Gujarat Co-operative Societies Act, 1961, in excess of banking reserves or SLR funds, in short-term deposits with other banks could not be considered to be ‘banking activity’ and, therefore, interest earned on such deposits was not entitled for deduction under s. 80P(2)(a)(i).
20. The learned counsel for the Revenue and the assessees both of them sought to place reliance on the judgment of the apex Court in the case of Bihar State Co-op. Bank Ltd. (supra), wherein, while dealing with income derived by way of interest on short-term deposits by the bank, the apex Court held that it was income from normal banking business and was, therefore, exempt from the liability to pay income-tax. It was held that since the society in that case was engaged in banking activity, its normal business was to deal in money and credit and, therefore, the money laid out in the form of short-term deposit did not cease to be a circulating capital and interest earned thereon could be other than income generated from the business of banking and was, therefore, exempt from tax.
21. The learned counsel for the Revenue, however, tried to read this decision in his favour and contended that in the above case bank’s funds were utilised in short-term deposits or in Government securities which were easily encashable to meet with the probable sudden rush of depositors and, therefore, the fund employed for the purpose never went out of circulation, but was kept apart to meet a probable eventuality and a business obligation. He pointed out that applying the said principle to the investments made in the securities like IVPs, the same could not be utilised for want of easy liquidity thereof. That is how the learned counsel for the Revenue went on to read this judgment in support of his contention. In the above case, the submission made on behalf of the Revenue that income earned from the investment of surplus fund, not required for business of banking activity, be treated as income earned from the banking business, was rejected by the apex Court holding that on the facts the question did not arise for decision. In other words, no material was produced in that case to show that the monies which were in deposits were surplus within that bye-law so as to take it out of banking business. It was, thus, held that it could not be said that the funds of the bank which were not lent to borrowers but were laid out in the form of deposits in another bank to add to the profit instead of lying idle ceased to be a part of the stock-in-trade of the bank, or that the interest arising therefrom did not form part of its business profits.
22. The another decision of the Supreme Court pressed into service by the learned counsel for the assessee was the decision in the case of Cambay Electric Supply Industrial Co. Ltd. vs. CIT 1978 CTR (SC) 50 : (1978) 113 ITR 84 (SC) : TC 25R.306. In this case while construing the expression ‘profits and gains attributable to the business’ in s. 80(e) which provides for deduction in respect of profits and gains from specified industries in case of certain companies, the apex Court was pleased to accept the submission that since the assessee, as a licensee, was required to appropriate certain amounts in contingency reserve and to invest the same as securities authorised under the Indian Trust Act, 1982, the income by way of such investments as securities had to be treated as profits and gains attributable to the business of the assessee which was to generate electricity as licensee under the Electricity (Supply) Act. In the said case, the apex Court further observed:

“… In our view, since the expression of wider import, namely, ‘attributable to’, has been used, the legislature intended to cover receipts from sources other than the actual conduct of the business of generation and distribution of electricity.”

23. The other decision of the apex Court relied upon by the learned counsel for the respondents is CIT vs. Bangalore District Co-op. Central Bank Ltd. (1998) 148 CTR (SC) 226 : (1998) 233 ITR 282 (SC) : TC S26.2714, wherein on the facts of the case, the apex Court found that the investments made by the assessee was in compliance with the statutory provisions and in order to carry out business of banking, such investments were necessary and, consequently, such investments were part of the business of the banking activity within the meaning of s. 80P(2)(a)(i) of the Act.

Emerging principles derived from precedents

24. On a conspectus of the various authorities it emerges that if the income is derived by a co-operative society (bank) is from the business of banking, then only it will fall within the exemption, but if it arises from and out of the business with third party as in case of investment of surplus assets, the exemption is not available because investment of fluid assets is not a part of business of banking. The income must be attributable to banking facility. The investment made to generate income must form part of circulating capital or stock-in-trade of the (co-operative) bank. The business must have a direct or proximate connection with or nexus to the earnings in order to attract the provisions of s. 80P(2)(a)(i) of the Act.
25. As a sequiter to the above emerging principles, it follows that each investment has to be examined, considered and decided on its own merits applying the above norms derived from the various precedents. In order to apply these principles, investigation of facts and definite findings are necessary.

Application of principles to these cases

26. Let us turn to the impugned orders, which are subject of the present proceedings, so as to apply the above emerging principles to the facts of each case at hand. The investments made in IVPs no doubt had an effect of withdrawing funds from the banking business. Mere withdrawal of funds is not sufficient. It must be proved that the withdrawal of funds have resulted in permanent deprivation of funds for banking activity. It ought to have been examined as to whether such investments had an effect of temporary withdrawal of the funds or the investments made in IVP could be brought back to the banking business. In absence of detailed enquiry in the nature of available surplus and investments thereof, it is difficult to go along with the submissions made by the Revenue. No enquiry in this behalf was made by any of the authorities below. It was obligatory on the part of the fact-finding authorities below to make enquiry and record finding of fact in this behalf. No such attempt was made by either of the authorities below in this regard. We are, therefore, left with no other alternative but to decide these matters on the facts found and available on record.
27. The facts found and available on record do suggest that the interest income was attributable to the assessees’ business income and the investment made in IVPs or investments made from the fund generated from the banking business. It has a direct and proximate connection with or nexus to the earning from banking business in order to attract provisions of s. 80P(2)(a)(i) of the Act. It was expected of the authorities below to go into factual aspect of the matter and to find out as to whether the investments made were from surplus funds or from the funds which were temporarily surplus in the hands of the bank. It was further expected of the authorities below to find out whether the investments made in IVPs ceased to be circulating capital or that the securities could not be used as working capital or that it did form part of the circulating capital or stock-in-trade of the bank, so as to reach to the finding that the interest earned therefrom and shown as forming part of the banking activity qualified for exemption.
28. We, therefore, confine our judgment to the facts of these cases as found by the Tribunal and in some cases by the CIT(A), wherein in the facts and circumstances, it was held that the interest income derived from IVPs by the assessees was clearly from and out of banking business and, therefore, entitled to exemption under s. 80P(2)(a)(i) of the Act and that the said income had been derived from the interest on securities of the Central Government, which were easily capable of being converted into liquid funds so as to make it available to the assessee banks for their banking business. Confining our judgment to the facts of the cases in hand, we uphold the findings recorded in favour of the assessees and hold against the Revenue.

In the result, appeals are dismissed with no order as to costs. So far as IT Ref. No. 474 of 1997 is concerned, for the reasons recorded hereinabove, we answer the question in favour of the assessee and against the Revenue.