The judgment of the court was delivered by
A. M. AHMADI C. J. I.--Special leave granted in S. L. P.
(C) Nos. 5813 14 of 1982.
The assessee in all these cases is a co-operative society
registered under the Madhya Pradesh Co-operative Societies (Amalgamation) Act,
1957 (hereinafter called "the Act"). While framing assessment for the
relevant assessment years in question, the Income-tax Officer included in the
taxable income of the assessee, interest earned on securities earmarked against
reserves and interest earned on provident fund deposits. The assessee contended
that it was entitled to the benefit of section 81 of the Income-tax Act, 1961,
as in force at all material times. The Income-tax Officer rejected this claim of
exemption from tax put forward by the assessee. Since the assessee's contention
did not find favour at the higher levels also, including the reference to the
High Court, the assessee has approached this court.
Section 81 of the Income-tax Act on which the assessee's
case is based read thus at all material times :
" Income of co-operative societies.--Income-tax shall
not be payable by a co-operative society,--
(i) in respect of the profits and gains of business
carried on by it, if it is--
(a) a society engaged in carrying on the business of
banking or providing credit facilities to its members ; or . . . .
Provided that, in the case of a co-operative society,
which is also engaged in activities other than those mentioned in this clause,
nothing contained herein shall apply to that part of its profits and gains as is
attributable to such activities and as exceeds fifteen thousand rupees."
On a plain reading of this provision it becomes clear that
every income of a society carrying on banking business is not exempt from
payment of tax : Only the income from banking business is exempt from tax. The
question which we are required to answer is whether the income from interest
accruing on Government securities earmarked for reserve fund/provident fund can
be said to be income derived by the assessee from the business of banking within
the meaning of section 81 to qualify for exemption. This question arises in the
backdrop of the following facts :
The assessee is an apex body controlling all District
Co-operative Banks. It is registered under the provisions of the Co-operative
Societies Act, 1912, read with section 6 of the Act. The assessee filed returns
for the relevant years claiming that the entire income was from banking business
and, therefore, exempt from tax under section 81 of the Income-tax Act. The
Income-tax Officer rejected the claim in regard to interest being exempt under
the said provision. There is no dispute, and indeed there can be none, that the
assessee is engaged in carrying on the business of banking which, inter alia,
includes the activity of providing credit facilities to its members. In the
course of its business, it receives deposits and makes advances to the borrowers
at a rate of interest higher than what it pays on deposits. A part of these
deposits are, however, invested in the form of Government securities with the
State Bank of India or the Reserve Bank. Under section 44 of the Co-operative
Societies Act, the assessee is required to invest or deposit its funds to
maintain a cover to the extent necessary and further provides that the reserve
fund of the society shall be invested and utilised as may be laid down by the
Registrar, which it does by investing in Government securities purchased with
the bank's funds. The question is whether the interest earned by the assessee
from the Government securities placed with the State Bank or the Reserve Bank
can qualify for exemption under section 81 of the Income-tax Act ?
Before we proceed to answer this question, we may refer to
the M. P. Government's Instructions No. CR 25/26, dated October 7, 1960, which,
in so far as it concerns apex banks, reads as under :
" (C) Apex -Bank :
The reserve fund of the apex bank shall be fully invested
outside its business in the Government securities. No part of its reserve fund
should be utilised as its working capital.
3. All investments of reserve fund shall be specially
marked as ' Reserve fund investment ' and shall be shown separately in the
annual balance-sheets. The reserve fund deposits at every level shall carry the
maximum rate of interest which a Central Bank or apex bank pays on fixed
deposits for longest period or three per cent., whichever is higher. No part of
the reserve fund deposits shall be drawn without the previous sanction of the
Registrar, in the case of apex bank, Central Banks and large-sized societies and
in the case of other primary societies without the permission of the Deputy
Registrars. Such approval can be given when the amount is either required to
meet losses, or, when the society is to be wound up. These eventualities will,
however, be very rare."
Obviously, as per the above instructions, no part of the
reserve fund can be utilised as working capital nor can any part of the reserve
fund deposits be withdrawn except with the permission of the Registrar to meet
losses or at the time of winding up and not otherwise. In the circumstances, the
Revenue contends that the securities relating to the reserve fund can never be
considered to be the circulating or working capital of the bank or its
stock-in-trade to qualify for exemption under section 81 of the Income-tax Act.
In so far as interest on provident fund deposits is
concerned, admittedly, the same was included in the profit and loss account of
the bank. It appears from the observations in paragraph 11 of the appellate
order of the Tribunal that even the assessee's counsel found it difficult to
justify the claim and said that it ought not to have been included in the profit
and loss account of the bank since it belonged to the provident fund as the bank
was merely holding those deposits as trustees. The Tribunal did not examine this
contention, and in our opinion rightly, since the same was not agitated before
the authorities below and no foundation was laid for the same. The Tribunal held
that since the interest earned therefrom was included in the profit and loss
account of the assessee and was shown as earnings, it was liable to tax since it
did not form part of the assessee's stock-in-trade or circulating capital and
could not, therefore, be described as income from the business of banking to
qualify for exemption. The Tribunal, therefore, held that this income was liable
to tax. Mr. Salve, learned senior counsel for the assessee with his usual
fairness stated that in the absence of the foundational facts, the Tribunal was
justified in refusing to examine the contention of the assessee's counsel and he
was not in a position to assail the Tribunal's approach. He, therefore, did not
press the contention under this head. We are, therefore, left with the first
contention only, namely, whether interest on Government securities earned by the
assessee is exempt from tax under section 81 of the Income-tax Act.
There can be no doubt that the object of section 81 was to
encourage co-operative movement in the country by providing tax exemption to
those co-operatives engaged in activities set out in clauses (a) to (f) thereof.
One such activity is the carrying on of the business of banking or providing
credit facilities to its members by a co-operative society. The section,
therefore, provides that income-tax shall not be payable by a co-operative
society in respect of the profits and gains of business carried on by it, if it
arises from the business of banking or providing credit facilities for its
members. However, if such a co-operative society also engages itself in
activities other than the business of banking or providing credit facilities the
profits derived from such business shall not be exempt from tax if it exceeds
rupees fifteen thousand. It is, therefore, obvious that the entire income
derived by a co-operative society from the business of banking or providing
credit facilities to its members is exempt from income-tax, but if that society
also engages itself in any other activity and earns-profit therefrom, the income
so derived becomes liable to assessment and payment of income-tax, if it exceeds
the ceiling amount. The normal banking activity is to receive deposits and
utilise such deposits by advancing loans, etc., to borrowers. Since the rate at
which interest is paid to depositors is lower than the rate charged from
borrowers, the difference in the rates generates income for the banks. The banks
may have to maintain certain reserves to meet with emergencies, e.g., a spurt in
withdrawals by depositors for diverse reasons. Investments which permit
withdrawals 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. That is why this court in Bihar State Co-operative Bank Ltd. v. CIT
[1960] 39 ITR 114, while dealing with income derived by way of interest on
short-term deposits by the bank, held that it was income from normal banking
business and was, therefore, exempt from the liability to pay income-tax. This
court held that since the society was engaged in banking activity, its normal
business was to deal in money and credit and, there fore, the money laid out in
the form of short-term deposit did not cease to be a circulating capital and
interest earned thereon cannot be other than income generated from the business
of banking and was, therefore, exempt from tax. The same view was reiterated in
CIT v. Bombay State Co-operative Bank Ltd. [1968] 70 ITR 86 (SC) ; Malabar
Co-operative Central Bank Ltd. v. CIT [1975] 101 ITR 87 (Ker) and CIT v. Orissa
State Co-operative Housing Corporation Ltd. [1976] 104 ITR 157 (Orissa). The
Privy Council in Punjab Co-operative Bank Ltd. v. CIT [1940] 8 ITR 635 also held
that bankers have always to keep sufficient cash or readily realisable
securities to meet with any probable demand of depositors in the normal course
of banking business and such funds, counsel argued, would really form part of
the bank's circulating capital and, therefore, interest earned thereon would be
exempt from tax.
Placing strong reliance on the aforesaid line of
reasoning, counsel for the assessee argued, that interest earned on Government
securities placed with the State Bank or the Reserve Bank would be income earned
by the bank from its circulating capital and in any case in the normal course of
banking business and cannot, therefore, be brought to tax. It was said that the
Government securities form part of the bank's stock in-trade and any income
earned thereon would be outside the tax net. Counsel for the Revenue, however,
distinguished the decisions relied on by the assessee mainly on the ground that
the bank's funds were utilised in short-term deposits or in Government
securities which could be easily encashed to meet with a 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, therefore, a
business obligation. He pointed out that in the case of reserve fund investments
no part of the deposits was permitted to be withdrawn unless the money was
required to meet losses or the society had to be wound up and that too with the
Registrar's permission only. Therefore, he submitted, these securities could not
be utilised as working capital nor did they form part of the circulating capital
or stock-in-trade of the bank and, hence, the interest earned thereon and shown
as forming part of the income of the society cannot qualify for exemption.
Counsel for the Revenue did not join issue on the
proposition that if circulating capital or stock-in-trade of a co-operative bank
is invested in securities, interest earned thereon would be income from banking
business and would, therefore, qualify for exemption. However, can the
investment in securities of the reserve fund be said to be investment of
circulating capital or stock-in-trade, more so when it is noticed that the
co-operative bank does not have an absolute and unfettered right to withdraw the
same whenever it liked ? We have noticed that the co-operative bank is legally
obliged to place certain Government securities with the State Bank/Reserve Bank
and these securities cannot be withdrawn by the said bank at its sweet will and
can only be withdrawn in certain situations referred to earlier. That is because
the investment of the reserve fund in securities is not to meet the probable
eventuality to pay off the depositors should they demand the same. It is,
therefore, difficult to comprehend how such Government securities relating to
reserve fund can be considered the bank's stock-in-trade or circulating capital.
It is clearly understood in banking parlance that circulating capital is that
which is put into circulation or turned over to earn profits. Government
securities coming out of the reserve fund which cannot be easily encashed and
which can be utilised only when the contingencies mentioned therein arise cannot
be considered to be circulating capital or stock-in-trade. It is more or less in
the nature of a fixed asset of the society, being out of circulation for an
indefinite period. It is, so to say, at arm's length from the normal banking
business, to be utilised on the happening of certain events, events which may
virtually bring a cessation of the business. If that be the purpose and object
of setting apart the funds in the form of the Government securities and the
like, it cannot be reasonably contended that the funds placed in cold storage
continue to constitute the bank's stock-in-trade or circulating capital. Learned
counsel for the Revenue was, therefore, right in contending that the case law
cited at the Bar by learned counsel for the assessee cannot come to the rescue
of the assessee.
We may make a brief reference to two more cases to which
our attention was drawn by learned counsel for the Revenue. The first case is of
CIT v. U. P. Co-operative-Federation Ltd. [1989] 176 ITR 435 (SC). In that case,
the apex co-operative society, which was expected to regulate the supply of
sugar, coal, cloth, etc., to its members, had received two sums, namely,--
(i) Rs. 9,000 as interest on cash security deposit with a
co-operative sugar factory for carrying on sugar agency business ; and (ii) Rs.
51,295 as interest on amounts which it had advanced to its members since they
were not able to arrange for the entire finance needed to lift the stocks. This
court held that the first amount did not qualify for exemption because it
represented only interest on security deposit and could not be mixed up with the
other sums received in the course of business. Even learned counsel for the
assessee did not press for exemption so far as that claim is concerned. The
second claim was allowed on the ground that the money had to be provided to run
the business and generate profit and the funding was, therefore, in the nature
of "investment" within the meaning of the relevant provision, in that,
the money was ultimately to be utilised by the member society for the purchase
of stocks. The distinction is obvious, namely, where the money is ultimately to
be used for business purpose, either directly or through the member-bank, the
interest thereon would qualify for exemption and not otherwise. The second case
to which our attention was drawn is of Assam Co-operative Apex Marketing Society
Ltd. v. CIT (Addl.) [1993] 201 ITR 338 (SC). In that case, the appellant was
appointed as the procuring agent for paddy by the Assam Government. The members
of the appellant were primary marketing societies and societies at the village
level, with membership of agriculturists, being the members of the former. Thus,
no agriculturist was the direct member of the appellant. So, the produce was
received by the village level societies from its agriculturist-members and was
then passed on to the primary societies which in turn made it over to the
appellant. A commission was charged for the procuring activity which was divided
between the three, the appellant and the village society each taking 19 paise in
a rupee and the remaining 62 paise went to the primary society. The question was
whether the appellant's share in the commission could be brought to tax. The
Tribunal as well as the High Court on reference held that the assessee was not
entitled to exemption and this court affirmed the finding on the following line
