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PETITIONER: THE MADHYA PRADESH CO-OPERATIVEBANK LIMITED, JABALPUR

       Vs.

RESPONDENT: ADDITIONAL COMMISSIONER OF INCOMETAX MADHYA PRADESH, BHOPAL

DATE OF JUDGMENT:       19/01/1996

BENCH: AHMADI A.M. (CJ) BENCH: AHMADI A.M. (CJ) HANSARIA B.L. (J)

CITATION:  1996 SCC  (2) 541        JT 1996 (1)   487  1996 SCALE  (1)511

ACT:

HEADNOTE:

JUDGMENT:                             WITH              CIVIL APPEAL NO. 1196 (NT) OF 1992 Madhya Pradesh Rajya Sahkari Bank Maryadit, Bhopal V. Commissioner of Income Tax, Jabalpur                             WITH              CIVIL APPEAL NOs. 2211-12 OF 1996          (Arising out of SLP (C) 5813 & 14 of 1982) (The Madhya Pradesh Co-operative Bank Limited V. The Additional Commissioner of Income Tax                       J U D G M E N T AHMADI, CJI      Special leave granted in SLP (C) Nos. 5813-14 of 1982.      The assessee  in all  these  cases  is  a  Co-operative Society registered  under the  Madhya  Pradesh  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 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 assesee’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  -

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    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;      xxx                xxx               xxx           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 the  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  ear-marked  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 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 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,  insofar 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 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

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    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      3% 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.      Insofar as  interest on  Provident  Fund  deposits  are 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, the  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  the 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

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arises from  the business  of banking  or  providing  credit activities 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. vs. Commissioner of Income  tax (1960)  39 ITR  114 (SC),  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, therefore,  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  Commissioner of  Income Tax  vs. Bombay State Co-operative bank,  Ltd. vs.  Commissioner  of  Income  Tax, Kerala (1975) 101 ITR 87 (Kerala) and Commissioner of Income Tax, Orissa  vs. Orissa  State Co-operative  Housing  Corpn. Ltd. (1976)  104 ITR  157 (Orissa).  The  Privy  Council  in Punjab Co-operative Bank Ltd. vs. Commissioner of Income Tax (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 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 encased  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

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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  a 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 with 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 Reserve Fund which cannot be easily encased 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  a p  art the  funds in  the form  of  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.  The learned counsel  for the  revenue was,  therefore, right  in contending that the case law cited at the Bar by the 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 the learned counsel for the revenue. The  first case  is of  Commissioner of Income Tax, Lucknow vs.  U.P. Cooperative 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 other sums received in the  course of business. Even the 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

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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. vs.  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 commissioner 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 of reasoning.      "A reading  of clause  (i) of section 81      shows that the idea and intention behind      the said  clause was  to encourage basic      level  societies   engaged  in   cottage      industries,    marketing    agricultural      produce of its members and those engaged      in purchasing and supplying agricultural      implements,  seeds,   etc.,   to   their      members   and    so   on.    The   words      ‘agricultural produce  of  its  members’      must be  understood consistent with this      object and  if so  understood, the words      mean the  agricultural produce  produced      by  the   members.  it     is   not   so      understood, even  a co-operative society      comprising    traders     dealing     in      agricultural produce  would also  become      entitled to  exemption which could never      have been  the intention  of Parliament.      The agricultural produce produced by the      agriculturist can legitimately be called      agricultural produce in his hands but in      the  hands   of  traders,  it  would  be      appropriate  to   call  it  agricultural      commodities;  it   would  not   be   his      agricultural  produce.  Accordingly,  it      must be held in this case that since the      agricultural  produce  marketed  by  the      assessee  was   not   the   agricultural      produce produced by its members, namely,      the primary  co-operative  society,  the      assessee cannot claim the benefit of the      said exemption."      The  learned   counsel  for   the  assessee   tried  to distinguish both  these cases but in our opinion the purport of the  decisions is  obvious. However,  even if  we were to

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agree with  learned counsel for the assessee that both these cases had  no application to the f acts of these appeals, it would make no difference because we have on first principles come to  the conclusion,  for reasons  set out hereinbefore, that the  interest on  government securities placed with the State Bank  of India/Reserve  bank of  India, cannot qualify for exemption  under Section  81 (now  Section 80  P) of the Income Tax Act.      Before we  part, we  must take  note  of  Shri  Salve’s contention that the proviso to section 81 would apply in the case of  that co-operative society alone which is engaged in an activity other than those mentioned in clauses (a) to (f) which not  being so  as regards  the appellants, the proviso has no  application; and  so, no  part of its profit of gain can attract  income tax.  We do  not think  this to  be  the correct reading  of the  proviso, notwithstanding the use of the word  "also". According to us, what the proviso seeks to convey is  that even  if a  co-operative society  is engaged only in the business of banking, but part of its activity is not attributable  to engagement  in  such  activity,  income derived from that part of activity would become taxable. And as held  above, the  income derived  from the  investment in Government  securities   placed  with   the  State  bank  of India/Reserve  bank  of  India  cannot  be  regarded  as  an essential part  of its banking activity inasmuch as the same does   not    form   part    of   its    stock-in-trade   or working/circulating capital.  Therefore, we  see no force in Mr. Salve’s premises.      For the  above reasons we see no merit in these appeals and dismiss the same with costs.