2016 (8) TMI 64 - AT - Income Tax

Accrual of income and expenditure - Real income - co-operative society - Provision on interest on share capital by assessee society - addition to profit of assessee trust - Held that - We are of the opinion that the order passed by the authorities below are required to be set aside and the appeal of the assessee is required to be allowed. In our view, in case of Cooperative Society, there is a liability to repay the share capital to the members concerned. Once he ceases to be a member, therefore, the share capital in the hands of Cooperative Society cannot be treated with the share capital of the company, it could be treated as a borrowed capital. Further the assessee was following the mercantile system of accounting and any business expenditure relating to a financial year which is not paid during the financial year is required to be provided in the P&L account and the said provision will be set up with actual payment paid in the subsequent year. On the same analogy, the assessee made the provision for ₹ 23,97,359/- towards the interest on share capital in the P&L account for the financial year 2008-09 and the same was paid in the subsequent year. The interest paid on the share capital goes to reduce the interest collected by the society from its members and it did not form part of the profit. The making provision for the payment of interest on the share capital and paying the interest on the share capital will not make any change in the application of law. - Decided in favour of assessee.

Issues Involved:
1. Validity of the disallowance of ?23,97,359/- towards provision for interest on share capital.
2. Applicability of previous judgments in similar cases.
3. Treatment of share capital in cooperative societies versus companies.
4. Adherence to the mercantile system of accounting.
5. Interpretation of the Income Tax Act, 1961 concerning provisions and payments.

Detailed Analysis:

1. Validity of the Disallowance of ?23,97,359/- Towards Provision for Interest on Share Capital:
The assessee, a cooperative society engaged in banking, filed a return for the year declaring a total income of ?14,47,977/-. During scrutiny assessment, the Assessing Officer (A.O.) disallowed ?23,97,359/- debited in the P&L account as a provision for interest on share capital, bringing it to tax. The A.O. reasoned that under the Income Tax Act, 1961, there is no provision to allow a deduction for provisions for payments on interest on share capital unless it is a charge on profit or incurred to earn income. This decision was upheld by the Commissioner of Income Tax (Appeals) [CIT(A)].

2. Applicability of Previous Judgments in Similar Cases:
The assessee cited judgments from the ITAT Vishakhapatnam and Hyderabad benches in similar cases, arguing that the provision for interest on share capital should be allowed. However, the CIT(A) distinguished these cases, noting that they dealt with actual payments of interest on share capital rather than provisions. The CIT(A) maintained that only actual payments, not provisions, are allowable as deductions under the IT Act.

3. Treatment of Share Capital in Cooperative Societies Versus Companies:
The assessee argued that the nature of share capital in a cooperative society differs from that in a company. In cooperative societies, share capital is akin to borrowed capital, as members subscribe to shares not as a voluntary investment but to avail services. This share capital is refundable once the member repays their loan, unlike in companies where share capital is a non-refundable investment aimed at earning returns. The tribunal acknowledged this distinction, noting that in cooperative societies, share capital could be treated as borrowed capital, and thus, the provision for interest on it should be considered differently.

4. Adherence to the Mercantile System of Accounting:
The assessee followed the mercantile system of accounting, where business expenditures are accounted for in the year they are incurred, regardless of when they are paid. The tribunal agreed that under this system, provisions for expenses like interest on share capital, which are paid in subsequent years, should be allowed. The tribunal noted that the provision made for ?23,97,359/- towards interest on share capital for the financial year 2008-09 was paid in the subsequent year, aligning with the mercantile system.

5. Interpretation of the Income Tax Act, 1961 Concerning Provisions and Payments:
The tribunal emphasized that the Income Tax Act allows deductions for business expenditures that are incurred wholly and exclusively for business purposes. It reiterated that provisions for expenses, like interest on share capital in cooperative societies, should be considered allowable deductions if they align with the mercantile system of accounting and are eventually paid. The tribunal also referenced the Coordinate Bench's decision in the case of DCIT Vs. Navbharat Cooperative Urban Bank Ltd., which supported the view that interest paid on share capital reduces the interest collected by the society from its members and does not form part of the profit.

Conclusion:
The tribunal set aside the orders of the lower authorities, allowing the appeal of the assessee. It concluded that in the context of cooperative societies, share capital is akin to borrowed capital, and provisions for interest on such share capital should be allowable deductions under the mercantile system of accounting. The tribunal's decision was guided by previous judgments and the specific nature of cooperative societies' operations.

Order Pronounced:
The appeal of the assessee was allowed, and the order was pronounced in the open court on 27th July 2016.

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