2019 (12) TMI 970 - AT - Income Tax

Benefit of deduction u/s 80P(2) - interest income received - basis of declining claim of deduction u/ s 80P(2) is that the surplus funds deposited in bank account would partake character of 'income from other sources' but not 'income from business' - HELD THAT - In the present case, the undisputed fact is that the assessee society is required to deposit 25% of its profit as mandated by section 43(2) of the M.P./ Chattisgarh Societies Act, 1960. Hence, the assessee is under legal obligation to keep 25% of its profits as reserves. Any interest accrued there on would certainly, in our considered view partake character of business income of the assessee. Hence, it would be eligible for deduction. Therefore, the A.O. is directed to allow deduction on the interest earned out of amount so reserved by the assessee i.e. 25% of profit transferred to reserves. A.O. ought to have allowed the expenditure incurred for the earning of the interest income, when he treated the same as 'income from other sources' - We find merit into the contention of the assessee that the set off of expenditure incurred ought to have been allowed by the A.O. When the interest income is charged to tax, the expenditure incurred for earning of such income would certainly be deductible. We direct accordingly. The A.O. would allow the deduction of expenditure incurred for earning of the interest income. We would like to clarify that the allowance of expenditure is restricted to the interest income, which has not been treated as a business income, in view of the discussion herein above. Both the grounds of the assessee are allowed in terms indicated herein above. Appeal of the assessee is allowed.

Summary

Issues Involved:
1. Treatment of interest received from banks as "income from other sources" and denial of deduction under Section 80P(2).
2. Rejection of the claim for allowing proportionate expenses, including interest paid, as a deduction against the interest earned from the bank.

Issue-wise Detailed Analysis:

1. Treatment of Interest Received from Banks as "Income from Other Sources" and Denial of Deduction under Section 80P(2):

The assessee, a cooperative society, argued that the interest income from banks should be considered as "business income" and thus eligible for deduction under Section 80P(2). The assessee contended that the funds deposited in banks were part of their operational activities and statutory obligations, as mandated by the Madhya Pradesh Cooperative Society Act. The society maintained that the interest earned on such deposits was attributable to its core banking activities and should be treated as "profits and gains of business."

The Assessing Officer (A.O.) and the Commissioner of Income Tax (Appeals) [CIT(A)] denied the deduction, treating the interest income as "income from other sources." They relied on the Supreme Court's decision in M/S. Totgars Co-operative Sale Society vs. ITO, where it was held that interest income from surplus funds invested in banks did not qualify for deduction under Section 80P(2).

The Tribunal, however, distinguished the present case from Totgars. It noted that the assessee was engaged in full-fledged banking activities, unlike Totgars, which was primarily a marketing society. The Tribunal emphasized that the interest income was earned from funds that were part of the society's operational activities and statutory reserves, thus qualifying as "business income." The Tribunal relied on the Karnataka High Court's judgments in Guttigedarara Credit Co-operative Society Ltd. vs. ITO and Tumkur Merchants Souharda Credit Co-operative Ltd. vs. ITO, which supported the assessee's claim.

The Tribunal concluded that the interest income from statutory reserves and operational funds should be treated as "business income" and allowed the deduction under Section 80P(2).

2. Rejection of the Claim for Allowing Proportionate Expenses, Including Interest Paid, as Deduction Against the Interest Earned from the Bank:

The assessee argued that if the interest income was treated as "income from other sources," the proportionate expenses incurred to earn that income, including interest paid, should be deductible. The A.O. and CIT(A) had rejected this claim.

The Tribunal found merit in the assessee's contention. It held that when interest income is charged to tax, the related expenditure incurred to earn such income should be deductible. The Tribunal directed the A.O. to allow the deduction of expenses incurred for earning the interest income, restricted to the portion of interest income not treated as business income.

Conclusion:

The Tribunal allowed the appeals filed by the assessee for both assessment years, directing the A.O. to treat the interest income from statutory reserves and operational funds as "business income" and allow the deduction under Section 80P(2). Additionally, the Tribunal instructed the A.O. to allow the deduction of proportionate expenses incurred for earning the interest income, where applicable.