1996 (1) TMI 8 - SC - Income Tax

Proviso to section 81 seeks to convey 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 - income derived from the investment in Govt. securities placed with the SBI/RBI 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

Issues Involved:
1. Whether the income from interest accruing on Government securities earmarked for reserve fund/provident fund qualifies for exemption under section 81 of the Income-tax Act.
2. Whether the interest on provident fund deposits is exempt from tax.

Detailed Analysis:

1. Interest on Government Securities and Section 81 Exemption:
The primary issue was whether the interest earned on Government securities earmarked for reserve fund/provident fund can be considered income derived from the business of banking under section 81 of the Income-tax Act, 1961, to qualify for tax exemption. Section 81 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, specifically if it is engaged in banking or providing credit facilities to its members. However, the proviso states that if a co-operative society is also engaged in other activities, the exemption does not apply to profits from such activities exceeding fifteen thousand rupees.

The court clarified that not every income of a society carrying on banking business is exempt from tax; only the income from banking business is exempt. The assessee, an apex body controlling all District Co-operative Banks, argued that its entire income was from banking business and thus exempt under section 81. However, the Income-tax Officer and higher authorities rejected this claim.

The court examined whether the interest earned on Government securities placed with the State Bank of India or the Reserve Bank could qualify for exemption. The M.P. Government's Instructions mandated that the reserve fund of the apex bank be fully invested in Government securities and not utilized as working capital. The court noted that the reserve fund investments could not be withdrawn without the Registrar's permission, indicating they were not part of the bank's circulating or working capital. Consequently, the interest earned on these securities did not qualify for exemption under section 81 as it did not form part of the bank's stock-in-trade or circulating capital.

2. Interest on Provident Fund Deposits:
The second issue was whether the interest on provident fund deposits was exempt from tax. The interest on provident fund deposits was included in the profit and loss account of the bank. The Tribunal noted that even the assessee's counsel found it difficult to justify the claim, acknowledging that the interest should not have been included in the profit and loss account since it belonged to the provident fund, with the bank merely holding those deposits as trustees. The Tribunal held that since the interest was included in the profit and loss account of the assessee and shown as earnings, it was liable to tax. The Tribunal's approach was justified as the foundational facts were not established, and the assessee's counsel did not press the contention further.

Conclusion:
The court concluded that the object of section 81 was to encourage the co-operative movement by providing tax exemption to co-operatives engaged in specified activities, including banking. However, the exemption applied only to income derived from the business of banking or providing credit facilities to members. The court held that the interest on Government securities relating to the reserve fund did not qualify for exemption under section 81 as it did not constitute the bank's circulating capital or stock-in-trade. The interest on provident fund deposits was also taxable as it was included in the profit and loss account and did not form part of the bank's circulating capital.

The appeals were dismissed with costs, affirming that the income from Government securities and provident fund deposits did not qualify for tax exemption under section 81 of the Income-tax Act.

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