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Facts
The assessee, a co-operative society, filed its ROI declaring nil income after claiming deduction u/s 80P(2)(a)(i). The AO disallowed a provision of Rs. 14,20,000 for interest payable to members, treating it as hybrid accounting. Similarly, interest income of Rs. 32,043 from scheduled banks was taxed as income from other sources.
Held
Regarding the provision for interest, the Tribunal held that even if disallowed, the addition would be absorbed by the deduction u/s 80P(2)(a)(i), leading to a revenue-neutral exercise. For the interest income from scheduled banks, the Tribunal found that the AO did not properly examine the nature and source of funds, which are crucial for determining eligibility for deduction u/s 80P(2)(a)(i).
Key Issues
Whether a provision for interest payable to members and interest income from scheduled banks are eligible for deduction u/s 80P(2)(a)(i)?
Sections Cited
80P(2)(a)(i), 250, 28
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Income Tax Appellate Tribunal, ‘SMC’ BENCH, BANGALORE
Before: SHRI WASEEM AHMED & SHRI KESHAV DUBEY
PER WASEEM AHMED, ACCOUNTANT MEMBER:
The present appeal has been instituted by the assessee against the order of the Ld. CIT(A) passed u/s 250 of the Act dated 31.07.2025.
The assessee in its memorandum of appeal has raised many grounds. However, for the sake of brevity and convenience, we are not inclined to reproduce the same here.
Ground Nos. 1 and 2 are interconnected and relates to provision for interest payable to members.
The relevant facts are that the assessee is a society, filed its ROI for captioned AY declaring income as nil after claiming deduction u/s 80P(2)(a)(i) of the Act. The case of the assessee was selected for scrutiny to verify the deduction claimed by assessee u/s 80P(2)(a)(i) of the Act.
On perusal of the audit report of assessee, the AO observed that the assessee is following mercantile system of accounting. However, in the profit and loss account, the assessee is following hybrid system of accounting which is not permissible as per the Income Tax Act, 1961. Consequently, AO disallowed the provision made for interest on deposits amounting to Rs. 14,20,000/- only and added to the total income of the assessee.
Aggrieved, assessee preferred an appeal before the Ld. CIT(A) who rejected the plea of assessee and upheld the disallowance made by the AO.
Aggrieved by the order of Ld. CIT-A, the assessee preferred an appeal before us.
The Ld. AR before us has filed paper books running from page Nos. 1 to 824, written submission along with the case laws and submitted that the assessee is following a hybrid system of accounting, wherein interest income is recognized on cash basis while interest expenditure is accounted on accrual basis. It was submitted that such method is not arbitrary but is followed in compliance with Rule 22(a) and (b) of the Karnataka Co-operative Rules, 1960, which prescribes the . manner of determining net profits of a co-operative society. The assessee therefore contended that the accounting method adopted by the assessee is in accordance with the statutory mandate governing co- operative societies and hence the same cannot be disturbed by the AO. Without prejudice to the above, the assessee submitted that even if the disallowance proposed by the AO is sustained, the resultant addition would merely increase the business income of the assessee u/s 28 of the Act. Since the assessee is eligible for deduction u/s 80P(2)(a)(i) in respect of income derived from providing credit facilities to its members, as already held by the Ld. CIT(A) following the decision of the Hon’ble Supreme Court in Mavilayi Service Co-operative Bank Ltd., the enhanced income would also qualify for the said deduction. Accordingly, the learned AR submitted that the net tax effect would remain NIL, and therefore the disallowance would serve no practical purpose and therefore, the same is liable to be deleted.
On the contrary, the learned DR supported the orders of the AO and the Ld. CIT(A). He submitted that the assessee has adopted a hybrid system of accounting, recognizing interest income on cash basis while claiming interest expenditure on accrual basis. According to the learned DR, such selective recognition of income and expenditure results in distortion of true profits and is not permissible under the provisions of the Act.
We have carefully considered the rival submissions of both the parties and perused the materials placed on record. The assessee has raised an alternative contention that even if the disallowance made by the AO is sustained, the resultant addition would only enhance the . business income of the assessee which would otherwise qualify for deduction u/s 80P(2)(a)(i) of the Act.
10.1 It is an undisputed fact on record that the assessee is a co- operative society and engaged in providing credit facilities to its members. Therefore, once the income of the assessee is assessed under the head “profits and gains of business or profession” arising from the activity of providing credit facilities to its members, the same would qualify for deduction u/s 80P(2)(a)(i) of the Act.
10.2 In the present case, even if the disallowance made by the AO on account of accounting treatment of interest is sustained, the addition would merely lead to re-computation of the business income of the assessee at a higher figure. Such enhanced income would also partake the character of business income derived from providing credit facilities to the members and consequently would be eligible for deduction u/s 80P(2)(a)(i) of the Act. Thus, the disallowance proposed by the AO does not result in any taxable income in the hands of the assessee as the same would stand absorbed by the deduction allowable u/s 80P of the Act. In such circumstances, sustaining the disallowance would only lead to a revenue neutral exercise without any tax implication. In view of the above facts and circumstances, we find merit in the alternative plea raised by the assessee. Accordingly, even assuming the disallowance made by the AO is upheld, the resultant income shall be allowed as deduction u/s 80P(2)(a)(i) of the Act. Consequently, the addition does not survive for taxation. The ground raised by the assessee is therefore allowed.
Ground No. 3 and 4 relates to interest on mandatory deposits with bank.
The relevant facts are that the assessee earned an interest income of Rs. 32,043 from scheduled banks. The AO relying on the judicial of Totgars, Co-operative Sale Society Ltd. vs. Income-tax Officer, Karnataka reported in [2010] 188 Taxman 282 (SC)/[2010] 322 ITR 283 (SC)/[2010] 229 CTR 209 (SC)[08-02-2010] submitted that interest earned from deposits from scheduled banks does not qualify for deduction u/s 80P of the Act and consequently, taxed the same as income from other sources.
Aggrieved, assessee preferred an appeal before the Ld. CIT(A) who rejected the plea of assessee and upheld the disallowance made by the AO.
Aggrieved by the order of ld. CIT-A, the assessee preferred an appeal before us.
The Ld. AR before us submitted that the assessee earned interest of Rs. 32,043/- from deposits with scheduled banks, which constitutes only 1.28 percent of the total interest income. It was submitted that such deposits are statutorily required to be maintained u/s 58 of the Karnataka Co-operative Societies Act for maintaining reserves. Therefore, the interest earned is closely connected with the banking operations of the assessee and forms part of its business income eligible for deduction u/s 80P(2)(a)(i) of the Act.
The assessee further submitted that the decision of the Hon’ble Supreme Court in Totagar's Co-operative Sale Society Ltd. is distinguishable, as that case dealt with investment of surplus funds not required for business. Reliance was also placed on the decisions of the Bangalore Bench of the Tribunal in Saptagiri Pattina Soudharda Sahakari Sangha Niyamitha Vs. ITO in wherein interest from statutory deposits with scheduled banks was held eligible for deduction u/s 80P(2)(a)(i) of the Act.
Per Contra, the Ld. DR vehemently supported the orders of the AO and the Ld. CIT(A). He submitted that the interest earned from deposits with scheduled banks cannot be treated as income from the business of providing credit facilities to members. According to the Ld. DR, such interest arises from investment of funds with third parties, i.e., scheduled banks, and therefore the same does not have a direct nexus with the business activity carried on by the assessee with its members.
We have considered the rival submissions of both the parties and perused the materials placed on record. The limited issue before us is whether the interest income of Rs. 32,043/- earned from deposits with scheduled banks is eligible for deduction u/s 80P(2)(a)(i) of the Act.
18.1 The contention of the assessee is that the deposits with scheduled banks were made out of statutory reserves which were required to be maintained u/s 58 of the Karnataka Co-operative Societies Act, and therefore the interest earned therefrom is intrinsically connected with the banking operations carried on by the assessee. On . the other hand, the Revenue has relied upon the decision of the Hon’ble Supreme Court in the case of Totagar's Co-operative Sale Society Ltd. to contend that such interest income is assessable under the head income from other sources.
18.2 On perusal of the record, we find that the nature of the deposits and the source of funds invested in scheduled banks have not been examined by the AO in proper perspective. The crucial aspect which requires verification is whether the deposits with scheduled banks were made out of statutory reserves or funds integrally connected with the business of providing credit facilities to members and in accordance with the mandate of Karnataka Co-operative Societies Act. The eligibility of deduction u/s 80P(2)(a)(i) would depend upon this factual determination. Considering the above facts and in the interest of justice, we deem it appropriate to set aside the orders of the lower authorities on this issue and restore the matter to the file of the AO for fresh examination. The AO shall verify the nature of the deposits, the source of funds, and the statutory requirement under the Karnataka Co- operative Societies Act and thereafter decide the eligibility of deduction u/s 80P(2)(a)(i) in accordance with law and the judicial precedents on the issue. Needless to say, the AO shall provide adequate opportunity of being heard to the assessee and the assessee shall cooperate by furnishing the necessary details and supporting documents. Thus, the ground of appeal of the assessee is allowed for statistical purposes.
In the result, the appeal of assessee is partly allowed for statistical purposes.