THE KARNATAKA STATE CO-OPERATIVE APEX BANK LTD,BANGALORE vs. DEPUTY COMMISSIONER OF INCOME TAX,, BANGALORE

O R D E R

Per INTURI RAMA RAO, AM :

2. The Learned Appellate Authority erred in confirming the Page 2 of 13 action of Learned Assessing Officer in not considering the Appellant's claim Rs. 33,93,782/- towards Rural Farmers Socio Economic Development Fund, 3. The Learned Appellate Authority erred in confirming the action of Learned Assessing Officer in not considering the Appellant's claim Rs.5,27,50,000/- towards PACS/DCCB Fund.

4. The Learned Appellate Authority erred in confirming action of Learned Assessing Officer in not considering the Appellant's claim Rs. 5,00,00,000/- towards Special Assistance Fund.

5. The Learned Appellate Authority erred in confirming action of Learned Assessing Officer in not considering the Appellant's claim Rs.8,28,65,052/- towards loss on sale of GOI securities. On the above and such other grounds as may be urged at the time of hearing your appellant prays your Honour to consider the facts and circumstances of the case and render justice.”

"The assessee returned a total income of 40,77,27,1501-. However, the taxable income is calculated as under from the profit and loss account available on records. Net profit as per profit and loss account … Rs.13,35,00,112 Add Provision for tax Rs.12,00,00,000 Add Depreciation Rs. 84,44,123 Add NPA Rs.12,00,00,000 Add Any Other u/s 28 to 44DA Rs. 7,91,07,95 ------------------ Rs.32,75,52,073 Total Rs.32,75,52,073 Less: Dep. As per income tax Rs. 1, 07,13,384 Act Less: 7.5% for BDDR Rs. 3,37,75,410 ------------------- Rs. 4,44,89,794 ------------------- Taxable Income … Rs. 41,65,63,391 ========== The assessee’s returned income is only 40,77,27,150/-. Further, the assessee has claimed deduction from certain funds viz., Common Good Fund Rs. 25,00,000 Special Assistance Fund Rs. 1,00,00,000 PACS/DCCB Fund Rs. 50,00,000 Rural Farmers Social Economic Dev.Fund Rs. 1,35,00,000 The assessee is not entitled to claim the above deduction as these are the funds created out of distributed profit. Hence cannot be allowed as deduction as per the Income tax Act. I am, therefore, satisfied that income chargeable to tax has escaped assessment. Proceedings u/s 147 of the Income tax initiated. Issue notice u/s 148 of the Income tax Act.”

Page 5 of 13 6.1 During the course of hearing, it was submitted on behalf of the assessee-co-operative bank that during the previous year relevant to assessment year under consideration, while adding back the provisions of contribution made to (a)Common Good Fund, (b)Special Assistance Fund, (c)Payment to PACS/DCCB Fund and (d)Rural Farmers Socio Economic Development Fund, the assessee-co-operative bank had claimed deduction of actual amounts spent out of provision created. It was submitted that it was a statutory obligation to spend money for the above purposes as the provisions of the Karnataka Co-operative Societies Act stipulates that certain percentage of profits should be spent towards the specified purposes. The amounts are spent only as a statutory obligation and it was also further submitted that the amounts were spent only to promote the business interest of the assessee-co-operative bank and therefore, they should be allowed as deduction under the provisions of sec.37(1) of the Act. As regards the additional claim of deduction on account of loss of securities of Rs.8,28,65,052/- it was submitted that it was not a fresh claim but only re-adjustment of the already made claim in the original proceedings. Therefore, the ratio of the decision of the Hon’ble Supreme Court in the case of Sun Engineering Works (supra) is not applicable.

6.2 On the other hand, ld.CIT(DR) vehemently opposed the submissions of the learned AR of the assessee-co-operative bank and submitted that the issues in appeal are squarely covered by the Page 6 of 13 decision of the Hyderabad bench of Tribunal in the case of A.P.Mahesh Co-operative Urban Bank Ltd. Vs. DCIT (55 Taxman.com 429).

a) Common Good Fund Rs. 25,00,000/- b) Special Assistance Fund Rs.5,00,00,000/- c) Payment to PACS/DCCB Fund Rs.5,27,50,000/- d) Rural Farmers Socio Economic Development Fund …. Rs. 33,93,782/- -------------------- Rs.10,86,43,782/- It is not the case of the revenue that the above expenditure is capital in nature. The lower authorities had disallowed the above expenditure solely on the ground that it is only appropriation out of profits and not expenditure. The approach of the lower authorities cannot stand the test of law laid down by the Privy Council in the case of Indian Radio Cable Communications Co. Ltd. Vs. CIT (5 ITR 270) wherein it is laid down that when the assessee makes a payment which is computed in relation to profits, it is still an item of expenditure though ascertained by reference to the profits. The payment is not allowable as deduction only in the case of division of profits. Lord Maugham, speaking for the Privy Council held as follows:

“It is not universally true to say that a payment the making of which is conditional on profits being earned cannot properly be described as an expenditure incurred for the purpose of earning such profits. The typical exception is that of a payment to a director or a manager of a commission on the profits of a company. It may, however, be worth pointing out that an apparent difficulty here is really

Page 7 of 13 caused by using the word 'profits' in more than one sense. If a company having made an apparent net profit of £10,000 has then to pay £1,000 to directors or managers as the contractual recompense for their service during the year, it is plain that the real net profit is only £9,000.” The above principle was followed subsequently by the Hon’ble Supreme Court in the case of Poona Electric Supply Co. Ltd. V.s CIT (57 ITR 521) and this principle was re-iterated again by the Hon’ble Supreme Court in the case of CIT vs. Travancore Sugars & Chemicals Ltd. (90 ITR 307). Thus, the principle laid down in all the above cases is that though an amount of expenditure is ascertained with reference to profits, it does not lose the character of expenditure. Therefore, the reasoning adopted by the AO and the ld. CIT(A) cannot be accepted.

Page 8 of 13 “XXI DISTRIBUTION OF PROFITS: 1) Not less than 25% of the net profit shall be carried to the Reserve Fund. 2) Out of the balance of the net profit, contribution to the Cooperative Education Fund and to the Sahakari Kalyana Nidhi be provided as laid down under the Act. 3) The balance of net profit may be utilised for all or any of the following purposes namely. a) dividend on share as fixed h the Board he paid to the members. b) Of the remaining balance a sum not less than 15% shall be contributed to the Agricultural Credit Stabilisation Fund. c) Of the remaining balance, a sum not less that 15% shall be contributed to the Bad and Doubtful Debt Reserve Fund. d) Of the remaining balance, a sum not less than 2% shall be contributed to the Bad and Doubtful Debt Reserve Fund. e) Of the remaining balance, a sum not less than 10% to the building fund. f) Of the remaining balance a sum not less than 15% to the Special Assistance Fund to the members of the Bank. g) Of the remaining balance a sum not less than 15% to the Primary Agricultural Credit Societies Development Fund. h) Of the remaining balance a sum not less than 2% to the Dividend Equalisation Fund. i) Of the remaining balance not less than 5% shall be contributed to the Farmers’ Welfare Fund and j) The remaining balance shall be transferred to Reserve Fund of the Bank.”

Page 9 of 13 8.2 Pursuant to the above by-law, during the year under consideration, assessee-co-operative bank has spent the above sum. From perusal of the scheme of the above funds, it is clear that the fund contributed neither remains with the Apex Co-operative Bank nor comes back to the assessee-co-operative bank in other form. The amounts are spent only out of statutory obligation. The provisions of section 37(1) provides for deduction of any expenditure laid down or expended wholly and exclusively for the purpose of business in computing the income chargeable under the head ‘profits and gains business or profession’. The only exception is the capital expenditure or personal expenditure of the assessee or expenditure of nature described in other sections of Chapter IV of the Act. It is not the case of the revenue that contribution to the above fund is capital expenditure or in the nature of personal expense or expenditure described in any other sections in chapter IV. The only controversy is whether the amount spent out of above funds is an expenditure laid out ‘wholly and exclusively for the purpose of business’. The expression ‘for the purpose of business’ had come up for interpretation before the Hon’ble Apex Court in the case of CIT vs. Malayalam Plantations Ltd.(53 ITR 140) wherein it was held that the expression ‘for the purpose of business’ is wider in scope than the expression ‘for the purpose of earning profits’. It may include not only the day-today running of business but also rationalisation of its administration and modernisation of its machinery; it may include measures for the preservation of the business and for the protection of its assets and Page 10 of 13 property from expropriation, coercive process or assertion of hostile title; it may also comprehend payment of statutory dues and taxes imposed as a pre-condition to commence or for the carrying on of a business; it may comprehend many other acts incidental to the carrying on of a business. The only limitations that the purpose should be for the purpose of the business, that is to say, the expenditure incurred should be for the carrying on of business and the assessee should incur it in his capacity as a person carrying on the business. It cannot include sums spent for purpose unconnected with the business, Therefore, the question that requires consideration in this case is whether the contribution to the education fund under section 68 of the Maharashtra Co-operative Societies Act is an expenditure laid out wholly and exclusively for the purpose of the business of the assessee.

8.3 Under the above by-law, different rates of contribution have been prescribed for different kinds of funds, needless to mention that these bye-laws are framed pursuant to the Karnataka Co-operative Societies Act, 1959. Therefore, it is a statutory obligation of the assessee-co-operative bank to contribute to the above fund. For allowance of expenditure, it is settled proposition of law that the expenditure should result in profit. In this connection, reference may be made to the decision of the Hon’ble Apex Court in the case of CIT vs. Rajendra Prasad Moody (115 ITR 519). It may be further stated that one of the objects of the assessee-co-operative bank is to develop or assist and co-operative the member district central co-operative

Page 11 of 13 banks and other co-operative societies and therefore the contribution was only made in further pursuance of the objects of the bank for which it was established and therefore it cannot be said that there is a business interest in incurring those expenditure and the law laid down by the Hon’ble Supreme Court in the case of S.A.Builders vs. CIT (288 ITR 1) is squarely applicable.

8.4 The Hon’ble Bombay High Court in the case of CIT vs. State Bank of India (261 ITR 82), while dealing with the issue of allowability of subsidy granted by it to its subsidiary banks, held that by grant of subsidies it has got the business advantage and therefore, allowed deduction by holding as under: “Lastly, by giving subsidy to the State Bank of Patiala, the State Bank of Saurashtra, etc., for opening branches, assets were created, but these assets belonged to the subsidiaries. The assets did not belong to the State Bank of India. Similarly, profits were earned by the subsidiaries and not the State Bank of India. At the highest, by giving subsidy under section 48(1) of the Act, the State Bank of India got a business advantage. In the circumstances, we hold that the expenditure incurred by the State Bank of India in giving subsidies to the State Bank of Saurashtra, the State Bank of Patiala, etc., under section 48(1) of the said Act of 1959, represented revenue expenditure. Lastly, we may mention that in the case of Empire Jute Company Ltd. v. CIT [1980] 124 ITR 1, it has been held by the Supreme Court that what may be a capital receipt in the hands of the payee, need not necessarily be capital expenditure in relation to a payer. In the circumstances, there is no merit in the argument of the Department that because the subsidy is not income in the hands of the payee, it cannot be revenue expenditure in relation to the payer.

8.5 Thus viewed from this angle, the amounts spent cannot be disallowed. The reliance placed by the ld.CIT(DR) on the decision of Page 12 of 13 the Hyderabad bench of Tribunal in the case of A.P.Mahesh Co- operative Urban Bank Ltd (supra) rests on the decision of the Hon’ble Supreme Court in the case of Vellore Electric Corporation Ltd. Vs. CIT (227 ITR 557). On perusal of the said decision, it is clear that the decision is relating to creation of reserve fund which always remained with the assessee-corporation. Therefore, the ratio of decision in teh case of A P Mahesh Co-operative Urban Bank Ltd (supra) is not applicable to the facts of the case. We, direct the AO to allow the amount spent on the above fund of Rs.10,86,43,782/- as deduction while computing income of the assessee-co-operative bank.

Order pronounced in the open court on this 29th day of February, 2016