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M.P. State Co-Operat... v. Additional Commissio...
Structured Summary of the Opinion — Reference by Income-tax Appellate Tribunal
Factual and Procedural Background
This opinion arises from a reference made by the Income-tax Appellate Tribunal (ITAT) at the instance of the assessee — M. P. State Co-operative Bank Ltd., Jabalpur — seeking the court's answer to a question of law about the tax treatment of interest on certain Government securities. The relevant assessment year is 1963-64 (previous year ended 30 June 1962).
The bank is the apex body of the district co-operative banks in Madhya Pradesh and was formed under the M. P. Co-operative Societies (Amalgamation) Act, 1957; it is registered under the Co-operative Societies Act, 1912, and governed at the relevant time by the M. P. Co-operative Societies Act, 1960. Statutory provisions required transfers to a reserve fund and regulated investment and use of reserve and provident funds. The Government of Madhya Pradesh issued a circular (7 October 1960) directing that the apex bank's reserve fund be invested outside its business in Government securities, not used as working capital, and not drawn without Registrar sanction except for meeting losses or winding-up.
The bank's balance-sheet for the relevant period showed Government securities (face value) distributed as follows:
- Securities pledged with State Bank of India (shown as "investment"): Rs. 44.92 lakhs
- Securities pledged with Reserve Bank of India (shown as "investment"): Rs. 55.59 lakhs
- Other unpledged securities (shown as "investment"): Rs. 11.30 lakhs
- Securities earmarked to reserve fund: Rs. 19.55 lakhs
- Securities earmarked to provident fund: Rs. 0.50 lakhs
- Total: Rs. 131.86 lakhs
The Tribunal held that the first three categories of securities comprised the bank's stock-in-trade (circulating capital) and that income from them was income from the business of banking (and thus exempt under the relevant statutory provision). In contrast, the Tribunal held that the securities earmarked to the reserve fund and to the provident fund did not form part of the stock-in-trade or circulating capital, and that interest therefrom did not amount to income from banking business.
Legal Issues Presented
- Whether, on the facts and in the circumstances of the case, the Appellate Tribunal was justified in holding that Government securities earmarked to the reserve fund and to the provident fund did not constitute the bank's stock-in-trade or business assets and that the interest therefrom was exigible to tax?
Arguments of the Parties
Appellant's (Assessee's) Arguments
- The assessee's counsel referred to several precedents (U. P. Co-operative Bank Ltd. v. CIT; CIT v. Orissa Co-operative Housing Corporation Ltd.; Malabar Co-operative Central Bank Ltd. v. CIT; CIT v. Ahmedabad District Co-operative Bank Ltd.) in which investments in securities were held to be circulatory capital or stock-in-trade and income from them was treated as income from banking business (and thus exempt).
- It was contended that the provident fund did not belong to the assessee and hence interest income from investment of the provident fund was not income of the assessee.
Respondent's Arguments
The opinion does not contain a detailed account of the respondent's legal arguments.
Table of Precedents Cited
| Precedent | Rule or Principle Cited For | Application by the Court |
|---|---|---|
| Punjab Co-operative Bank Ltd. v. CIT [1940] 8 ITR 635 (PC) | Investments in easily realisable securities to meet probable withdrawals by depositors is a normal and integral component of banking business/circulating capital. | The court used this precedent to confirm that investments can form part of banking business where they are held to meet withdrawals and are part of circulating capital; it thereby distinguished such normal banking investments from reserve/provident fund investments in the present case. |
| Bihar State Co-operative Bank Ltd. v. CIT [1960] 39 ITR 114 (SC) | It is normal for a bank to invest funds in a readily available form as part of circulating capital; but if moneys are surplus (not required for banking business) they are not part of banking business. | The court relied on the decision to explain that where funds are surplus (not used in banking business) income from their investment would not be treated as income from banking business. This supported the conclusion that reserve fund investments (not available for banking operations) are not circulating capital. |
| Madras Co-operative Central Land Mortgage Bank Ltd. v. CIT [1968] 67 ITR 89 (SC) | Where investments are made both for trading and non-trading purposes, the exempt proportion of income corresponds to the proportion of capital used for the business to the total working capital. | The court cited the proportionality principle to indicate that only that portion of income attributable to capital used in the business could be exempt; this supports distinguishing non-business reserve investments from business investments. |
| Andhra Pradesh Co-operative Central Land Mortgage Bank Ltd. v. CIT [1975] 100 ITR 472 (AP) | It is the assessee's burden to establish that income from investment in securities was earned in carrying on the business of banking. | The court cited this precedent to affirm the principle that the assessee must prove that the investment income arose from banking business; this informed the court's approach to the classification of reserve/provident fund investments. |
| Assam Co-operative Apex Bank Ltd. v. CIT [1978] 112 ITR 87 | Not all investments of a bank are necessarily part of its circulating capital; some securities may be trading assets while others may not (e.g., where funds are idle or not utilised for banking purposes). | The court expressly agreed with these observations and used this principle to support the finding that some securities (reserve/provident fund investments) may lie outside circulating capital. |
| Commissioner Of Income Tax, Mysore v. Canara Bank Ltd. [1967] 63 ITR 328 (SC) | An example where funds lying idle and not utilised for banking purposes were held not to be part of the bank's trading assets. | Cited within the Assam Apex Bank observation and relied on to illustrate that idle or non-utilised funds do not form part of trading assets; this aided the court's differentiation of reserve fund investments. |
| U. P. Co-operative Bank Ltd. v. CIT [1966] 61 ITR 563 (All) | Investment in securities may constitute circulating capital/stock-in-trade in particular factual contexts. | Referred to by the assessee's counsel as supporting exemption; the court distinguished this and similar cases on facts, noting they do not establish a universal rule that all investments in securities are part of banking business. |
| CIT v. Orissa Co-operative Housing Corporation Ltd. [1976] 104 ITR 157 (Orissa) | Investment in securities can be held to be circulatory capital/stock-in-trade in the facts of that case. | Referred to by assessee's counsel; the court treated such cases as fact-specific and not controlling where reserve/provident funds are restricted from business use. |
| Malabar Co-operative Central Bank Ltd. v. CIT [1975] 101 ITR 87 (Ker) | Investment in securities may constitute stock-in-trade/circulating capital depending on factual circumstances. | The court acknowledged the case but distinguished it on the basis that the present reserve fund was not available for banking business and therefore not part of circulating capital. |
| CIT v. Ahmedabad District Co-operative Bank Ltd. [1975] 101 ITR 733 (Guj) | Investment in securities treated as circulating capital in the facts of that case. | Referred to by the assessee; court treated it as fact-dependent authority and did not accept it as establishing a general rule applicable to reserve/provident fund investments. |
Court's Reasoning and Analysis
The court's analysis proceeded in a sequence of statutory interpretation, factual assessment and application of established principles from authority:
- Statutory framework: The court examined Section 81(i)(a) of the Income-tax Act, 1961, which exempts income-tax for a co-operative society "in respect of the profits and gains of business carried on by it" where the society is engaged in banking. The court emphasised that the exemption applies only to income that is "from banking business" and not to all income of the society.
- Nature of banking business: The court described banking business as the dealing with money and credit, which normally requires keeping cash or readily realisable securities to meet depositor demands. Investments in such securities, when made to meet withdrawals and as part of circulating capital, are integral to banking business (citing Punjab Co-operative Bank Ltd. and Bihar State Co-operative Bank Ltd.).
- Distinction for reserve and provident funds: The court examined statutory constraints on reserve and provident funds under the Co-operative Societies Act — notably Section 44(2) (investment/use of reserve fund only as permitted by Registrar) and Section 46 (a contributory provident fund "shall not be used in the business of the society and shall not form part of the assets of the society"). The Government circular (7 October 1960) mandated that the apex bank's reserve fund be fully invested outside its business in Government securities, not be used as working capital, and only be drawn with Registrar sanction (for losses or winding-up).
- Application to facts: Given the statutory and regulatory restrictions, the court held that investments of the reserve fund are not held to meet withdrawals or normal banking transactions and therefore do not constitute circulating capital or stock-in-trade of the bank. The court further observed that where capital is not needed for banking business (i.e., surplus or otherwise restricted), income from investment of that capital is not income from banking business (relying on Bihar State Co-operative Bank and related authorities).
- Precedent reconciliation: The court accepted that some authorities (cited by the assessee) held investments in securities to be circulating capital in their facts, but emphasised those decisions do not create a universal rule. The court repeatedly underlined that the critical inquiry is whether the particular investment is attributable to circulating capital or stock-in-trade. Where statutory provisions and the facts show funds are segregated and not available for banking business (as in the reserve fund and, by statutory command, the provident fund), the income from such investments cannot be treated as income from banking business.
- Provident fund specific point: The court noted the Tribunal had found interest from provident fund investments included in the gross interest of the assessee and that the point whether such interest was not income of the assessee was not raised before earlier authorities (ITO/AAC). The reference question did not include the narrower point whether such interest is the assessee's income; the court therefore proceeded on the assumption that it was assessable income of the assessee but concluded that, even on that assumption, it was not income from banking business because the provident fund could not be utilised in the business of the society.
The court thus applied statutory text (Sections 44 and 46 of the Co-operative Societies Act and Section 81(i)(a) of the Income-tax Act), the Government circular, and the line of precedent distinguishing trading/circulating capital from segregated/reserve capital to reach its conclusions.
Holding and Implications
Holding: The court answered the referred question in the affirmative. In other words, the court held that the Appellate Tribunal was justified in holding that the Government securities earmarked to the reserve fund and to the provident fund did not constitute the bank's stock-in-trade or business assets and that the interest therefrom did not amount to income from the banking business for the purpose of exemption under Section 81(i)(a) of the Income-tax Act.
Direct Effect on the Parties: The immediate consequence is that interest earned on the securities earmarked to the reserve fund and to the provident fund is not to be treated as income from the business of banking and therefore does not qualify for exemption under Section 81(i)(a) of the Income-tax Act. The court expressly declined to decide the separate legal question (not covered by the reference) whether interest from the provident fund investments was not income of the assessee at all; it proceeded on the assumption that such interest was included in the assessee's gross interest for purposes of this reference.
Broader Implications and Precedential Effect: The court emphasised that its conclusion rests on the statutory restrictions and factual position regarding the non-availability of reserve/provident funds for banking business. It did not lay down a rule that all investments in securities are outside banking business; rather, it reaffirmed the established principle that the characterisation depends on whether the relevant funds form part of circulating capital or stock-in-trade. The opinion therefore resolves the specific reference but does not create a blanket rule for all cases of investment in securities.
Costs: There shall be no order as to costs.
1. This is a reference made by the Income-tax Appellate Tribunal, at the instance of the assessee, referring for our answer the following question of law :
" Whether, on the facts and in the circumstances of the case, it could be said that the Appellate Tribunal was justified in holding that the Government securities earmarked to reserve fund and to provident fund did not constitute the bank's stock-in-trade or business assets and the interest therefrom was exigible to tax ?"
2. The relevant assessment year is 1963-64. The corresponding previous year ended on 30th June, 1962. The assessee is the M. P. State Co-operative Bank Ltd., Jabalpur, which is the apex body of the district co-operative banks in the State of Madhya Pradesh. The bank in the present shape came to be formed under the M. P. Co-operative Societies (Amalgamation) Act, 1957. The bank is registered under the Co-operative Societies Act, 1912. At the relevant time, the bank was governed by the M. P. Co-operative Societies Act, 1960. under Section 43(2) of this Act, a society is required to transfer, unless exempted by a general or special order of the Registrar, at least twenty-five per cent, of its profits to its reserve fund. Section 44 of the Act deals with investment of funds. sub-section (2) of this section provides that the reserve fund of a society shall be invested or utilised only in such manner and on such terms and conditions as may be laid down by the Registrar in this behalf. Section 46 deals with the constitution of the employees' provident fund. The section enacts that a society may establish a contributory provident fund for the benefit of its employees to which shall be credited all contributions made by the employees and the society in accordance with the bye-laws of the society. The section further enacts that a contributory provident fund established by a society shall not be used in the business of the society and shall not form part of the assets of the society. The Government of Madhya Pradesh issued a circular, dated 7th October, 1960. The circular states that "the reserve fund of the apex bank shall be fully invested outside its business in Government securities ". The circular also states that no part of the reserve fund should be utilised as working capital. The circular further provides that " no part of the reserve fund deposits shall be drawn without the previous sanction of the Registrar". It also provides that the approval of the Registrar can be given " when the amount is either required to meet losses, or when the society is to be wound up ".
3. The total break-up of the securities held by the bank during the relevant period in terms of face value as evidenced from the balance-sheet is as under :
Rs.
(i) Securities pledged with the State Bank of India and shown under " investment "
44-92 lakhs
(ii) Securities pledged with the Reserve Bank of India and shown under " investment "
55-59 lakhs
(iii) Other unpledged securities shown under "investment"
11-30 lakhs
(iv) Securities earmarked to reserve fund 19-55 lakhs
(v) Securities earmarked to provident fund 0-50 lakhs Total 131-86 lakhs
4. Section 81(i) of the I. T. Act, 1961, as it stood on the relevant date, reads as follows I "81. Income of co-operative societies.--Income-tax shall not be payable by a co-operative society-
(i) in respect of the profits and gains of business carried on by it, if it is--(a) a society engaged in carrying on the business of banking or providing credit facilities to its members;......
Provided that, in the case of a co-operative society which is also engaged in activities other than those mentioned in this clause, nothing contained herein shall apply to that part of its profits, and gains as is attributable to such activities and as exceeds fifteen thousand rupees."
5. The Tribunal came to the conclusion that the first three items of investments in securities constituted the assessee's stock-in-trade and that the income from these secutities was income from the assessee's business of -banking. In respect of securities earmarked for reserve fund and provident fund, which constitute the remaining two items of investments, the Tribunal came to the conclusion that these investments did not form part of the assessee's stock-in-trade or circulating capital and, therefore, the interest from these investments did not amount to income from the business of banking.
6. A look at section 81(i)(a) of the i. t. act will show that all income of a society carrying on banking business is not exempt from taxation. It is only that income from banking business which is exempt and not the income arising from any other activity of the society. The question before us is, whether the interest income from the Government securities earmarked for reserve fund and provident fund was income of the assessce from the business of banking and was exempt under Section 81(i)(a) of the Act.
7. In the case of a bank, the business normally consists, in its essence, of dealing with money and credit. Depositors place their money with the bank and receive a small rate of interest. Borrowers from the bank receive loans of a large part of the deposits at somewhat higher rates of interest. The banker has always to keep enough cash or easily realisable securities to meet any probable demand by the depositors. Investments in easily realisable securities to meet withdrawals by depositors is a normal step in carrying on banking business. [Punjab Co-operative Bank Ltd. v. CIT[1940] 8 ITR 635 (PC).]. In Bihar State Co-operative Bank Ltd. v. C1T [1960] 39 ITR 114 the Supreme Court observed (p. 122):
......it is a normal mode of carrying on banking business to invest moneys in a manner that they are readily available and that is just as much a part of the mode of conducting a bank's business as receiving deposits or lending moneys or discounting hundies or issuing demand drafts. That is how the circulating capital is employed and that is the normal course of business of a bank. The moneys laid out, in the form of deposits ......would not cease to be a part of the circulating capital......nor would they cease to form part of its banking business.
8. It is not disputed that if circulating capital or stock-in-trade of a co-operative bank is invested in securities, interest earned on the securities would be a part of the income from banking business and would be exempt under Section 81(i)(a) of the Act. The point, however, is whether the investment in securities of the reserve fund can be said to be investment of circulating capital or the stock-in-trade of the bank. We have already noticed that as provided by Section 44(2) of the Co-operative Societies Act, the reserve fund can be utilised only as may be permitted by the Registrar in that behalf. We have also referred to the Government circular, the binding nature of which was not disputed before us, that the reserve fund cannot be utilised as a working capital and that it can be withdrawn only on the approval of the Registrar which can be given only when the amount is either required to meet losses or when the society is to be wound up. The investment of the reserve fund in securities is obviously not to meet withdrawals by depositors or other transactions as is the case with the circulating capital or stock-in-trade. Having regard to the aforesaid features, the reserve fund cannot be taken to be circulating capital or stock-in-trade of the assessee.
9. The entire capital of a bank cannot always be said to be employed in banking business. Income arising from investment of that part of the capital which is not needed for banking business cannot be said to be income arising from banking business. In Bihar State Co-operative Bank Ltd.'s case [1960] 39 ITR 114 (SC), the bye-law provided that the bank would invest surplus funds when not required for the business of the bank. Referring to this bye-law, the Supreme Court observed that it had not been shown that the moneys which were in deposit with other banks were " surplus within that bye-law so as to take it out of banking business ". It follows from this observation that had it been shown that the moneys were surplus, it would have been held that the income therefrom was not a part of the income from banking business. Similarly, in Madras Co-operative Central Land Mortgage Bank Ltd. v. CIT [1968] 67 ITR 89 (SC), the co-operative society concerned had made investments in Government securities for trading purposes and also for non-trading purposes. It was held that in such a case the proportion of income from securities exempt from taxation will be that proportion which the capital of the society used for the purpose of the business bears to the total working capital. In Andhra Pradesh Co-operative Central Land Mortgage Bank Ltd. v. CIT [1975] 100 ITR 472 (AP), it was held by the Andhra Pradesh High Court that it was for the asses-see to establish that the income from investment in securities sought to be exempted was earned in carrying on the business of banking. A Division Bench of the Gauhati High Court in Assam Co-operative Apex Bank Ltd. v. CIT [1978] 112 ITR 87 observed (p. 92) :
" All investments may not necessarily be part of the circulating capital of a bank. A bank may conceivably have certain securities which are its circulating capital and some which are not. For example, where the funds of a bank are lying idle and are not being utilised by it for its banking purposes as was the case in Commissioner Of Income Tax, Mysore v. Canara Bank Ltd. [1967] 63 ITR 328 (SC), such funds will not be part of its trading assets. In other words, any investment by a banking concern would not necessarily represent its trading assets. There may well be cases where certain funds are idle or not utilised by the bank, in which case such funds will not be trading assets."
10. We respectfully agree with these observations.
11. The learned counsel for the assessee referred to us U. P. Co-operative Bank Ltd. v. CIT [1966] 61 ITR 563 (All), CIT v. Orissa Co-operative Housing Corporation Ltd. [1976] 104 ITR 157 (Orissa), Malabar Co-operative Central Bank Ltd. v. CIT [1975] 101 ITR 87 (Ker) and AW. CIT v. Ahmedabad District Co-operative Bank Ltd. [1975] 101 ITR 733 (Guj). In these cases, it was held that investment in securities was of circulatory capital or stock-in-trade of the society concerned and that income therefrom was income from banking business. These cases, however, do not hold that all income from investment in securities made by a society would be regarded as income from banking business. As earlier pointed out by us, the income would form part of banking business only when the investment in securities relates to circulating capital or stock-in-trade. The reserve fund in the instant case is not a part of the circulating capital of the assessee. It can be utilised only when permitted by the Registrar in case of loss or winding-up. Income from investment of reserve capital in securities is thus not a part of the income from banking business and does not qualify for exemption.
12. As regards investment of provident fund, it is expressly provided in Section 46 of the Co-operative Societies Act that provident fund cannot be used in the business of the society. It was contended before us that the provident fund does not belong to the assessee and, therefore, interest income from investment of provident fund in securities is not income of the assessee. The Tribunal negatived this contention by pointing out that interest from investment of provident fund was included in the gross interest shown in the profit and loss account of the assessee. The point that interest from investment of provident fund was not income of the assessee was not raised before the ITO or the AAC. The Tribunal held that as interest earned from investment of provident fund was included in the gross interest, it had to be held that the income was income of the assessee. The question referred to us does not cover the question whether interest from investment of provident fund is the assessee's income or not. We are, therefore, not entitled to go into this question. We have to proceed on the assumption that this income was income of the assessee. This income, however, cannot be a part of the income from banking business as the provident fund cannot be utilised in the business of banking. The income from interest of investment of provident fund also, therefore, does not qualify for exemption under Section 81(i)(a) of the Act.
13. For the reasons given above, we answer the question referred to us in the affirmative. There shall be no order as to costs.
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