IN THE HIGH COURT OF GUJARAT AT AHMEDABAD INCOME TAX REFERENCE Nos 48 and 49 of 1999 with TAX APPEAL Nos 5, 6, 7, 8 and 11 of 1999 For Approval and Signature: Hon'ble MR.JUSTICE A.R.DAVE and Hon'ble MR.JUSTICE M.S.SHAH ============================================================ 1. Whether Reporters of Local Papers may be allowed : YES to see the judgements? 2. To be referred to the Reporter or not? : YES 3. Whether Their Lordships wish to see the fair copy : NO of the judgement? 4. Whether this case involves a substantial question : NO of law as to the interpretation of the Constitution of India, 1950 of any Order made thereunder? 5. Whether it is to be circulated to the Civil Judge? : NO -------------------------------------------------------------- THE GUJARAT STATE CO.OP. BANK-LTD. Versus THE COMMISSIONER OF INCOME TAX -------------------------------------------------------------- Appearance: 1. Income Tax Reference No. 48 fo 1999 MR KH KAJI for Petitioner MR MIHIR JOSHI i/b MR MR BHATT for Respondent MR JP SHAH, MR NR DIVATIA AND MR SN SOPARKAR FOR INTERVERNERS 2. Tax Appeal No. 5 of 1999 MR MIHIR JOSHI i/b MR MR BHATT for Petitioner MR KH KAJI for Respondent -------------------------------------------------------------- CORAM : MR.JUSTICE A.R.DAVE and MR.JUSTICE M.S.SHAH Date of decision: 29/11/2000 CAV JUDGEMENT (Per M.S. Shah, J) Reference No. 48 of 1999 under Section 256(1) of the Income Tax Act, 1961 (hereinafter referred to as "the Act"), at the instance of the assessee, arises from the judgment dated 3.12.1997 of the Income Tax Appellate Tribunal, Ahmedabad Bench (hereinafter referred to as "the Tribunal") in Appeal Nos. 3796, 3797, 4482, 4483, 4810 and 4311/Ahd/95 for the Assessment Years 1988-89, and 1990-91 to 1994-95. Tax Reference No. 49 of 1999 is made at the instance of the Revenue in respect of the rectification order dated 24.9.1998 in Misc. Application No. 26/Ahd/98. Tax Appeals are filed by the Revenue under Section 260-A of the Act against the orders dated 6.10.1998 passed by the Tribunal in Misc. Application No. 27/Ahd/98 and cognate applications of the assessee for rectification of the aforesaid judgment of the Tribunal. In view of the fact that the questions referred to this Court and the questions raised in the Tax Appeals are inter connected and involve interpretation of the same statutory provision viz. Section 80P(2)(a)(i) of the Act, with the consent of the learned counsel for the parties, the tax references and the appeals were heard together and are being disposed of by this common judgment. 2. In Tax Reference No. 48 of 1999, the following questions have been referred by the Tribunal :- "(i) Whether the Tribunal was right in law in holding that interest income earned from short term deposits with nationalized banks out of its reserve funds was not entitled to exemption u/s. 80P(2)(a)(i), in view of the decision of the Supreme Court in 218 ITR 438 ? (ii) Whether the Tribunal was right in law in holding that the provision of Madhya Pradesh Cooperative Societies Act was substantially in pari materia with the Gujarat Cooperative Societies Act with regard to utilization of reserve funds and, therefore, income from investment of such reserve funds did not fall within the scope of Section 80P(2)(a)(i) ? (iii) Whether the Tribunal was right in law in holding that the locker rent is not entitled to exemption u/s. 80P(2)(a)(i)?" 3. In Tax Reference No. 49/99 at the instance of the revenue, the following question has been referred :- "Whether, the Appellate Tribunal ought not to have appreciated that deduction under section 80-P(2)(a)(i) is allowable for those profits only which are earned by carrying on the business of banking or providing credit facilities to its members when in the instant case the assessee had earned income utilizing building fund, dividend equalization fund, investment reserve, depreciation reserve and other reserves which cannot be treated as normal banking activity ?" 4. Since the entire controversy in both these proceedings revolves round the question whether earnings by the Bank from the aforesaid activities are deductible under the provisions of Section 80P of the Act, the relevant portion of Section 80P is set out hereunder :- "(1) Where, in the case of an assessee being a co-operative society, the gross total income includes any income referred to in sub-section (2), there shall be deducted, in accordance with and subject to the provisions of this section, the sums specified in sub-section (2), in computing the total income of the assessee. (2) The sums referred to in sub-section (1) shall be the following, namely :- (a) in the case of a co-operative society engaged in - (i) Carrying on the business of banking or providing credit facilities to its members ... ... ... .... .... the whole of the amount of profits and gains of business attributable to any one or more of such activities." 5. Mr JP Shah, Mr NR Divetia and Mr SN Soparkar, learned counsel sought our leave to intervene at the hearing of these proceedings as their respective clients have a number of proceedings before the Income Tax Appellate Tribunal or before the Appellate Authorities under the Act wherein similar questions about deductibility of interest earned by Co-operative Banks on deposits from out of reserve funds are pending for consideration. We are also informed that the aggregate of the tax demands involved in all such proceedings amounts to a few hundred crores of rupees and that, therefore, also the learned counsel requested for permission to intervene at the hearing of these proceedings before this Court, although none of the assessees on whose behalf they sought to intervene have any proceedings pending before this Court. Having heard the learned counsel for the assessee and the learned counsel for the revenue at whose instance the present tax references and the tax appeals are filed, we have permitted the above named learned counsel to intervene at the hearing of these proceedings. All the learned counsel have been heard at length on all the questions being answered by this judgment. 6. The facts leading to filing of the Tax References and the Tax Appeals, briefly stated, are as under :- 6.1 The Gujarat State Cooperative Bank Ltd. (hereinafter referred to as "the Bank"), an apex Cooperative Bank is carrying on business of banking. It is rendering services in the nature of bankers' bank. In the course of its activities - (i) the Bank having surplus funds including the funds in the various reserves invests the same in short term deposits with various scheduled banks and earns interest from such investments. (ii) the Bank also has lockers in the bank premises for benefit of its customers who come to the bank for banking purposes and the locker rent is earned by the bank by renting the lockers to the customers. (iii) the Bank also earns commission income from its customers while issuing bank drafts, and levies collection charges for collecting the amounts of cheques on behalf of its customers or commission for issuing bank guarantees. 6.2 The assessments for A.Ys. 1989-89 to 1994-95 were originally completed on the footing that the interest income was deductible under Section 80P as income from banking business. However, the assessments were reopened by the Income Tax authorities relying on the judgment of Madhya Pradesh High Court in M.P. State Co-Op. bank Ltd. 119 ITR 327(MP), which held that the income from investment of reserves in certain deposits was not deductible as it was not income from banking business, and was taxable. In re-assessment proceedings, relying on the aforesaid judgment of Madhya Pradesh High Court, the Assessing Officer held that the income by way of interest from investment of reserves was not deductible. He also held as not deductible income by way of locker rent as also commission income. He further held that the income earned by way of dividend from investment in shares of public sector Corporations primarily IFCI was falling within the scope of Section 80P(2)(d) and was, therefore, not deductible under Section 80P(2)(a)(i). 6.3 In appeals, the CIT(A) held by his order dated 29.6.1995 that the judgment of the Madhya Pradesh High Court was not applicable because the provisions of the Madhya Pradesh Cooperative Societies Act were different from the provisions of Gujarat Cooperative Societies Act under which the reserves are permitted to be used for the business of the Bank and were, therefore, part of working capital/stock in trade of the Bank. The CIT (A) also held that the income by way of locker rent as well as commission income fell within the scope of banking business deductible under Section 80P(2)(a)(i). The CIT(A) remanded the issue regarding the dividend income as to whether it was covered by sub-clause (d) or sub-clause (a). 6.4 The Department preferred appeals to the Tribunal. By its judgment dated 3.12.1997, the Tribunal held as follows, while partly allowing the appeals of the revenue:- (i) Interest income earned on deployment of funds out of reserve funds with banks other than Co-operative banks is not deductible under section 80P(2)(a)(i). The Tribunal, however, upheld the alternative contentions of the assessee that if the said income is taxable, then proportionate expenses incidental to the said investment would be allowable and the Assessing Officer was directed to decide this aspect after hearing the assessee. (ii) The income by way of locker rent was held as not falling within income from banking business, following the judgment of Madhya Pradesh High Court in Bhopal Co-operative Central Bank vs. CIT, 169 ITR 573(MP). (iii) The issue whether income by way of commission was deductible as income from banking business was remanded to the Assessing Officer to examine the facts and decide the point. (iv) The remand by CIT(A) on the issue of dividend income was confirmed. 6.5 Thereafter, an application for rectification for AY 1991-92 (No. 26/A/98) was preferred by the assessee Bank as it was not clarified nor decided whether the order of the Tribunal applied only with respect to statutory reserves required to be created under the Gujarat Co-operative Societies Act or it applied to all other reserves as well which were voluntary and which could be brought back in the profit and loss account. The Tribunal allowed the application for rectification and by judgment dated 24.9.1998 held that it had not decided this aspect and hence the rectification application was maintainable and consequently held that the judgment of the Tribunal was only in relation to statutory reserves. The clarification was given on the ground that the Supreme Court decision in M.P. Co-Op. Bank Case (218 ITR 438) pertained to only statutory reserves. Similar rectification applications filed by the assessee Bank for the other years were disposed of by the Tribunal on 6.10.1998 by observing that the order dated 24.9.1998 in M.A. No. 26/A/98 was applicable to other cognate rectification applications as well. 6.6 Against the aforesaid judgment dated 3.12.1997 of the Tribunal, Reference No. 48/99 has been made to this Court at the instance of the assessee and against the judgment dated 24.9.1998 in Rectification Application No. 26/A/98, Tax Reference No. 49 of 1999 is made at the instance of the revenue. Although the Revenue had also prayed for referring questions regarding power of the Tribunal to pass rectification orders under Section 254(2) those questions were not referred. 6.7 Since the provisions of Section 260A of the Act came into force w.e.f. 1.10.1998, against the orders dated 6.10.1998 of the Tribunal in the other rectification applications, the Revenue has filed the Tax Appeals in which the following questions have been raised as substantial questions of law :- "(1) Whether, the Appellate Tribunal is right in law and on fact in entertaining and allowing application filed under section 254 of the Act which tantamount to reviewing its earlier decision ? (2) Whether, the order dtd. 6/10/1998 can be said to be a rectification order under section 254 of the Act, when there was no mistake apparent from the face of the record ? (3) Whether, the Appellate Tribunal ought not to have appreciated that deduction under section 80-P(2)(a)(i) is allowable for those profits only which are earned by carrying on the business of banking or providing credit facilities to its members when in the instant case the assessee had earned income utilizing building fund, dividend equalization fund, investment reserve, depreciation reserve and other reserves which cannot be treated as normal banking activity ?" 7. Since earlier, while disposing of reference application for A.Y. 1991-92, questions in relation to Section 254(2) were not referred and since the issues are interconnected, the learned Standing Counsel for the Revenue agreed that since question No. 3 is otherwise also required to be decided while deciding the questions referred to this Court in the two Tax References, it is not necessary for the Court to give its decision on question Nos. 1 and 2 raised in the Tax Appeals. Hence out of the questions raised in the Tax Appeals, only question No. 3 is required to be decided by this Court. TAX DEDUCTIBILITY OF INTEREST ON DEPOSITS / INVESTMENTS OF RESERVES 8. Question Nos. (i) and (ii) in Tax Reference No. 48/99, the question referred in Tax Reference No. 49/99 and question No. 3 in the tax appeals are all interconnected and are, therefore, being discussed jointly and not separately. Before narrating the contentions raised and the submissions made on behalf of various assessees and the Revenue, looking to the nature of the controversy, we have perused the relevant provisions of the Madhya Pradesh Co-operative Societies Act (M.P. Act), Rajasthan Co-operative Societies Act, Maharashtra Co-operative Societies Act and Karanataka Co-operative Societies Act and Gujarat Co-operative Societies Act (Gujrat Act). However, the provisions of only the M.P. Act and the Gujarat Act & Rules are set out. Statutory provisions of the Cooperative Societies Act- Madhya Pradesh ACt and the Gujarat Act 9. Madhya Pradesh Co-op. Societies Act. "43. Funds and Projects - (1) No parts of the funds of a society other than the net profits shall be paid by way of bonus or dividend or otherwise distributed among its members. (2) A society shall, out of its net profits in any year - (a) transfer an amount not being less than twenty-five per cent of such profits to the reserve funds unless such society has been by general or special order, partially or wholly exempted in this behalf the Registrar, and (b) & (c) ... ... ... .... (3) to (5) ... ... ... .... 43. Subject to the provisions of sub-sections (2) and (3), a society may invest or deposit its funds :- (a) in Government Savings Bank or in a Co-operative Bank; or (b) to (d) ... .... .... ... (e) with any bank approved for this purpose by the Registrar and on such terms and conditions, if any, as may be laid down by him in this behalf. (2) The Reserve Fund of a society shall be invested or utilized only in such manner and on such terms and conditions as may be laid down by Registrar in this behalf. (3) No investment of any of its funds in immovable property other than funds created for specified purposes, shall be made by a society other than a housing society without the approval of the Registrar. (4) A society accepting deposits shall maintain, as a cover against such deposits, fluid resources to such extent and in such manner as may be specified by the Registrar from time to time. 10. M.P. Government's Instructions No. CR 25/26, dated October 7, 1960 which, in so far as it concerns apex banks, read as under :- (C) Apex Bank : The reserve fund of the apex bank shall be fully invested outside its business in the Government securities. No part of its reserve fund should be utilized as its working capital. 3. All investments of reserve fund shall be specially marked as 'Reserve fund investment' and shall be shown separately in the annual balance-sheets. The reserve fund deposits at every level shall carry the maximum rate of interest which a Central Bank or apex bank pays on fixed deposits for longest period or three per cent, whichever is higher. No part of the reserve fund deposits shall be drawn without the previous sanction of the Registrar, in the case of apex bank, Central Banks and large-sized societies and in the case of other primary societies without the permission of the Deputy Registrars. Such approval can be given when the amount is either required to meet losses, or, when the society is to be wound up. These eventualities will, however, be very rare." 11. Gujarat Co-operative Societies Act, 1961 2(24). "Working capital" means funds at the disposal of a society inclusive of paid up share capital, funds built out of profits, and money raised by borrowing and by other means. 67. Reserve fund.- (1) Every society which does, or can, derive a profit from its transactions, shall maintain a reserve fund. (2) Atleast one-fourth of the net profits of the society each year, shall be carried to the reserve fund; and such reserve fund may be used in the business of the society or may, subject to the provisions of section 71, be invested, as the State Government may be general or special order direct, or may, with the previous sanction of the State Government, be used in part for some public purpose likely to promote the objects of this Act, or for some such purpose of the State, or of local interest: Provided that if the Registrar is satisfied that financial condition of the society is such that it is unable to carry to its reserve fund an amount upto the aforesaid limit of one-fourth of its net profits, he may by order in writing for such period as he may specify in the order, fix for the society a limit lower than the aforesaid limit but not lower than one-tenth of its net profits. (3) Where the reserve fund of a society exceeds its authorized share capital, then, notwithstanding anything contained in sub-section (1), the society may, with the previous permission of the Registrar carry to its reserve fund each year an amount which may be less than one-fourth but not less than one-tenth of its net profits. 71. Investments of funds .- (1) A society may invest, or deposit its funds, - (a) in a Central Bank, or the State Co-operative Bank, (b) in the State Bank of India, (c) in the Postal Savings Bank, (d) in any of the securities specified in section 20 of the Indian Trusts Act, 1882 (II of 1882), (e) in shares, or security bonds, or debentures, issued by any other society with limited liability, or (f) in any co-operative bank or in any banking company approved for this purpose by the Registrar, and on such conditions as the Registrar may from time to time impose. (g) in any other mode permitted by the rules, or by general or special order of the State Government. (2) Notwithstanding anything contained in sub-section (1), the Registrar may, with the approval of the State Co-operative Council, order a society or a class of societies to invest any funds in a particular manner, or may impose conditions regarding the mode of investment of such funds. 12. The relevant Rules from the Gujarat Co-Op. Societies Rules read as under :- Rule 29. Investment of Funds .- (1) With the previous sanction of the Registrar any society may invest the fund or a portion thereof - (a) xxx (b) in loans raised by a local authority in the State under the authority of the Local Authorities Loans Act, 1914 (IX of 1914) (c) in the purchase or leasing of land or buildings, and in the construction of buildings; Provided that the purchase of such land or the construction of such building is likely to be advantageous to the society in the conduct of its business. (2) Notwithstanding anything contained in sub-rule (1), an urban co-operative bank - (a) which has a paid up share capital of not less than Rs.50,000, and a reserve fund of not less than Rs.50,000. (b) which has completed ten years from the date of its registration, and (c) which is classed A or B at the last audit made under section 84, may invest its surplus funds in such shares or debentures of any company registered under the Companies Act, 1956 as may be approved by the Registrar. Rule 30. Restrictions on investment.-(1) The investment under rule 29 shall not at any time exceed 5 per cent of the deposit liabilities or 15 per cent of the surplus fund of the bank whichever is less. (2) The investment in shares or debentures under rule 29 shall not exceed - (a) in the case of preference shares. 10 per cent (b) in case of ordinary share 5 per cent (c) in the case of debentures 15 per cent of the total surplus funds; Provided that no investment shall be made under this sub-rule if it is likely to affect the ordinary business of the bank. Explanation - For the purpose of this sub-rule "fund" shall mean such portion of the funds as are available for advancing loans to members but not so advanced. 13. Reference to certain notifications under Section 71(2) of the Gujarat Act is made at an appropriate place as there is some controversy about their applicability. 14. Summary State Law Where can the funds Ref. be invested --------- ------------------- ----- M.P. Only outside the Sec.44(2) business read with instructions of the Govt. Withdrawal only after Govt. permission and that Instruction too under certain specified circumstances only Rajasthan (Unless permission is Rule 55(2) obtained), there is prohibition against investing reserve fund in the business. Once funds are separa- Rule 55(3) tely invested, cannot be withdrawn without sanction of Registrar which will be given only for certain purposes Mahrashtra Reserve fund may be Sec.66(2) used : (1) in the business, or (2) invested otherwise Investment may be as Sec.70 per : Rule 54 (1) Sec.70 of the Act or, (2) Rule 54(1) of the Rules Once invested, funds Rule 54(2) cannot be utilised without permission of the Registrar Gujarat Reserve fund may be Sec.67(2) used : (1) in the business or, (2) invested otherwise Investment may be Sec.71 made as per Rule 29 (1) Sec.71 of the Act or (2) Rule 29 of the Rules 15.0 CONTENTIONS URGED ON BEHALF OF CO-OP. BANKS The contentions raised by the learned counsel for the assesses, are as under :- 15.1 The restrictive provisions of section 44 of the M.P. Act and more importantly the notification issued by the Registrar on 7.10.1960 categorically state in the first para that the reserve fund shall be fully invested outside its business. Secondly, it states that no part of the reserve fund should be utilized as its working capital. Subsequent paragraphs of the notification state that such reserve fund invested in deposits shall not be withdrawn without previous sanction of the Registrar which can be given when the amount is required to meet losses or when the society is to be wound up. In other words, under the M.P. Act, the statutory reserve was taken out of the banking business or working capital of the bank and it could only be used for twin objectives mentioned in the notification. Contrasted with this, the Gujarat Act under section 67 unequivocally permits the use of statutory reserve in the business of the society or investment. There is, therefore, fundamental difference between the M.P. Act and the Gujarat Act regarding treatment of statutory reserve funds. It may be further noted that the restrictions under the M.P. Act by virtue of the notification of the Registrar apply only to apex bank and not to other cooperative banks. 15.2 The Supreme Court judgment in the case of Madhya Pradesh Co-op. Bank Ltd. 218 ITR 438 is clearly based on the prohibitions and restrictions contained in the M.P. Act with regard to the use of the reserve funds. The judgment accepts