Income Tax Appellate Tribunal - Bangalore
The Income-Tax Officer vs D.C.C. Bank Ltd. on 31 August, 2005
Equivalent citations: [2007]104ITD280(BANG), (2007)107TTJ(BANG)83
ORDER
N.L. Kalra, Accountant Member
1. This appeals has been filed by the revenue against the order of the Commissioner of Income-tax (Appeals), Gulbarga dated 1.7.2003. Since the grounds of appeal are the same, therefore, these appeals are being disposed off by a single consolidated order.
2. The only grievance of the dept. is that the learned CIT(A) has erred in allowing exemption under Section 80P(2)(a)(i) on the interest earned on investment including IVP & KVP made voluntarily out of surplus funds.
3. The Assessing Officer during the course of asst. proceedings observed that reserve fund as on 31.3.97 was of Rs. 6,59,17,100.27. In respect of maintenance of statutory liquid ratio and cash reserve ratio, the following facts are observed.
As on As on As on
4.4.97 25.9.97 27.3.98.
(Rupees in lakhs)
Total liabilities (Part A
(IV) for The purpose of
Sections 18 & 24 of B&R Act. 4487 5089 6280
Assets to be required to
Maintain (Under Section
24 (Part C (XI) 1256 1425 1758
Assets actually maintained for
Compliance with Section 24(Part C
(XII) 1994 1510 2259
As could be seen from the details furnished and Form No. I mentioned above against the amount of assets maintained for compliance with Section 24 (as mentioned in Part C (XII) of Form No. I), the following investments out of total investments referred to in Annexure 'A' & 'B' were considered for furnishing information in respect of SLR & CRR to the Reserve Bank of India.
a) Balance of all types with Apex Bank : 1572 b) Unencumbered approved securities : 150 c) Cash on Hand : 536 d) Balance with current bank a/c : 54 As mentioned in Part A (VII) of Form No. I, filed for the month of March, 1998 2312
The investment held by the asses see on 31.3.1998 as per Annexure 'A ' were made out of its surplus funds. As could be seen from the Annexure 'A', these investments were held by he assessee from the date of its investments as back as on 2.9.1985 till their maturity. These investments wee apparently held as investments and not as with a view to call back at short notice and for utilisation in its proper banking. However, it is pertinent to note that the deposits and investments held by the assessee as pr Annexure 'B' were in fact in the nature of call deposits for utilization in the assessee's business. Hence, the investments held by the assessee as per Annexure 'A ' were made out of its surplus funds and extraneous to the banking activity of the assessee.
4. It was further noticed by the Assessing Officer that the assessee has made investment of Rs. 3.45 crores in Kisan Vikas Patras, 1.05 crores in Nabard Bonds and 0.3 crores in State Govt. Securities. The above investments were considered to have been made out of surplus funds. It was also observed that these investments were held by the assessee from 2.9.1985 till their maturity. These investments cannot be treated to have been held with a view to call back at short notice so as to be available for utilization in proper banking activity. It was therefore proposed to treat interest income earned from such investment as income not attributable to the banking activity within the meaning of Section 80P(2)(a)(i). The assessee society objected to above disallowance by submitting as under:
In this regard your attention is invited to the wording of the Section 80P(2) "the whole of the amount of profits and gains of business attributable to any one or more of such activities " out of which one activity under (a)(i) is carrying on the business of banking or providing credit facility to its members.
The word "Attributable to " is distinguished from "Derived from" in the case of Cambay Electricity Supply Industrial Company Ltd. v. CIT 113 ITR 84 by the Hon'ble Supreme Court. It is pertinent to note that the legislature has deliberately 'derived from'. The word 'attributable to' is wider in import than the expression 'derived from'.
Thus as the interest earned on investments is attributable to the Banking activities, the interest income is exempt from tax Under Section 80P(2)(a)(i).
Further, this is to state that the facts of the case of Madhya Pradesh State Cooperative Bank v. Addl. Commissioner of Income-tax are not applicable to the co-operative banks in Karnataka as held by the Apex Court in Bangalore District Central Co-operative Bank v. CIT (1998) 233 ITR 282 (SC). It has been held in this case that interest on Govt. Securties and dividends earned by co-operative society engaged in banking business is eligible for deduction Under Section 80P(2)(a)(i). The Tribunal also had found that such income is attributable to its business.
Apart from the above two contentions this is to be noted that all the investments made by us are out of circulating capital The investments made does not seize the working capital. The investments made are 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 investments in securities as in our case would not cease to be part of the circulating capital nor would they cease to form part of its banking business. In a commercial sense the Directors of the bank owe it to the bank to the bank to make investments which earn them interest instead of letting moneys lie idle. It cannot be said that the funds of bank which wee not lent to borrows but were laid out in the form of investments in securities to add to the profit instead of lying idle necessarily ceased to be a part of stock-in- trade of the bank, or that the interest arising there form did not form part of its business profit. Under the bye-laws one of the objects of the bank is to carry on the general business of banking and therefore, subject to the Co-operative Societies Act, it has to carry on its business in the manner that ordinary banks do.
Interest Accrued on Investment Inkisan Vikas Patras.
The KVPS can be prematurely enchased. In 172 ITR (St) 24, the rules as originally framed have been given. Rule 13 deals with premature encashment of KVPs. Please see Rule 13(2), Rule 13(3) and 13(4). The said sub-rules provide for premature encashment in all circumstances. So it is clear that premature encashment is authorized. under the rules. In view of this the co-operative bank can hold these KVPs as part of the banking business and the decision given in the CIT v. Bangalore DCC Bank will apply.
Further, out of the total investment, Rs. 60.00 lakhs worth of KVPs are due for final encashment within a year.
The bank can also avail loan at any time on KVPs.
Interest Accrued on Investment in Indira Vikas Patras The IVPs are bearer securities and are easily transferable at any point of time. The IVPs are like bearer cheques and are fast liquidatables securities. They can be transferred immediately at any time and without much formalities. Thus, the investment do form part of circulating capital.
Inteest Accured on Investment in Govt. of Karnataka Securities, IDBI Bonds, RBI Bonds, Krishna Bhagya Jalanigam Bonds, UTI Scheme, Medinova Diagnostic Etc. All the above securities (Shares and Bonds) are the investment for the purpose of maintaining SLR and CRR. The bank has to maintain SLR and CRR for the purpose of running banking activities as pr the RBI guidelines. Therefore, the bank has to invest in such form of securities to run its normal banking activities. Therefore, all these investments clearly comes within the purview of banking business and activities. Hence, the claim of interest income for deduction under Section 80P(2)(a)(i) is rightly made.
Further, this is to be noted that all the above securities are listed on stock exchanges though the duration of these holdings are for longer period. As the securities are listed on the stock exchanges they are easily transferable and liquidatable. Thus these securities do form part of the Banking business and are funds out of circulating capital and stock-in-trade. The interest on these securities is eligible for deduction Under Section 80P(2)(a)(i).
In view of all the above facts given and in view of the judgment given by the Hon 'ble Apex Court in the above cited case of CIT v. Bangaloe DCC Bank Ltd., it is argued that deduction for interest earned on all the Govt. Securities and investments is rightly claimed Under Section 80P(2)(a)(i) and it is requested to allow the deduction accordingly.
5. The Assessing Officer after considering the above submissions mentioned that the investments are out of surplus funds as those stood at Rs. 6,59,17,100/-. Income from such investments cannot be said to be attributable to banking activity. Looking to the date of investments, the Assessing Officer was of the opinion that such investments cannot be out of working capital. The fact that some of the investments may be en-cashed prematurily or transferable easily does not make such an investment out of working capital. As the asset required to be maintained under RBI Act were of Rs. 851 lakhs hence F.D. with apex bank was sufficient to meet the requirement under RBI Act. Hence it can not be accepted that investment in securities were made for the purpose of SLR and CRR. The learned Assessing Officer relied on the judgment of the Supreme Court in the cae of Madhya Pradesh State Co-operative Bank v. Addl. CIT 218 ITR 438 to hold that earning from deposits which are at arm's length from the normal banking business and which are not available on short term notice for being used as circulating capital in the banking business are out of purview of Section 80P(2)(a)(i). It was also held on the basis of following judgments that income arising from the investment of idle or surplus funds is assessable as income from other sources.
(a) Collis Line (P) Ltd. v. ITO 135 ITR 390 (Ker)
(b) Bokaro Steel Ltd. v. CIT 170 ITR 545 (Pat)
(c) Murli Investments Co. v. CIT 167 ITR 368 (Raj)
(d) CIT v. Rajasthan Land Dev. Corporation 211 ITR 597
6. The learned Assessing Officer further held that decision of Supreme Court in the case of Bangaore District Central Co-operative Bank v. CIT 233 ITR 282 is not applicable in the instant case as in that case the factual finding of the Tribunal that interest income was attributable to the business of the assessee was not challenged.
7. The learned Assessing Officer further observed that interest income from investment in co-operative societies are exempt under Section 80P(2)(d). Incase these were exempt under Section 80P(2)(a)(i), then there was no need for separate exemption of such income under Section 80P(2)(d). It was therefore concluded that interest income from investments other than investments in cooperative societies is not exempt under Section 80P(2)(a)(i).
8. The learned CIT(A) has also passed a detailed speaking order. It will be relevant to reproduce the following paras from the order of learned CIT(A) in order to appreciate the reasons given by him to allow the appeal of the assessee.
I have perused carefully the well drafted order of asst. by the learned Assessing Officer. Indeed, the efforts of the Assessing Officer are laudable and praiseworthy. The learned Assessing Officer has tried his best to apply the decision of the Apex Court reported in 218 ITR 438 to the instant case. I have also gone through the voluminous written representation submitted by the learned Counsel for the assessee who has also orally dealt at length the various issues involved during the appellate proceedings. On careful examination of facts and circumstances of the case, the views expressed by the learned Assessing Officer in the asst. order and the submissions made by the learned Counsel for the assessee. I am inclined to feel that the points and issues raised by the assessee in its voluminous submissions wins the appeal in its favour especially because of the latest decision of bench of three judges of Hon 'ble Supreme Court in the case of CIT v. Karnataka CO-op Apex Bank 251 ITR 194. It ought to be mentioned to the Assessing Officer that the said decision of Supreme Court 251 ITR 194, hit on the scene only in August 2001 and was not delivered when the learned Assessing Officer had passed the asst. order in the instant case. In short, the learned Assessing Officer was not lucky to have knowledge of a number of judgments including the one in the case of Karnataka State Co-op Apex Bank to the passing of asst. order. The Assessing Officer also did not have opportunity to go through the decision of Bombay High Court in the case of CIT v. Ratnagiri DCC Bank Ltd. 174 CTR 116 which was delivered in September 2001 wherein it was held that interest income on investment in Indira Vikas Patras was entitled to exemption under Section 80P(2)(a)(i) of the Act. As a sequel, even while appreciating the best efforts put in by the learned Assessing Officer, I have no option but to decide the issues involved in the favour of the assessee on account of discussion made into subsequent paragraphs.
At the outset only, the assessee in its submission before the Assessing Officer, had pointed out that the word 'attributable to' is distinguished from derived from' by the Hon'ble Supreme Court in the case of Cambay Electricity Supply Industrial Co. Ltd. The Assessing Officer should have appreciated the interpretation of Apex Court that the expression 'attributable to' is of 'wider significance and import' than the expression 'derived from' which is narrower in concept. In Para 7 of the asst. order, the learned Assessing Officer has made passing reference to the expression 'attributable to' but has not elaborated his reasons as to why and how the word 'attributable to' does not come to the rescue of the assessee. The Assessing Officer ought to have, for clarity sake, further analyzed the facts of the case to buttress his opinion that the wider import of 'attributable to does not help the assessee in claiming the deduction under Section 80P(2)(a)(i) of the Act in so far as the interest earned on investments made is concerned. I am also in agreement with the view expressed by the learned Counsel of the assessee that all the reserve funds created by the assessee in accordance with the provisions of the co-op society Act cannot automatically be termed as 'surplus funds' since the 'reserves' are created automatically be termed as 'surplus funds' since the 'reserves' are created by transfer of part of profit every year as per the provisions of governing act of Co-operative Society.
In Para 7 of the asst. order, the Assessing Officer has concluded that interest earned from investments is in no way concerned with the assessee 's banking activity. However, the leaned Assessing Officer ought to have given due weightage to the argument advanced by the assesse that the interest earned on investments is attributable to the banking activities and as such is exempt under Section 80P(2)(a)(i) of the Act. This is so because the Section 5(b) of Banking Regulation Act, 1949 clearly defines the 'Banking's under:
Banking means the accepting, for the purpose of lending OR Investment, of deposit of money....
As seen from the above definition, boththe lending and Investment of funds form part of banking activities only and as such interest earned on these in a general sense are eligible for deduction under Section 80P(2)(a)(i), subject of course to interpretations of laws laid down by the Apex Court in its various decisions.
It is also seen that in Para 8 of the asst. order, the Assessing Officer makes an averment that the fact that some of the investments may be enchased prematurely or transferred easily does not make such investment out of working capital. However, the Assessing Officer does not advance his logic behind such sweeping averment. As a matter of fact, premature encashment or easier transferability or convertibility of an asset does point out its liability and as such is a material indicator for deciding whether such investments are of temporary nature of not and whether such investments can be brought back into 'banking business (in its narrowest meaning)'. The point raised by the assessee is very much relevant as in the decision relied upon by Assessing Officer and reported in 218 ITR 438 of Madhya Pradesh Co-op Bank Ltd., the Apex Court had indeed given weightage to the factor that securities of Madhya Pradesh Co-op Bank Ltd because of instructions of Madhya Pradesh Govt. could NOT be withdrawn by the bank at its will and could ONLY be withdrawn in certain situations like winding up etc. And only because of he inability of the Madhya Pradesh CO-op Bank Ltd. to withdraw the funds at will, the Apex Court felt it difficult to comprehend as to how such securities relating to reserve fund could be considered as the bank's stock-in-trade or circulating capital. None of such fetters were placed on the investments made by the appellant bank The learned Assessing Officer has not established, rather not even indicated such restrictive shackles placed by the Karnataka Govt. or any other lawful authority on the appellate bank. The Assessing Officer does not appear to have grasped intricacies of the judgment of the Hon'ble Apex laid down in the case of Madhya Pradesh Co-op Bank Ltd. The Assessing Officer has, in Para 8 of his order, held rather erroneously that deduction under Sections 80P(2)(a)(i) is allowable only when the funds available to the society can be utilized for its banking activity proper and not for earning income from investments extraneous to the proper banking activity. The Assessing Officer, as a matter of fact, erred in treating investments made so as if for extraneous purpose because such investments are to be made in view of regulation of RBI or other statutory guidelines and since such funds are not diverted permanently so that normal banking operations are deprived of their usability after conversion, the learned Assessing Officer has erred in treating the interest earned on such investments as something earned out of non-banking activity.
The Assessing Officer in para 8 of the asst. order has also asserted that the assessee's contention that investments made as per Annexure 'A ' does not cease to be circulating capital, cannot be accepted. In the case of CIT v. Karnataka State Co-op Apex Bank 251 ITR 194, the 3 Judge bench of Apex Court has, categorically observed that it is unable to agree with the view that found favour with thebench that decided the case of Madhya Pradesh CO-op Bank Ltd. 218 ITR 438 (SC) that only income derived fromcirculating or working capital would fall within Section 80P(2)(a)(i) of the Act. The Hon 'ble 3 Judge bench court further laid down that there is nothing in the phraseology of that provision which makes it applicable only to income derived from working or circulating capital.Ultimately, the, Hon'ble Supreme Court Bench of 3 Judges opined clearly that the decision of Supreme Court in the case of Madhya Pradesh CO-op Bank Ltd. 218 ITR 438 does NOT set down the correct law and that the law is as they have put it earlier.The rationale behind the said decision of Apex Court was that placements of funds in compliance with statutory of RBI regulations being imperative for the purpose of banking business, the income there from would be income from the assessee's business. As a sequel, the Hon 'ble Apex court has now finally settled down the position of law that interest arising from investment made in compliance with statutory provisions to enable it to carry on banking business, out of Reserve Fund by a co-operative society engaged in banking business, is EXEMPT under Section 80P(2)(a)(i) of I.T Act, 1961.
As the above decision of Supreme Court is directly on the point, the views expressed by the learned Assessing Officer in paras 10 to 13 of his asst. order have lost meaning. Even the hairsplitting indulged by the learned Assessing Officer in para 14 of his asst. order has been rendered meaningless by the decision of 3 Judge Bench of Apex Court in the case of Karnataka State Co-op Apex Bank 251 ITR 194.
As regards the IVP, KVP, the learned Counsel of the assessee has pleaded vociferously that in light of the decision of Bombay High Court in the case of CIT v. Ratnagiri Dist-Central Coop Bank Ltd. 174 CTR 116, the interest income derived from IVPs need to be held clearly from and out of banking business and therefore is entitled to exemption wider Section 80P(2)(a)(i) of the Act. The learned Counsel has emphasized that the judgment delivered by the Bombay High Court is of direct relevance to it as the majority of investments of assessee are in IVPs and KVPs. In view of the decision available directly on the point involved, I have no qualms in concurring with the learned Counsel of the assessee.
9. Before us, the learned DR submitted that investments have been made out of surplus funds and not out of circulating capital. Such investments can not be treated as part of banking activity. As per Section 80P(2)(a)(i), income arising from banking activity is exempt. Hence it was contended that learned Assessing Officer by his elaborate order has rightly denied exemption under Section 80P(2)(a)(i) on the interest income from certain investments. The learned DR supported the order of Assessing Officer and stated that learned CIT(A) has erred in not appreciating the facts in proper perspective.
10. We have heard the learned DR and have gone through the order of the authorities below. Before making discussion on the issue, it will be relevant to reproduce the relevant sections of Banking Regulation Act applicable to co-operative societies. Section 56 of Banking Regulation Act, 1949 makes the provisions of the Act applicable to co-operative societies subject to certain modification. Section 6 of Banking regulation Act is applicable to co-operative societies with some modifications in 6(1)(b), 6(1)(d) and 6(1)(m). For discussion in the instant case Section 6(1)(a) and 6(2) are relevant and these are reproduced as under:
6(1) In addition to the business of banking, a banking co-operative society may engage in any one or more of the following forms of business, namely -
(a) The borrowing, raising or taking up of money, the lending or advancing of money either upon or without security; and drawing, making, accepting, discounting, buying, selling, collecting and dealing in bills of exchange, hundies, promissory notes, coupons, drafts bill of lending, railway receipts, warrants, debentures, certificates, scrips and other instruments and securities whether transferable or negotiable or not the granting and issuing of letters of credit, traveler's cheques and circular notes, the buying and selling and dealing in bullion and specie, the buying and selling of foreign exchange including foreign bank notes, the acquiring holding, issuing commission, underwriting and dealing in stock, funds, shares, debentures, debenture stock bonds obligations, securities and investments of all kinds.The purchasing and selling of bonds, scrips or other forms of securities on behalf of constituents or others, the negotiating of loan and advances, the receiving of all kinds of bonds, scrips or valuables on deposit or for safe custody or otherwise, the providing of safe deposit valits, the collecting and transmitting of money and securities,
(b) to (o)--
6(2) No banking co-operative society shall engage in any form of business and other than those referred to in sub. Section (1) Section 24(2A).
(2A) (a) Notwithstanding anything contained in Sub-section (1) or in Sub-section (2), after the expiry of two years from the commencement of the Banking Laws (Application to Co-operative Societies) Act, 1965 (23 of 1965), or of such further period not exceeding one year as the Reserve Bank having regard to the interests of the Co-operative Bank concerned, may think fit in any particular case to allow -
(i) a Scheduled State Co-operative Bank, in addition to the cash reserve which it is required to maintain under Section 18, shall maintain in India, in cash, or in gold valued at a price not exceeding the current market price or in unencumbered approved securities valued at a price determined in accordance with such one or more of, or combination of, the following methods of valuation, namely, valuation with reference to cost price, market price, book value or face value as may be specified by the Reserve Bank from time to time, an amount which shall not, at the close of business on any day, be less than twenty-five per cent or such other percentage not exceeding forty percent as the Reserve Bank may, from time to time, by notification in the Official Gazette, specify, of the total of its demand and time liabilities in India, as on the last Friday of the second proceeding fortnight.
Section 17(1) Every banking company incorporated in India shall create a reserve fund and shall, out of the balance of profit of each year, as disclosed in the profit and loss account prepared under Section 29 and before assessment year dividend is declared, transfer to the reserve fund a sum equivalent to not less than twenty per cent of such profit.
11. In AIR 1983 Mad 15, it was held that Section 6 provides for variety of business which a banking company may engage itself in, chit fund transactions indulged in by a banking company partakes character of banking activity.
12. Section 24 of the banking requirement Act is a statutory provision to give legal sanction to a sound banking practice that a bank should keep a reserve of cash and liquid assets to meet its demand liabilities. The tendency of smaller banks to overtrade at the expense of liquidity was required to be curbed. Section 24 provides a minimum as well as maximum percentage of keeping assets wit reference to demand and liabilities. If such assets exceeds 40% then it can be said such excess is voluntary and without sanction of law. Under such circumstances one can conclude that interest from such investment is not income from banking business. In the instant case, such investments do not exceed the prescribed limit.
13. The Assessing Officer in his order has mentioned the following reserve funds as on 31.3.97.
Sl.No. Particulars Amount
1. Statutory Reserve Fund 2,06,65,577.00
2. Agrl. Credit Stab. Fund 1,56,25,509.00
3. Building & Bhavan Fund 1,35,22,630.00
4. Bad & Doubtful Reserves 1,03,70,159.00
5. Dividend Equalisation Fund 10,60,642.00
6. Capital Redumption Fund 7,29,258.00
7. Employee Benefit Fund 4,59,724.00
8. Investment depreciation 3,22,888.00
9. Education Fund 7,091.00
10. Common Goods fund 2,56,057.00
11. Farmers Benefit fund 1,92,206.00
12. Capital Reserve fund 4,57,435.00
13. Co-op. Welfare fund 3,50,000.00
14. Provision for Gap fund 73,33,000.00
15. PACs Development fund 8,30,000,00
16. Development of Bank fund 10,00,000.00
17. Computerisation of Bank 69,76,500.00
18. NPA Reserve Fund 36,00,000.00
TOTAL 8,37,58,679.00
14. It is not the case of revenue that such reserve funds have been created voluntarily. Schedule III to Banking regulation Act prescribes the form of Balance sheet. As per this form, the following reserves are to be specifically mentioned.
(i) Statutory reserve
(ii) Agricultural Credit Stabilization Fund
(iii) Building Fund
(iv) Dividend Equalization Fund
(v) Special Bad Debts Revenue
(vi) Bad and doubtful debts reserve
(vii) Investment depreciation reserve
(viii) Other funds and reserve
15. From above, it is clear that reserves mentioned from (i) to (vii) are to be created as per guidelines of Reserve Bank of India. In the instant case, total of reserves in repect fo item No. (i) to (vii) will exceed the amount of investment treated by Assessing Officer as investment out of surplus fund. The learned Assessing Officer has treated reserve funds as surplus funds. Surplus is the amount which is left after setting aside reserve. Surplus can be used for distribution of dividend or can be again utilized in business or can be kept apart in the form of investment. It is reflected in balance sheet on credit side as accumulate balance in profit and loss account. Reserves are made for specific purposes. Reserve can be credited even if there is a loss so that true picture emerges. Depreciation reserve or reserve for bad and doubtful debts can be taken as example of this nature.
Reserve : On the meaning of the expression 'reserve', the Supreme Court observed as follows at page 503 in Commissioner of Income-tax v. Century Spinning & Manufacturing Co. Ltd. [1953]24 ITR 494 S.C.:
The term 'reserve' is not defined in the Act and we must resort to the ordinary natural meaning as understood in common parlance, "The dictionary meaning of the word 'reserve' is :
(a) TO keep for future use or enjoyment; to store up for some time or occasion; to refrain from using or enjoying at once.
(b) To keep back or hold over to a later time or place or for further treatment.
(c) To retain or preserve for certain purposes. [Oxford Dictionary, Vol. VIII, p. 513].
In Webster's New International Dictionary, 2ndEd., p. 2188, 'reserve' is defined as follows :
1. To keep in store for future or special use; to keep in reserve; to retain, to keep, as for oneself
2. To keep back; to retain or hold over to a future time or place.
3. To preserve - A.P.V. Engg. Co. Ltd. v. CIT West Bengal ; see also Commissioner of Income-tax, Kerala v. Periakra Malai Tea and Produce Co. Ltd. (1974) 1 Tax LR 463 at pp. 465-66 (ker.) Characteristics of a reserve which appear from the observation of he Supreme Court in the. cases of, Metal Box Co. of India v. Their Workmen and CIT, Bombay City v. Century Spinning and Manufacturing Co. Ltd. which has been considered in detail in the case of Duncan Brothers & Co. (1976) 1 Cal. Tax Cases 288 are as follows :
(a) Reserve are appropriation of profits which are retained to form part of the capital employed in the business.
(b) A reserve is not designed to meet any liability contingency, commitment or diminution in the value of assets known to exist at the date of the balance sheet.
(c) A reserve is something set apart for future use or enjoyment, - Commissioner of Income-tax & Super Profits Tax, v. Eyre Smelting Pvt. Ltd. 1978 Tax L.R. 567 at pg. 571.
The term 'reserve' means something specially kept apart for future use or for a specific occasion. Companies in India maintain diverse types of reserves : such as capital reserve, reserve for redemption of debentures, reserve for replacement of plant an machinery, reserve for buying new plant to be added to the existing ones, reserve for bad and doubtful debts, reserve for payment of dividend and general reserve. Depreciation reserve with the limit prescribed by the Income-tax Act or the Rules there under is the only reserve which is a permissible allowance in the computation of taxable profits.
Regulation 99 of the 1stSchedule, Table A, required that reserve must be set apart before the directors recommended any dividend, but out of the profits of the company no amount was set apart towards reserve before the directors recommended payment of dividend to the shareholders. The identity of the amount remaining on hand of the foot of the profit and loss account was not preserved. There was no allocation of the amount to reserve and from the mere fact that it was carried forward in the accounts of the next year and ultimately applied in payment of dividend, it could not be said to be specially set apart for any purpose at the relevant date, i.e the end of the year of account.
The undivided profits brought into account of the assessee-bank under the head 'Assets, capital, capital stock and reserves' were reserves within the meaning of Rule 2(1) of Schedule II of the Business Profits-tax Act.
'Earned surplus' has, it is true, not been called 'Reserve', but if it is truly a reserve, it must be taken into account in the computation of capital.
Where the balance of net profits after allocation to specific reserves and payment of dividend are entered in the account under the caption 'Earned surplus' it is intended thereby to designate a fund which is to be utilized for the purpose of such business of the assessee. Such a fund may be regarded according to the Indian practice as 'General reserves'. - CIT Calcutta v. Standard Vacuum Oil Co. .
16. Thus, the surplus is reflected in the balance sheet on credit side as general reserve or credit balance under the head 'profit and loss account'. In case the surplus or idle money is invested in the investment earning interest, then such interest cannot be termed as business income. Specific reserves are credited out of the profits to meet the specific liabilities. Such specific reserves are the capital employed in the business as observed by the Supreme Court in the case of Metal Box Co. of India Ltd. v. their workmen 73 ITR 53. It will be relevant to quote the following lines from pg. 68 of the judgment:
On the other hand, reserves are appropriations of profits, the assets by which they are represented being retained to form part of the capital employed in the business. Provisions are usually shown in the balance sheet by way of deductions from the assets in respect of which they are made whereas general reserves and reserve funds are shown as part of the proprietor's interest.
17. It is not the case of the revenue that reserve credited is voluntary and without any guidelines of the Reserve Bank of India or the Karnataka Government. Hence, it is not correct to hold that amounts reflected by reserve represent the surplus. Acquiring the security or debenture is mentioned in Section 6(1)(a) of the Banking Regulation Act. The learned jurisdictional high court in the case of CIT and Anr. v. Grain Merchants Co-operative Bank Ltd. 267 ITR 742 observed at pg. 747 as under:
But as noticed by us earlier, Section 6 of the Regulation Act intendeds to make to several business referred to in Clause (a) to (o) of Sub- section (1) of the Act as 'banking business' in addition to the definition of 'banking' provided under Clause (b) of Section 5 of the Regulation Act. In support of our view, we derive support form the observation made by the Hon 'ble Supreme Court in the case of Gujarat State Co-operative Bank Ltd. 251 ITR 522. In that decision, the locker rent received by the banking company is exempt under Section 80E, as providing a safe deposit vault is part of the ordinary bank business of the bank in terms of Section 6(1)(a) of the Regulation Act. Hence, investment acquired by the bank within the limitation prescribed under Section 24 of the Regulation Act are part of the bank business. Interest from such investments cannot be denied exemption under Section 80E.
18. The jurisdictional high court in the case of CIT and Anr. v. Sri Ram Sahakari Bank Ltd. 266 ITR 632, held that interest received on investment in National Savings Certificates, Indira Vikas Patras, Kisan Vikas Patras and Short term Fixed Deposits in banks is entitled to deduction under Section 80P(2)(a)(i). While holding so, the learned jurisdictional high court has quoted the following para from the judgment of Supreme Court in the case of Bihar State Cooperative Bank Ltd. 39 ITR 114.
As we have pointed out above, it is a normal mode of carrying on banking 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 as in the instant case would not cease to be a part of the circulating capital of the assessee nor would they cease to form part of its profits from its banking business. The return flowing from them would form part of its profit from its business. In a commercial sense the directors of the company owe it to the bank to make investments which earn them interest instead of letting moneys lie idle. It cannot be said that the funds of he bank which were not lent to borrowers but were laid out in the form of deposits in another bank to add to the profit instead of lying idle necessarily ceased to be a part of the stock-in-trade of the bank, or that the interest arising therefrom did not form part of its business profits.
19. The learned Supreme Court in the case of CIT v. Karnataka State Co-Operative Apex Bank 251 ITR 194 held that interest arising from investment made out of reserve fund is income from bank business and is exempt under Section 80P. The learned Supreme Court in the case of Mehsana District Central Co-Operative Bank Ltd. v. CIT 251 ITR 522 held that income derived from the investment of its voluntary reserves will be exempt in case such reserves are utilized in the course of its ordinary banking business.
20. The learned Bombay high court in the case of CIT v. Ratnagiri District Central Cooperative bank ltd. 254 ITR 697 held that interest receivable on Indira Vikas Patra is entitled to special deduction, as such securities were capable of conversion into liquid funds. Similarly, Rajasthan High court in the case of CIT v. Rajasthan State Co-Operative Bank 136 TM 458 held that income from investment of reserves and other funds in various securities can be said to be from bank business and exempt under Section 80P(2)(a)(i).
21. Keeping in view the above legal and factual position, it is held that learned Assessing Officer has not justified in holding that interest income arising from the funds invested in Kisan Vikas Patra, NABARD Bonds, State Govt. securities and IDBI bonds is not income from banking business. The learned Assessing Officer in this case is not justified in concluding that reserves created represent surplus funds. Interest income, so earned is exempt under Section 80P(2)(a)(i).
In the result, the appeals filed by the revenue are dismissed.