The Income Tax Appellate Tribunal, Bangalore, has clarified a critical distinction in the application of Section 80P of the Income Tax Act, holding that interest earned on statutorily mandated deposits by cooperative societies is attributable to their core business of providing credit facilities and thus eligible for deduction. This ruling resolves long-standing ambiguity regarding the treatment of interest income from regulatory reserves.
Background & Facts
The Dispute
The appellant, Shri Shanteshwar Vividoddeshagala Sahakara Sangha Niyamit Horti, is a cooperative society registered under the Karnataka State Co-operative Societies Act, 1959. Its primary objective is to provide credit facilities to its members and collect deposits exclusively from members. For Assessment Year (AY) 2018-19 and AY 2020-21, the society claimed a deduction of Rs. 25,00,017 under Section 80P of the Income Tax Act, 1961, on interest and dividend income earned from deposits made with cooperative and scheduled banks.
Key Facts
- The society filed its return for AY 2018-19 on 13.08.2018 declaring income of Rs. 9,080
- The Assessing Officer (AO) selected the case for limited scrutiny under the e-assessment scheme
- The AO disallowed the entire claim of Rs. 25,00,017 under Section 80P, treating the income as "Other Income" under Section 56
- The disallowed amount comprised:
- Rs. 24,90,017 as interest and dividend from cooperative and scheduled banks
- Rs. 10,000 as a gift from VDCC Bank, Vijayapur
- The society maintained statutory liquid ratio (SLR) funds under the Karnataka Co-operative Societies Act, 1959
- For AY 2018-19, the society had Demand and Time Liabilities (DTL) of Rs. 53,47,58,818 and was required to maintain SLR of 25% (Rs. 13,36,89,705)
- The society maintained SLR of Rs. 2,91,53,163 and earned interest of Rs. 14,02,008 on such deposits
- The society also held surplus funds beyond statutory requirements
Procedural History
- 13.08.2018: Return filed for AY 2018-19
- 13.02.2021: AO completed assessment under Section 143(3), disallowing Rs. 25,00,017 under Section 80P
- 18.08.2025: Commissioner of Income Tax (Appeals) / NFAC dismissed the appeal
- 23.02.2026: Hearing before ITAT Bangalore
- 12.05.2026: Judgment pronounced by ITAT Bangalore
The Parties' Positions
For the Appellant
- Argued that interest earned on statutory deposits mandated under the Karnataka Co-operative Societies Act, 1959, is attributable to the business of providing credit facilities
- Relied on Circular No. 104:XMC:92-93 dated 29.09.1992 requiring SLR of 25% of DTL
- Invoked Section 57 of the Karnataka Act requiring transfer of 25% of net profit to reserve fund, which must be deposited in cooperative banks
- Contended that the term "attributable to" in Section 80P(2)(a)(i) is wider than "derived from" and includes income arising from legally compelled activities
- Cited Supreme Court decisions in Cambay Electrical Supply Industrial Co. Ltd. v. CIT, CIT v. Karnataka State Co-operative Apex Bank, and Mehsana District Central Co-operative Bank Ltd. v. ITO
- Requested that interest on statutory deposits be allowed under Section 80P(2)(a)(i), and only excess interest be taxed under Section 56
For the Respondent
- Supported the AO and CIT(A) orders
- Argued that interest from banks is not earned from members and thus not eligible under Section 80P(2)(a)(i)
- Relied on Totgars Cooperative Sale Society v. ITO [2017] 395 ITR 611 (Karnataka HC) to contend that cooperative societies are distinct from cooperative banks
- Asserted that Section 80P(2)(d) applies only to interest from other cooperative societies, not banks
- Maintained that the entire interest income should be taxed under Section 56 as "Other Income"
Relief Sought
The appellant sought:
- Allowance of Rs. 25,00,017 as deduction under Section 80P(2)(a)(i)
- Alternatively, allowance of interest on statutorily required deposits under Section 80P(2)(a)(i)
- Allowance of expenses under Section 57 for interest income taxed under Section 56
- Setting aside of the orders of AO and CIT(A)
The Legal Issue
The central question was whether interest income earned by a cooperative society on deposits mandated by statute under the Karnataka Co-operative Societies Act, 1959, qualifies as "profits and gains attributable to the business" of providing credit facilities to members under Section 80P(2)(a)(i) of the Income Tax Act, 1961.
Arguments Presented
For the Appellant
The appellant relied on the Supreme Court’s interpretation of the term "attributable to" in Cambay Electrical Supply Industrial Co. Ltd. v. CIT (113 ITR 84), emphasizing that the legislature deliberately chose "attributable to" over "derived from" to broaden the scope of eligible income. It argued that statutory compliance is not ancillary but integral to the cooperative’s business operation. The Karnataka Act compels the society to maintain SLR and transfer reserves to banks, restricting its liquidity and forcing investment. The interest earned on these funds is therefore inseparable from the business of credit provision. The society also cited Karnataka State Co-operative Apex Bank v. CIT (251 ITR 194) and Mehsana District Central Co-operative Bank Ltd. v. ITO (251 ITR 522), where the Supreme Court held that interest on statutorily required deposits with the Reserve Bank or State Bank is attributable to banking business. The appellant further invoked Tumkur Merchants Souharda Credit Cooperative Ltd. v. ITO [2015] 230 Taxman 309 (Karnataka HC), which held that depositing idle funds to earn interest is part of the cooperative’s business activity.
For the Respondent
The Revenue contended that Section 80P(2)(a)(i) applies only to income directly from members, and interest from banks is a passive investment income. It relied on Totgars Cooperative Sale Society v. ITO to argue that cooperative societies are not "co-operative banks" under Section 80P(4) and thus cannot claim banking-related deductions. The Revenue maintained that Section 80P(2)(d) applies only to interest from other cooperative societies, not banks, and that the entire interest income should be taxed under Section 56. It further argued that allowing deduction on statutory deposits would render Section 80P(2)(d) redundant and undermine the legislative intent to restrict deductions to core cooperative activities.
The Court's Analysis
The Tribunal undertook a detailed analysis of the statutory framework and judicial precedents. It acknowledged the Revenue’s position but found it inconsistent with the Supreme Court’s interpretation of "attributable to".
"The legislature has deliberately used the expression 'attributable to' and not the expression 'derived from'. It cannot be disputed that the expression 'attributable to' is certainly wider in import than the expression 'derived from'."
The Tribunal held that the statutory requirement to maintain SLR and transfer reserves under the Karnataka Act imposes a legal obligation that directly affects the cooperative’s operational capacity. The funds deposited are not surplus idle cash but mandatory reserves essential for regulatory compliance and business continuity. The interest earned on these funds is therefore an integral part of the cooperative’s business activity.
The Tribunal distinguished between two categories of deposits:
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Statutory deposits: Mandated under the Karnataka Act, including SLR and reserve fund deposits. Interest on these is attributable to the business and eligible for deduction under Section 80P(2)(a)(i).
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Surplus deposits: Funds beyond statutory requirements, deposited voluntarily to earn interest. Interest on these is not attributable to the business and must be taxed under Section 56.
The Tribunal further held that the Revenue’s reliance on Totgars Cooperative Sale Society was misplaced, as that case dealt with a society acting as a bank under Section 80P(4), whereas the appellant is a primary credit society. The Supreme Court’s decision in Kerala State Co-operative Agricultural and Rural Development Bank Ltd. v. AO (2023) 458 ITR 384 reinforced that eligibility under Section 80P depends on the nature of the entity and its activities, not its name.
The Tribunal also addressed the issue of expenses under Section 57. Although the appellant did not raise this before the lower authorities, the Tribunal held that the fundamental principle of taxing net income requires allowance of proportionate expenses for interest income taxed under Section 56. It relied on Totagars Co-operative Sales Society Ltd. v. ITO [2015] 58 Taxmann.com 35 (Karnataka HC), which held that if income is taxed under Section 56, expenses incurred to earn that income must be allowed under Section 57.
The Verdict
The appellant succeeded in part. The Tribunal set aside the orders of the AO and CIT(A) and directed the Assessing Officer to:
- Allow deduction under Section 80P(2)(a)(i) for interest earned on statutorily mandated deposits under the Karnataka Co-operative Societies Act, 1959
- Tax interest earned on surplus funds beyond statutory limits under Section 56 as "Income from Other Sources"
- Allow deduction under Section 57 for expenses incurred in earning interest income taxed under Section 56
- Compute the quantum of statutory deposits required based on the society’s DTL and reserve fund obligations
- Grant a reasonable opportunity to the assessee to submit supporting records
- Apply the same principles mutatis mutandis to AY 2020-21
What This Means For Similar Cases
Statutory Compliance Creates Business Nexus
- Cooperative societies must now document and quantify statutory deposit requirements under state co-operative laws to substantiate claims under Section 80P(2)(a)(i)
- Interest on SLR, reserve fund deposits, and other mandatory reserves qualifies for deduction, even if earned from scheduled banks
- Practitioners should prepare detailed schedules showing statutory obligations versus voluntary investments
Distinction Between Statutory and Surplus Funds Is Critical
- Only interest on funds legally required to be deposited qualifies for deduction under Section 80P(2)(a)(i)
- Interest on excess funds must be segregated and taxed under Section 56
- The burden of proof lies on the assessee to demonstrate the statutory basis for each deposit
Section 57 Expenses Are Now Recognized
- Even when interest is taxed under Section 56, proportionate expenses (e.g., bank charges, administrative costs) must be allowed under Section 57
- Practitioners must now maintain records of costs incurred in mobilizing and maintaining deposits
- Failure to claim Section 57 deductions at the appellate level does not preclude relief if the higher forum finds the income taxable under Section 56
