The Bihar State Co-Operativebank Ltd vs The Commissioner Of Income-Tax

Rewritten Version Notice: This is a rewritten version of the original judgment.

Court: Supreme Court of India

Case Number: Civil Appeals Nos. 228 to 230 of 1958

Decision Date: 22 February 1960

Coram: J.L. Kapur, A.K. Sarkar, M. Hidayatullah

The Supreme Court of India heard the appeal titled The Bihar State Co‑Operative Bank Ltd. versus The Commissioner of Income‑Tax. The judgment was delivered on 22 February 1960. The opinion was authored by Justice J. L. Kapur, who was joined by Justices A. K. Sarkar and M. Hidayatullah. The petitioner in the matter was The Bihar State Co‑Operative Bank Ltd., and the respondent was the Commissioner of Income‑Tax.

This case is reported in the 1960 volume of the All India Reporter at page 789 and also appears in the 1960 edition of the Supreme Court Reports, volume three, page 58. The statutory framework involved the Income‑Tax Act of 1922 (the “Act”), specifically sections 10 and 12, together with the provisions of a notification issued under section 60 of the same Act. The central question concerned whether the interest earned by the bank on deposits placed with other banks fell within the category of income that was exempt from tax under the notification.

The bank, which was incorporated under the Co‑Operative Societies Act of 1922, had, in the relevant assessment years, received sums of money as interest on deposits it had placed with the Imperial Bank of India. The Income‑Tax Officer assessed those sums as income under section 12 of the Act, classifying them as “income from other sources.” The bank contested this assessment, arguing that the deposits were not made as an investment but rather to further its banking operations, and therefore the interest received represented profit derived from its ordinary business activities. The bank relied on a government notification issued under section 60, which exempted the profits of co‑operative societies from tax, contending that the interest should be treated as exempt profit rather than taxable “other source” income.

The Court examined the distinction drawn in the notification between profits of a co‑operative society, which are exempt, and income derived from “other sources,” which remains taxable under section 12. The Court held that the interest earned by the appellant bank arose from a transaction that was entered into for the purpose of carrying on its banking business. Consequently, the interest fell within the category of profit attributable to the bank’s business activities and therefore qualified for the exemption provided by the notification.

In reaching its conclusion, the Court relied on the earlier decision of Punjab Co‑Operative Bank Ltd. v. Commissioner of Income‑Tax, Punjab, reported in the 1940 volume of the Income‑Tax Reports at page 635. The precedent established that interest earned on deposits made by a co‑operative bank for the purpose of its banking operations is exempt from tax under the relevant notification.

The appeal was brought before the Supreme Court under its civil appellate jurisdiction, encompassing Civil Appeals Nos. 228 to 230 of 1958. These appeals challenged the judgment and decree dated 2 July 1957 issued by the Patna High Court in Miscellaneous Judicial Case No. 640 of 1955. Counsel for the appellant included senior lawyers representing the bank, while the respondent was represented by the Solicitor General of India and other counsel appointed by the government.

The appellant bank was described as a banking institution registered under the Co‑Operative Societies Act of 1912 (Act II of 1912) and, by operation of law, deemed to be registered under the Bihar & Orissa Co‑Operative Societies Act of 1935 (Bihar Act VI of 1935), which had superseded the 1912 Act in Bihar. The bank was engaged in the business of banking within the State of Bihar. Its bylaws specified that one of its objects was to conduct the general business of banking in a manner not repugnant to the provisions of the Bihar Act and the rules then in force, as set out in Bye‑Law 3(a)(vi). During the calendar years 1945, 1946 and 1947, the appellant bank received, by way…

In the years 1945, 1946 and 1947 the bank received interest on deposits held with the Imperial Bank of India in the amounts of Rs 7,192, Rs 20,250 and Rs 22,600 respectively. These three amounts formed the core of the dispute in the present appeals, each appeal relating to a distinct assessment year – namely 1946‑47, 1947‑48 and 1948‑49. When the original assessment was made, the sums were not taxed under section 23(3) of the Income‑Tax Act; however, they were later assessed under section 34 and were treated as “income” falling under the head “other sources”. The assessment order was affirmed by the Appellate Assistant Commissioner and subsequently by the Income‑Tax Appellate Tribunal. Dissatisfied, the bank filed a petition under section 66(1) of the Act before the High Court, but the High Court ruled against the bank. Consequently, the bank lodged three separate appeals before this Court, each appeal covering one of the assessment years and naming the Commissioner of Income‑Tax, Bihar & Orissa as the respondent. Because the appeals raised a common question of law, they were consolidated for determination in a single judgment. In its tax return the bank declared the interest receipts under the heading “other sources”, and the Court noted that the precise manner in which the bank labelled the income was irrelevant to the issue at hand. Nevertheless, the Income‑Tax Officer had assessed the interest for the three years under section 12 of the Income‑Tax Act, again classifying it as income from “other sources”. The bank then appealed to the Appellate Assistant Commissioner, arguing that its principal activity of lending money meant the deposits were not intended as investments but were made to fulfil the bank’s cooperative purpose, and therefore the interest should be exempt under the Central Government Notification issued under section 60 of the Income‑Tax Act. The relevant extracts of that Notification – C.B.R. Notification No. 35 dated 20 October 1934 and No. 33 dated 18 August 1945 – were cited. The Notification stipulated that certain classes of income, including the profits of a cooperative society registered under the applicable Cooperative Societies Acts, were exempt from tax, although such profits would not include income derived from investments in securities governed by section 8 of the Income‑Tax Act, property referred to in section 9, dividends or similar payments. The bank’s contention rested upon this exemption provision.

The Appellate Assistant Commissioner rejected the appellant’s argument that the bank’s interest earnings should be exempt from tax. He observed that the appellant’s ordinary business activities comprised lending money and selling agricultural and other products to its members, activities that could be planned in advance and that did not require any special provision for unexpected claims. Examining the balance‑sheets, he noted that during the accounting year 1945 the bank had placed Rs 13,50,000 as fixed deposits, that the amount had increased to Rs 15,00,000 in the following year, and that these deposits were only realised with interest in the accounting year 1947 when they matured. He further commented that the considerable length of time for which the funds remained locked away indicated that the deposits were not made out of an urgent need for cash but were motivated by a desire to invest surplus funds. On that basis he concluded that the fixed deposits with the Imperial Bank of India were held as a separate investment, unrelated to the bank’s ordinary banking operations, and consequently the interest earned therefrom could not be treated as exempt income. He added that the statutory exemption for the profits of a co‑operativ​e society applied strictly to profits arising from the society’s co‑operativ​e activities; therefore, interest earned from investments such as fixed deposits did not form part of the appellant’s business profits and was not exempt from income‑tax.

The appellant appealed this finding before the Income‑tax Appellate Tribunal, contending that the deposits were not made as investments but solely to ensure that cash was continuously available for the bank’s business purposes, and that the deposits were therefore intrinsically linked to the bank’s operations, making the interest earned part of its business profits. The Tribunal, by its order dated 11 April 1955, rejected that submission. It held first that the interest earned was correctly classified as income under the head “other sources” referred to in section 12 of the Indian Income‑tax Act. Second, it explained that the profit of a co‑operativ​e society meant the profit derived from the society’s genuine business activities. Investments made by the society—in securities, shares or bank fixed deposits—were understood to be undertaken from surplus funds, and the interest or dividend arising from such investments could not be regarded as part of the society’s business profit. Accordingly, the interest was not exempt from tax, a position supported by the precedent set in Hoshiarvur Central Co‑operativ​e Bank v. Commissioner of Income‑tax. Dissatisfied with the Tribunal’s decision, the appellant invoked section 66(1) of the Act to refer two questions of law to the High Court: (1) whether, given the facts, the interest on the fixed deposits constituted income under the head “other sources”; and (2) whether, in the circumstances, that interest was exempt from tax under Co‑operativ​e Banking Regulations Notification No. 35 of 20 October 1934 and No. 33 of 18 August 1945.

In the reference made to the High Court, two legal questions were posed for its opinion. The first question was whether the interest earned on the fixed deposits should be characterised as income under the head “other sources”. The second question concerned whether, in the facts and circumstances of the case, the interest received from those fixed deposits was income that could not be exempted from tax under the C.B.R. Notification No 35 dated 20 October 1934 and Notification No 33 dated 18 August 1945. The appellant argued before the High Court that the deposits placed with the Imperial Bank of India were not intended as investments. Rather, the appellant claimed that the purpose of the deposits was to keep cash readily available for the bank’s own operations whenever such cash was required for business purposes. The appellant further asserted that the deposits were of a short‑term nature and that the bank could not continue its banking activities without maintaining such short‑term deposits. In other words, the appellant contended that placing money with the Imperial Bank was closely linked to the appellant bank’s ordinary business activities and that the interest earned on those deposits should be regarded as profit arising from those business activities. The High Court rejected this line of argument. It held that income derived by a cooperative society directly from its own business would fall within the exemption contemplated by the notifications, but income arising from dealings with third parties – such as the investment of surplus assets – would not be exempt. The Court observed that the investment of fluid assets is not part of the cooperative bank’s core business. It explained that the purpose of the notifications was to exempt profits accruing to a cooperative society from “carrying on the business of a mutual co‑operatives society”, based on the principle that a person cannot make a profit or loss out of himself. The ground of mutuality was not raised before the Court by the learned Solicitor‑General appearing for the respondent.

The essential question for determination, therefore, was whether the investment by a cooperative bank of its funds in fixed deposits – as the appellant bank had done – fell within the term “business” and thus was assessable under section 10 of the Income‑Tax Act, or whether such an investment was to be treated as “other sources” of income and consequently covered by section 12 of the Act. The learned Solicitor‑General contended that the finding of the Appellate Tribunal regarding the nature of these deposits was a matter of fact. The Court rejected this contention, noting that neither the Tribunal nor the High Court had treated the issue as a factual finding. Both authorities had framed the matter as a question of law, which was the basis for referring the question. Accordingly, the decision depends on what constitutes the ordinary business of a bank and whether the appellant bank’s business differs in any material respect. The Court indicated that its analysis would rely on the decision of the Privy Council in the relevant precedent.

In the case of The Punjab Co‑operative Bank Ltd v. The Commissioner of Income‑tax, Punjab, the counsel representing the appellant argued that a bank’s ordinary business consists of dealing in money and extending credit. The counsel maintained that placing funds in deposit with another bank was no different from lending those funds to borrowers, whether the borrowers were members of the cooperative society or other cooperative societies, and therefore such placements formed an integral part of the appellant’s business activities. According to this view, when a bank sets aside a portion of its deposited money in securities or in deposits with another banker, two purposes are achieved. First, the funds that are not immediately needed do not remain idle; instead, they generate interest. Second, if the bank later requires cash to satisfy any demand, the invested deposits and securities provide a readily available source of funds to meet that requirement. Consequently, the bank’s credit capacity remains intact and its money continues to accrue interest, which the counsel said was consistent with ordinary banking practice.

The counsel for the respondent, on the other hand, contended that money placed in such deposits could not be described as “carrying on the business of the bank.” Accordingly, any receipts arising from those placements should not be treated as profits derived from business operations but rather as income from “other sources.” To support this position, the respondent’s counsel referred to a series of earlier decisions, namely The Madras Central Urban Bank Ltd. v. Commissioner of Income‑Tax (1), The Madras Provincial Co‑operative Bank Ltd., Madras v. Commissioner of Income Tax, Madras (2), Commissioner of Income Tax, Burma v. Bengalee Urban Co‑operative Credit Society Ltd. (3), Commissioner of Income Tax, Madras v. Madras Provincial Co‑operative Bank Ltd. (4), Hoshiarpur Central Co‑operative Bank Ltd. v. Commissioner of Income Tax, Simla (5) and Cochin Cottage Industries Cooperative Marketing Society Ltd. v. Commissioner of Income Tax, Mysore & Co. (6). The Court examined each of these authorities and found that none supported the respondent’s argument. In the Madras Central Urban Bank case (1), the cooperative society was required to keep forty percent of its call‑deposit liabilities in a liquid form and chose to invest that amount in government securities. The court held that the interest earned on those securities did not constitute a portion of the society’s business profits because the society was not obligated to make such investments. Similarly, in the Madras Provincial Co‑operative Bank case (2), the disputed income consisted of interest earned from the bank’s holdings in government securities, and the court again ruled that this interest was not part of the income derived from the bank’s ordinary business. The Rangoon decision, Commissioner of Income‑tax, Burma v. Bengalee Urban Co‑operative Credit Society (3), also dealt with income generated from investments in government securities and reached a comparable conclusion. Consequently, the Court concluded that the cited cases did not establish that interest from deposits or securities should be classified as income from “other sources,” and therefore they could not be used to sustain the respondent’s position.

In this case the Court considered interest earned on capital that had been invested in Government securities. The Chief Justice, speaking at page 128 of the reported judgment, observed that neither interest earned from securities nor income derived from co‑operative property could be described as “profits” within the meaning of the term as used in the relevant notification. The Court added that it might be possible for the investment of capital in property or securities to form part of a taxpayer’s business; and if that were so, the net income accruing from such investments should, in the Court’s opinion, be treated as profits of the business and therefore be chargeable as such. Because the matter had not previously been examined from this perspective, the Court remitted the case for further consideration on that basis. The Court then noted that, prior to the amendment of the Notification, the cases cited demonstrated that the income which had been granted exemption was profit arising from the business of the assessee and not income that fell under sections eight and nine of the Income‑Tax Act. For example, in the case of the Commissioner of Income‑Tax, Madras v. The Madras Provincial Co‑operative Bank Ltd. (1), the bank had invested monies in debentures and, for reasons analogous to those given in the earlier authorities, the Court held that the interest earned therefrom did not constitute profits of the business. Counsel for the respondent relied upon a judgment of the Punjab High Court in Hoshiarpur Central Cooperative Bank v. Commissioner of Income‑Tax, Simla (2). In that matter the Government had authorised the bank to deal in sugar, oil and standard cloth, and the bank derived profit from those activities. The Court observed that those activities were neither part of the bank’s business under its bye‑laws nor within its objects, and therefore the profit could not be exempt on the ground that it was profit of a co‑operative society. The Court further observed that this line of reasoning was not advanced by the respondent before this Court and consequently the decision was inapplicable to the present facts. The Court also referred to the decision in Cochin Cottage Industries Co‑operative (1) I.L.R. [1943] Mad. 390 and (2) [1953] 24 I.T.R. 346, as well as to Marketing Society Ltd. v. Commissioner of Income‑Tax, Mysore & c. (1). In those cases the profit that was held not to be exempt under the Notification was the portion of profit attributable to the society’s dealings with non‑members. By contrast, in Surat Peoples’ Co‑operative Bank Ltd. v. The Commissioner of Income‑Tax, Ahmedabad (2), the profit arose during the ordinary banking business from the sale of Government securities that formed part of the bank’s stock‑in‑trade; because the institution was a co‑operative bank, the Court held that such profits were exempt from tax under the Notification. Finally, the Court observed that the appellant in the present matter is itself a co‑operative society that functions as a bank. One of its stated objects is to carry on the general business of banking. As with other banks, its money constitutes stock‑in‑trade or circulating capital, and its ordinary business consists of dealing in money.

In this case the Court observed that a bank’s business could not be limited solely to the receipt of deposits and the lending of money to its members or to other societies specified in its objects. The Court held that when a bank places its money in a manner that makes it readily available to meet depositor demands as they arise, such an activity formed a legitimate part of the bank’s ordinary business. The Court referred to the decision of the Privy Council in The Punjab Cooperative Bank Ltd. v. The Commissioner of Income‑tax, Lahore, where the profits arose from the sale of Government securities. At page 645 of that judgment the Privy Council noted that, in typical cases, the essential business of a bank consisted of dealing with money and credit. Depositors placed their funds in the bank for a modest rate of interest, and to satisfy any demands for withdrawal the bank was required to maintain sufficient cash or easily realizable securities. The Court described this requirement as a normal step in the conduct of banking operations and emphasized that such actions were genuinely part of carrying on the business. It further added that another recognised method of conducting banking business was to place the bank’s own funds in deposits with other banks, a practice also intended to meet possible demands on the bank. The respondents argued, citing authorities, that in the present matter the monies had been deposited with the Imperial Bank on long‑term terms, each deposit being for one year and periodically renewed for another year. However, the Court noted that the bank’s accounts demonstrated that these deposits matured at short intervals and would have been accessible to the appellant whenever a need arose. Both the tribunal and the High Court had stressed the use of the term “surplus.” The Court observed that the bank’s bye‑laws, under the heading “business of the bank,” permitted the investment of surplus funds when they were not required for the bank’s operations, in accordance with section 19 of the Bihar Act (Clause 4‑111(i) of the bye‑laws). The Court clarified that it was not called upon to decide whether investments made under section 19 constituted surplus, but it observed that the monies deposited with other banks had not been shown to be “surplus” within the meaning of that bye‑law, and therefore they could not be taken out of the bank’s ordinary business. Ultimately, the Court concluded that investing funds so that they remain readily available is a normal mode of banking, and it is as much a part of the bank’s business as receiving deposits or extending loans.

In this case, the Court explained that the normal functions of a bank include discounting hundies and issuing demand drafts, which are ways in which circulating capital is utilized. The Court observed that such use of circulating capital represents the ordinary course of business for a banking institution. It further held that the monies that had been placed as deposits, as in the present matter, would continue to constitute part of the appellant bank’s circulating capital and would remain within the scope of its banking operations. Consequently, any returns generated from those deposits would be included in the bank’s business profits. The Court added that, from a commercial perspective, the directors of a banking company have a duty to invest the bank’s funds in a manner that yields interest, rather than allowing the funds to remain idle. Accordingly, the Court stated that it could not be said that funds of the bank, which were not advanced to borrowers but were instead deposited with another bank to earn profit, ceased to be part of the bank’s stock‑in‑trade, nor could it be said that the interest earned on such deposits fell outside the bank’s business profits. Referring to the bank’s bye‑laws, the Court noted that one of the stated objects of the appellant bank is to carry on the general business of banking. Accordingly, subject to the provisions of the Co‑operative Societies Act, the bank is required to conduct its affairs in the same manner as ordinary banks do. The Court also mentioned that the various heads of income under section 6 of the Income Tax Act, together with the provisions applicable to those heads, are mutually exclusive. Section 12 of the Act functions as a residuary clause and becomes operative only after the earlier heads have been excluded. The Court cited the decision in Commissioner of Income‑tax v. Basant Rai Takhat Singh (1) in support of this interpretation. In the Court’s opinion, the High Court had erred in characterising the interest earned from the deposits as income that did not arise from the bank’s business, and consequently had excluded it from the income exempted by the relevant Notification. For that reason, the Court allowed the appeal, set aside the judgment and order of the High Court, and ordered that the appellant would be awarded costs both in this Court and in the lower Court. The appeal was thus allowed.