The Bombay High Court has delivered a significant ruling on the tax deduction at source (TDS) obligations of co-operative banks, holding that a co-operative bank is entitled to the exemption under Section 194A(3)(v) of the Income Tax Act, 1961, in respect of interest paid to depositor co-operative societies that are not its members.

The Bench of Justice G. S. Kulkarni and Justice Aarti Sathe quashed the Mumbai Income Tax Appellate Tribunal’s order and held that the bank could not be treated as an assessee-in-default under Sections 201(1) and 201(1A) for not deducting TDS on such interest payments.

The appeals arose from proceedings against different branches of the co-operative bank, each having separate Tax Deduction Account Numbers (TANs) and separate TDS returns. The dispute concerned interest paid on fixed deposits maintained by other co-operative societies with the bank.

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The bank had not deducted TDS on the interest paid to these co-operative societies. Its principal contention was that although it was a co-operative bank for banking-law purposes, it continued to retain its legal character as a co-operative society. Therefore, the second limb of Section 194A(3)(v), which exempts interest paid by one co-operative society to another co-operative society, continued to apply.

Importantly, the depositor co-operative societies were not members of the bank and, according to the bank’s bye-laws, could not become its members.

For one branch, the Assessing Officer had treated the bank as an assessee-in-default in respect of interest amounting to ₹2,40,89,521 paid or credited to co-operative societies. Similar orders were subsequently passed for the other branches.

The Income Tax Department took the position that the amendment introduced by the Finance Act, 2015 required co-operative banks to deduct TDS on interest paid on time deposits.

According to the Revenue, the specific TDS provisions applicable to co-operative banks prevailed over the general exemption under Section 194A(3)(v). The Assessing Officer also referred to Section 80P and concluded that the recipient co-operative societies could not claim the relevant deduction, thereby supporting the conclusion that TDS was required.

The CIT(A) subsequently dismissed the bank’s appeals, holding that the bank was at par with commercial banks for TDS purposes and could not claim the exemption under Section 194A(3)(v). The Tribunal also rejected the bank’s challenge and held that TDS was deductible on the interest paid to the other co-operative societies.

Before the High Court, the bank argued that the authorities had conflated two distinct portions of Section 194A(3)(v).

The first portion deals with interest paid by a co-operative society, other than a co-operative bank, to its members. Following the Finance Act, 2015 amendment, a co-operative bank cannot claim this exemption in respect of interest paid to its members.

The second portion, however, deals with interest credited or paid by a co-operative society to any other co-operative society. The bank contended that this provision contains no exclusion of co-operative banks.

The distinction was crucial because the interest in dispute was paid not to members of the bank, but to other co-operative societies that were its depositors.

The High Court accepted the bank’s interpretation after examining the statutory language.

The Court observed that the legislature had expressly excluded a co-operative bank in the first part of Section 194A(3)(v). However, it had consciously not used the words “co-operative bank” in the second part.

According to the Court, this distinction could not be ignored. A co-operative bank continues to possess the legal character of a co-operative society. Merely because it is also carrying on banking business does not extinguish that underlying character.

The Court therefore held that the second part of Section 194A(3)(v) applies where a co-operative bank pays interest to a non-member co-operative society.

One of the important aspects of the judgment is the Court’s emphasis on the plain language of the taxing provision.

The Bench held that if Parliament intended to exclude co-operative banks from the second part of Section 194A(3)(v), it could have expressly done so, just as it had done in the first part.

The Court observed that accepting the Revenue’s interpretation would effectively require the Court to read additional words into the statute. Such an approach, according to the Bench, would alter the legislative language rather than interpret it.

The Court therefore declined to read an exclusion of co-operative banks into the second part of the provision where no such exclusion had been enacted.

The High Court found that the statutory interpretation was also directly supported by CBDT Circular No. 19/2015 dated November 27, 2015.

The Court specifically relied on paragraph 42.7 of the Circular. The Circular clarified that the existing exemption from TDS on interest paid by one co-operative society to another co-operative society would continue to apply to co-operative banks.

Thus, according to the High Court, a co-operative bank was not required to deduct TDS from interest paid on time deposits to a depositor that was itself a co-operative society.

The Bench described paragraph 42.7 as providing a clear clarification in favour of the exemption and held that the Tribunal had failed to properly consider its effect.

The High Court particularly criticised the Tribunal’s reliance on paragraph 42.5 of CBDT Circular No. 19/2015 while overlooking paragraph 42.7. Paragraph 42.5 dealt with the amendment concerning interest paid by co-operative banks to their members. The amendment made the exemption unavailable to co-operative banks in respect of interest on time deposits of members with effect from June 1, 2015.

The present dispute, however, involved interest paid to non-member co-operative societies.

The High Court therefore held that the Tribunal’s reliance on paragraph 42.5 did not answer the issue before it, while paragraph 42.7 specifically addressed interest paid by a co-operative bank to a depositor that was a co-operative society.

The Court also rejected the Assessing Officer’s attempt to link the TDS issue with the recipient societies’ eligibility under Section 80P.

The Bench explained that Section 80P and Section 194A operate at different stages and serve different purposes.

Section 80P concerns deductions available while determining the taxable income and final tax liability of the recipient co-operative society. Section 194A, on the other hand, operates at the transaction stage and determines whether the payer has an obligation to deduct TDS.

Consequently, whether the recipient society is entitled to a deduction under Section 80P cannot determine whether the payer is required to deduct TDS under Section 194A. The Court specifically held that the Assessing Officer’s approach of intermixing the two provisions was not well-founded.

The Bombay High Court noted decisions of the Kerala and Madras High Courts that supported the interpretation adopted in the present case.

In the Kerala High Court decision concerning interest paid by a district co-operative bank to another co-operative society, the Revenue had conceded that the exemption under Section 194A(3)(v) was available.

The Madras High Court had also examined whether a distinction existed between a co-operative society engaged in banking business and a co-operative bank and found that the relevant statutory framework did not generally create such a dichotomy, except in specifically identified provisions.

The Bombay High Court found these decisions supportive of its understanding of the legislative intent behind Section 194A(3)(v).

Allowing all eight appeals, the Division Bench quashed and set aside the impugned judgment and order of the Income Tax Appellate Tribunal.

The Court answered the substantial questions of law in favour of the assessee and specifically held that a co-operative bank is entitled to the exemption under Section 194A(3)(v) in respect of interest paid to depositor/non-member co-operative societies. The bank cannot be treated as an assessee-in-default under Section 201(1) for failure to deduct such TDS. Consequently, interest liability under Section 201(1A) also cannot be sustained.

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