Co-Operative Banks Need Not Deduct TDS On Interest Paid To Co-Operative Societies: Bombay High Court

The Bombay High Court has ruled that co-operative banks are not required to deduct Tax Deducted at Source (TDS) on interest paid on fixed deposits held by another co-operative society, holding that the exemption for such payments continues to apply.

A Division Bench of Justice G.S. Kulkarni and Justice Aarti Sathe interpreted Section 194A(3)(v) of the Income Tax Act, which exempts certain categories of interest payments from TDS.

The dispute before the bench was whether the exemption available when one co-operative society pays interest to another continues to apply even where the payer is a cooperative bank.

Referring to CBDT Circular No. 19 of 2015, which explains the 2015 amendments, the bench observed that Parliament had amended only the provision dealing with interest paid to members of a co-operative bank, while leaving untouched the exemption for interest paid by one co-operative society to another

"The aforesaid discussion, in our opinion, would reflect on the intention of the legislature, which is also clear in the CBDT Circular (particularly paragraph 42.7) and clearly brings about the position that, in respect of interest credited by a co-operative bank to its non-member co-operative societies, the provisions relating to deduction of tax at source are not applicable." the court ruled.

"However, at the same time, under the first part of clause (v) of Section 194A(3), there is an obligation on a co-operative bank to deduct and deposit tax at source in accordance with the provisions of sub-section (1) of Section 194A(3). Thus, the Tribunal is not correct in holding that the second part of clause (v) of Section 194A(3) operates on the same footing as the first part of clause (v). This constitutes the legal fallacy in the Tribunal's reasoning, as the observations made therein are also without due consideration of the relevant provisions of the CBDT Circular, namely paragraph 42.7 (supra) thereof," it added.

This means that where a co-operative housing society or any other co-operative society keeps a fixed deposit with a co-operative bank, the bank need not deduct TDS before paying interest on the deposit.

The judgment came in a batch of appeals filed by Citizen Credit Co-operative Bank Ltd. against a common order of the Income Tax Appellate Tribunal (ITAT), which had upheld the Income Tax Department's decision treating the bank as an "assessee in default" for not deducting TDS on interest paid to co-operative societies on fixed deposits.

The department's case was that the Finance Act, 2015 required co-operative banks to deduct TDS on such interest payments. The bank, however, argued that Section 194A(3)(v) contains two distinct exemptions. While the 2015 amendment required co-operative banks to deduct TDS on interest paid to their members, it left untouched the separate exemption for interest paid by one co-operative society to another. Since a co-operative bank is also a co-operative society under law, the bank contended that no TDS was deductible on interest paid to another co-operative society.

Accepting the contention, the high court ruled that Parliament had consciously excluded co-operative banks only from the first limb of Section 194A(3)(v), which deals with payments to members. It did not amend the second limb, which exempts interest paid by one co-operative society to another. The bench also observed that a co-operative bank does not cease to be a co-operative society merely because it carries on banking business.

The bench found that both the Commissioner of Income Tax (Appeals) and the tribunal had overlooked paragraph 42.7 of CBDT circular. According to the circular, the existing exemption under Section 194A(3)(v) continues to apply where a co-operative bank pays interest to another co-operative society. The authorities had instead relied on paragraph 42.5 of the same circular, which deals with interest paid to members and was not applicable to the dispute.

The bench further observed, "Thus, the CBDT has clarified that the existing exemption under Section 194A(3)(v) of the Act from the deduction of tax on interest paid by one co-operative society to another co-operative society continues to apply to co-operative banks. Consequently, a co-operative bank is not required to deduct tax at source on interest paid on time deposits where the depositor is a co-operative society. There can be nothing clearer than what has been set out in paragraph 42.7 by the CBDT circular, which fully supports the contention as urged on behalf of the assessee."

Holding that the tribunal had committed a legal error by treating both parts of Section 194A(3)(v) as operating in the same manner despite applying to different situations, the high court allowed the appeals and set aside the tribunal's contrary view.

For Appellants (Citizen Credit Co-operative Bank Ltd.): Senior Advocate Jehangir Mistri with Advocate Harsh Kothari.

For Respondent (Income Tax Officer, TDS Ward, Mumbai): Advocate Y. S. Bhate.