ITAT Bangalore Treats Interest Provision Disallowance as Tax-Neutral for Co-operative Society Under Section 80P
The Bangalore Bench of the Income Tax Appellate Tribunal (ITAT) in the case of Auto Nirvahakara Credit Co-operative Society Ltd. Vs ITO examined two key issues relating to a co-operative credit society:
- Disallowance of provision for interest payable to members on the ground of adopting a hybrid method of accounting, and
- Eligibility of
Section 80P(2)(a)(i)deduction on interest income earned from deposits with scheduled banks.
The Tribunal ultimately held that even if the disallowance of interest provision is upheld, the resulting addition only increases business income which remains fully deductible under Section 80P(2)(a)(i) of the Income Tax Act 1961, rendering the adjustment revenue-neutral. On the second issue regarding bank interest, the matter was remanded to the Assessing Officer (AO) for a fresh factual examination.
Background of the Appeal
The assessee, Auto Nirvahakara Credit Co-operative Society Ltd., a credit co-operative society, filed its return of income declaring nil taxable income after claiming deduction under Section 80P(2)(a)(i) for the relevant assessment year. The case was picked up for scrutiny specifically to verify the correctness and eligibility of this deduction.
An order was passed by the AO under the regular assessment proceedings, which was later upheld by the Commissioner of Income Tax (Appeals) [CIT(A)]. The assessee then carried the matter in second appeal before the ITAT.
The appeal before the Tribunal arose out of the order of the CIT(A) passed under Section 250 dated 31.07.2025.
Issue 1: Disallowance of Provision for Interest Payable to Members
AO’s Finding on Accounting Method and Disallowance
While examining the financial statements and audit report, the AO noticed that:
- The assessee, as per the audit report, generally followed the mercantile system of accounting.
- However, in the profit and loss account, the assessee recognized:
- Interest income on a cash basis, and
- Interest expenditure (provision for interest payable on deposits of members) on an accrual basis.
The AO viewed this as a hybrid method of accounting that is not permissible under the Income Tax Act 1961 and held that such selective recognition of income and expenditure distorts the true profits.
Consequently, the AO:
- Disallowed the provision for interest on deposits amounting to Rs. 14,20,000/-, and
- Added this amount to the total income of the assessee.
Order of the CIT(A)
The assessee challenged this disallowance before the CIT(A). However, the CIT(A) concurred with the AO's reasoning:
- The hybrid system adopted was held to be impermissible,
- The disallowance of Rs. 14,20,000/- was upheld, and
- The assessee’s plea was rejected.
The assessee then preferred an appeal before the ITAT against this confirmation of disallowance.
Assessee’s Arguments Before ITAT on Interest Provision
Justification of Hybrid Method Based on Co-operative Law
The learned Authorised Representative (AR) submitted detailed written submissions and a voluminous paper book. Key contentions included:
- The assessee, a credit co-operative society, followed a mixed or hybrid method of accounting only in respect of interest:
- Interest income from members was brought to account on receipt (cash) basis,
- Interest payable to members on deposits was provided on accrual basis.
- This pattern was asserted to be statutorily driven, not arbitrary, and was claimed to be in compliance with Rule 22(a) and (b) of the Karnataka Co-operative Rules, 1960, which lay down the methodology for determining the net profit of a co-operative society.
Therefore, the assessee argued that:
Since the method of accounting is prescribed by the co-operative law framework, the AO cannot disturb it merely on the ground that it appears hybrid.
Alternative Argument: Revenue Neutrality Under Section 80P
Without giving up the primary contention on the validity of the accounting method, the assessee also advanced an alternative plea: