Kerala HC upholds proviso to section 194A(3) of Income tax Act, 1961 for high-turnover co-operative societies

The Hon'ble Kerala High Court (hereinafter referred to as ‘the Court') in the case of Vellangallur Peoples Welfare Co-Operative Society Ltd v. Union of India has upheld the Finance Act 2020 amendment to Section 194A(3) of the Income Tax Act, 1961 (‘the Act') which requires co-operative societies with annual turnover over INR 50 crore to deduct tax at source (TDS) on interest paid to members. The petitioners, primary agricultural credit co-operative societies, had argued that this turnover threshold created an unreasonable classification (violating Article 14 of the constitution) and that their interest income (deposited in the Kerala State Co-operative Bank) was exempt under Section 80P, so no TDS should be imposed. The Court rejected these arguments. It held that Section 80P affords a conditional deduction (not a blanket exemption) and that differentiating societies KEY HIGHLIGHTS by turnover has a rational basis in tax. The proviso was found constitutionally valid and the writ petitions were dismissed.

FACTS OF THE CASE

• All petitioners are primary agricultural credit co-operative societies providing loans to members.Under Section 194A(3)(v) [and (viia)], interest paid by a co-operative society (other than a co-operative bank) to its members or to another co-operative society was exempt from TDS.
• Finance Act 2020 inserted a proviso to Section 194A(3): if a co-operative's preceding-year turnover, gross receipts or total sales exceed INR 50 crore, then interest credited or paid to membersissubjecttoTDS.
• The Petitioners contended that the turnover-based ceiling creates an unreasonable sub classification among co-operative societies that are otherwise similarly placed and therefore violates Article 14 of the Constitution. They contended the threshold effectively nullifies the exemption they enjoyedandcausesthemhardship.
• It was submitted that interest income earned from mandatory deposits placed with the Kerala State Co-operative Bank is deductible under Section 80P(2)(d); therefore, subjecting such income to TDS, when they have no practical ability to avoid these deposits, results in arbitrariness, as the income is ultimately not taxable.

OBSERVATIONS OF THE KERALA HIGH COURT

• Relying on plethora of judicial precedents, the Court noted that the proviso as introduced by Finance Act 2020, was consciously introduced to limit the exemption under Section 194A(3) based on turnover and held that a proviso may validly alter the scope of the main provision where such legislative intent is clear. Accordingly, the amendment could not be treated as ultra vires merely because it is framed as a proviso.
• OnSection80P,the Court agreed with the Revenue that Section 80P grants a deduction and not an absolute exemption from tax. As the deduction is conditional to filing return of income in accordance with Section 80AC of the Act, interest received from the Kerala State Co-operative Bank continues to form part of total income unless conditions are met, and any excess TDScanbeclaimed onfiling of return.
• On the challenge under Article 14, the Court reiterated that tax statutes may classify assessees based on income or turnover if the classification has a rational nexus with the legislative objective. Relying onMurthy Match Works and Nitdip Textile, it held that the turnover-based distinction is reasonable, as higher-turnover societies undertake larger volumes of transactions,warrantinga TDS safeguard.
• TheCourt rejected reliance on Asianet Satellite, noting that the proviso differentiates on the basis of income and that taxpayers with differing income levels need not be treated alike. It further held that any hardship arising from mandatory deposit requirements under the State co-operative law cannotrenderthe centraltax provision arbitrary.
• The Court held that mere inconvenience or hardship does not invalidate a clear statutory provision, and that legislative awareness of such consequences cannot be presumed to defeat the mandateof thelaw.
• The contention that the petitioners should fall within Section 194A(3)(iii)(a) applicable to banking co-operatives was rejected on the ground that the petitioners do not carry on “banking” as definedas defined section 5(b) of the BankingRegulation Act, 1949.
• In conclusion, the Court held that the Petitioners had not demonstrated any ground to warrant interference with the proviso to Section 194A(3). The proviso was found to be within legislative competence, not arbitrary, and not violative of Article 14, as the turnover-based criterion had a rational nexus with the TDS framework. Any hardship arising from State law requirements could not invalidate a Central tax provision. Accordingly, the writ petitions were dismissed.

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