High Court Of Karnataka
CIT vs. Nagarbail Salt-Owners Co-Operative Society Ltd.
Section 80P, 2(31)
Ashok B. Hinchigeri And P.S. Dinesh Kumar, JJ.
IT Appeal No. 100067 Of 2015
November 19, 2016
P.S. Dinesh Kumar, J. – Revenue, aggrieved by the order passed by the Income Tax Appellate Tribunal, Panaji Bench, Panaji (‘ITAT’ for short) in ITA No.252/PNJ/2014 dated 23.1.2015 for the assessment year 2006-07 has presented this appeal raising certain questions of law. This Court after hearing the learned Standing Counsel for the Income Tax Department and Counsel for the respondent – assessee vide order dated 2.11.2016 framed following question of law:â
“Whether the respondent – Society assessed to tax on its income as ‘person’ as defined under Section 2(31) of Income Tax Act, 1961, is entitled to claim exemption over its profits paid to its members and claim it as expenditure in the accounts before offering the profit for tax?”
2. Heard Shri Y.V.Raviraj, learned standing Counsel for the Revenue and Shri Ashok Kulkarni, learned Counsel for the respondent.
3. Submissions on behalf of appellant/Revenue:
(i) Respondent is a Co-operative Society registered under the provisions of the Karnataka Co-operative Societies Act, 1959. Its objects are enumerated in Chapter IV of the Bye-laws of the Society;
(ii) All members of the Society shall be owners of land (Agar) upon which salt is manufactured. They are called as ‘Maliks’. The principal aim and object of the Society was inter alia to acquire Maliks’ rights over their lands and to manufacture salt and its by-products;
(iii) Pursuant to its objects, Society took over manufacturing rights of members over their individual pieces of lands (Agar);
(iv) Society acquired and installed necessary plants and machinery to manufacture salt and its by-products;
(v) Salt is manufactured and sold by the Society itself. A large portion of sale proceeds are transferred to an account called ‘Distribution Pool Fund Account’ and paid to its members commensurate with their land holding. The remaining income is offered to tax;
(vi) On 25.10.2006, Society filed return of income for the assessment year 2006-07 by returning a sum of Rs.1,19,251/-being loss carried forward and computed income as NIL after claiming deduction of Rs.3,45,021/- under Section 80P(1)(d) of the Income Tax Act, 1961 (‘the Act’ for short) as per the Profit and Loss account;
(vii) A notice under Section 148 was issued. In reply, respondent – assessee asserted that the total taxable income for the said assessment year was NIL. Revenue took up assessee’s case for scrutiny by issuing notice under Section 143(2) of the Act. Assessee was represented by one Shri Anil Shantharam Nadkarni, Manager of the Society and Shri R.V.Hublikar, an Income Tax Practitioner. Copies of Bye- laws, brief notes about the activities of the Society, certified copies of final accounts – Profit & Loss Account, Balance Sheet, Schedules showing Debtors and Creditors, Audit report under Section 44AB, copies of the VAT returns, details of cash sales, computation of income etc., were filed. However, Chartered Accountant’s certificate certifying the audit under Section 44AB of the Act was not filed. Therefore, Chartered Accountant was summoned and his statement was recorded. He was specifically called upon to answer a question as to whether transfer to ‘Distribution Pool Fund Account’ is an expenditure. The Chartered Accountant refused to answer the said question and sought time to furnish an explanation. Subsequently, he sent an explanation by email, which was not in consonance with the provisions of Section 44AB of the Act. The assessing authority held that the Chartered Accountant had hesitated to comment on the deduction and transferred to the ‘Distribution Pool Fund Account’;
(viii) After hearing the assessee, an Assessment Order was passed on 30.12.2013 under Section 143(3) read with Section 147 of the Act holding the total income of Rs.1,23,17,800/-, which would entail Income Tax of Rs.36,92,340/-. After adding surcharge, cess, interest etc., the Assessing Authority held that the assessee was liable to pay a total sum of Rs.72,69,991/-; and
(ix) Feeling aggrieved, respondent – Society challenged the assessment order before the Commissioner of Income Tax (Appeals), who vide order dated 5.5.2014, placing reliance on the judgment of the Hon’ble Supreme Court in the case of Radhasoami Satsang v. CIT  1 SCC 659 allowed the appeal in part by holding that the Bye-laws cannot be segregated and read in isolation to hold that the income generated was the income of the appellant-assessee. The said order was unsuccessfully challenged before the ITAT. Feeling further aggrieved, Revenue has preferred this appeal.
4. Assailing the orders passed by both the CIT (Appeals) and the ITAT, learned Standing Counsel for the Revenue contended that a combined reading of Society’s Bye-laws 4(a), (b), (c), (d) & (k) clearly indicates that the Assessee-Society had indeed acquired salt manufacturing rights from Maliks, who are the members of the Society. Plant and machinery have been installed by the Society. The final product namely, the Salt and the by-product are admittedly sold by the Society. Therefore, it is clear that entire activity of manufacture and sale is undertaken by the Society. Hence, Society was not justified in deducting fund transferred to ‘Distribution Pool Fund Account’ as expenditure.
5. He further contended that assessee was required to file an audit report under Section 44AB of the Act. But, the Chartered Accountant refused to answer the questions posed by the assessing authority. He also hesitated to submit a categorical reply with regard to the transfer of funds to the ‘Distribution Pool Fund Account’. Therefore, the order passed by the assessing authority is just and appropriate.
6. However, CIT (Appeals), the first appellate authority misdirected himself and came to an erroneous conclusion that the taxable income of the Society is only the commission. Similarly, ITAT also fell in an error in dismissing the appeal filed by the Revenue by accepting the arguments of the Assessee.
7. In sum and substance, learned Standing Counsel for the Revenue argued that the Assessee-Society as a juristic person was carrying on the business of both ‘manufacturing’ and ‘selling’ salt and its’ by-products. It was transferring funds to the Distribution Pool Fund to be distributed among its members. Only the remaining portion was being offered to tax. He contended that transfer of funds to the Distribution Pool Fund is impermissible because the Society had taken over the ‘right to manufacture’ Salt from the Maliks of the land. Therefore, the amount paid to the members of the Society cannot be treated as an expenditure. Hence, the orders passed both by the CIT (Appeals) and ITAT are unsustainable in law.
8. Submissions on behalf of Respondent/Assessee:
(i) Assessee-Society came into existence pursuant to an advice tendered by Salt Expert Committee appointed by the Government of India. The said Committee having foreseen the difficulties of individual holders of small units had suggested that a merger either under the Government control or preferably under a Co-operative sector appeared to be the sole remedy to save them from extinction. Accordingly, Assessee – Society was formed;
(ii) Objects defined in the bye-laws give a clear indication that the Society was formed only to manufacture salt on co-operative basis. Clause 4(l) makes it clear that the Society was required to pay the ‘assessment’ and ‘mulgeni’ rents in respect of individual areas on behalf of its members. Clause (m) indicates that it was expected of the Society to help the members in getting a fair price to their share of Salt manufactured by Society; Clause (u) permits the Society to recover manufacturing expenses from its members;
(iii) The purpose and intent of the Society is ‘Joint Manufacture’ of the salt as can be gathered from Chapter-VI of the Bye – laws and particularly clause (d) thereof;
(iv) Distribution of profits could be sanctioned by the General Body Meeting as prescribed in clause 35(c) of the Bye-Laws;
(v) A combined reading of clauses 58(g), (j) & (l) clearly suggests that the purpose of forming the co-operative Society was only to manufacture Salt collectively. The ownership of the Salt to the extent of individual member’s share remained with the respective member alone as members were permitted to raise loan proportional to their interest in the ‘Agar’ as per clause 80 of the Bye – laws; and
(vi) Therefore, the Society was justified in transferring the funds to the Pool for further distribution among the members. This practice was in vogue for several years and to be precise, even prior to the Karnataka Co-operative Societies Act coming into force. Therefore, the notice under Section 148 of the Act and all further proceedings thereon by the Assessing Authority are not only misconceived but also hit by doctrine of res judicata;
9. Thus, supporting the impugned order, Shri Kulkarni argued that, what is taxable is the income of the Society and the same is defined in Chapter-XVI of the Bye-laws. Society earns its income from levy of commission, collection of interest on loans, collection of rents, and collection of service charges only. Therefore, the assessing authority fell in an error by holding that the amount transferred to ‘Distribution Pool Fund Account’ is taxable in the hands of Society. In support of his contentions, he placed reliance on the few judgments and prayed for dismissal of this appeal.
10. We have given our careful consideration to the rival contentions urged at the bar, perused the records and the rulings cited.
11. The preamble to the approved Bye-laws reveals that Government of India had appointed a Salt Expert Committee to study Salt manufacturing activity in different parts of the country. After a study, the said Committee had suggested that a merger of Salt works either under the Government control or preferably under the Co-operative Society appeared as an inevitable option to save the individual salt owners holding small units. It was also suggested that if such remedial measures were not taken, small units would run the risk of extinction because of their uneconomical size and unfavourable climatic condition. The salt owners in an Extra-ordinary General Meeting of their Association held on 17.2.1952, resolved to form a Co-operative Society of Salt Owners for the ‘manufacture of Salt’ on co-operative basis. Accordingly, assessee – Society was formed and registered on 17.9.1952. The bye-laws were adopted on 2.10.1952.
12. Preamble to the approved Bye – laws of the Society reads as follows:â
” I PREAMBLE
1. Whereas the Government of India having been advised by the Salt Expert Committee in 1950, and other Committees appointed from time to time to investigate the question of salt manufacture in different parts of the country, have issued orders to the Salt Department that the recommendations made by the committee should be given effect to and whereas these recommendations inter alia refer to the raising of the standard purity of salt by certain methods most important of which is the remodelling of salt works so as to adopt an optimum ratio between the crystallisers and the condensers cum reservoir and whereas according to the instructions of the Salt Department conveyed to the Salt owners of the Nagarbail Saza through their Association from time to time, the highest standard of purity of salt has to be achieved in the manufacturing season of 1953, and whereas, the Salt Expert Committee having foreseen the difficulties of the individual salt owners holding small units, have suggested that a merger of the salt works either under Government control or preferably under a Co-operative Society appears to be the only remedy for saving these works as otherwise they are bound to be extinguished because of their uneconomic size, unfavourable climatic conditions etc. and whereas, the salt owners at the Extraordinary General Meeting of their Association held on the 17th February 1952 having resolved to form a Co-operative Society of the salt owners’ for the manufacture of salt on a co-operative basis, the following Byelaws have been framed and adopted by the Salt Owners’ at the meeting of their Association held on 8th May 1952 for the formation of such a co-operative Society. This Society was registered on 17-9-1952 and the byelaws adopted subject to certain amendments on 2nd October 1952. These byelaws were further amended in view of the Karnataka Co-operative Societies Act, 1959 in the Special General Meeting held on 19-9-1979.” (Emphasis supplied)
13. The words ‘Malik’ and ‘Agar’ are defined in Chapter-III of the Bye-laws and they read as follows:
‘”Malik” – means a person owning jointly or severally jointly or having an interest in agar in the Nagarbail Saza, Sanikatta on the date of the Registration of this Society whether he be Khatedar or not and shall be deemed to includes his heirs, successors and assigns and a receiver appointed by a competent Court. Record of Rights may also be taken into consideration as evidence.’
‘”Agar” – means land on which salt is manufactured in the Nagarbail Saza which includes Narnapur Salt Works.’
14. In order to decide whether the fund transferred to ‘Distribution Pool Fund Account’ ought to have been offered to tax, it is necessary to examine the aims and objects of the Society described in Chapter-IV of the Bye-laws. The salient objects of the Society read as follows:
“(a) to acquire from the Maliks the right of manufacturing salt in the nagarbail Saza, Sanikatta, and to manufacture salt and other byproducts in these areas on Co-operative basis.”
“(c) to consolidate and remodel the salt works so as to manufacture salt and byproducts economically and on a scientific basis, and to manufacture table salt and high purity salt.”
“(k) to purchase and instal suitable plant or any other machinery required in connection with the manufacture of salt and byproducts or any subsidiary works undertaken.”
“(l) to pay on behalf of the members the assessment and mulgeni rent in respect of the individual areas included in the salt works which will be a first charge on a produce of the individual members.”
“(m) to help members in getting a fair price for the salt and byproducts produced by the Society on their behalf.”
“(q) to sell the salt and by-products either directly or through agents.”
“(u) to recover all the manufacturing expenses of the Society and any other dues from the individual members from time to time.” (emphasis supplied)
15. The Society functions in consonance with the Bye-laws. Clause (a) of the objects extracted above shows that the principal aim of the Society was to acquire ‘right of manufacturing salt’ and to manufacture the same on co-operative basis. Clause (l) gives a clear indication that the ‘assessment’ and ‘mulgeni’ in respect of the individual lands ‘Agar’ is paid by the Society on behalf of its members. In furtherance of its objects contained in Clause (m), assessee – Society is obliged to help its members to get a fair price for the Salt. Clause (u) spells out the ‘precise understanding’ or the contract between the Society and its members, whereunder the Society is entitled to recover all manufacturing expenses.
16. Thus, a combined reading of the preamble to the Bye – laws and salient objects noted supra, lead to an irresistible inference that the Society was formed to save individual salt manufacturers from extinction as per the advise tendered by the Salt Expert Committee. The very fact that the Bye-laws permit the Society to recover the ‘manufacturing expenses’ and ‘other dues’ from its members is a sufficient and a robust indication that the ownership of the Salt to the extent of their respective share of each individual member continues to remain with the respective member himself. This inference is fortified by Clause 80 of the Bye – laws, which permits the members to raise loan on the ‘security’ of their proportional interest in the ‘Agar’ and ‘Salt produced’.
17. Income of the Society is defined in Chapter-XVI of the Bye-law, which reads as follows:â
” The income of the Society shall be :
(a) by levy of commission on manufacture on sale of salt and byproducts on behalf of members.
(b) by collection of interest on loan advanced to members and deposits with banks.
(d) By collection of rents;
(e) By collection of service charges;”
18. It is argued by the Revenue that, the Maliks had surrendered the right to manufacture salt and they had lost right to enjoy the physical possession of the property. Further, Society is a juristic person indulged in manufacture and sale of salt. It has obtained the license to manufacture salt, registered itself with Sales Tax, Service Tax and other statutory authorities. Salt is shown as the closing stock of the Society. Therefore, the amount transferred to ‘Distribution Pool Fund Account’ prior to offering to Income Tax is impermissible inasmuch as the said amount is distributed to individual members. Thus, a substantial portion of profit earned by the Society is diverted as expenses before offering to tax. In support of this contention, Revenue has placed reliance on the following rulings:
(i) Judgment of Hon’ble Supreme Court in the case of Tuticorin Alkali Chemicals & Fertilizers Ltd. v. CIT  227 ITR 172/93 Taxman 502 to contend that an issue will have to be decided on the principle of law and not in accordance with the accounting practice;
(ii) ITO v. Ch. Atchaiah  218 ITR 239/84 Taxman 630 (SC) to contend that if the income is of an ‘association of persons’, then, in law, it is the association alone which has to be taxed.
(iii) CIT v. Indira Balkrishna  39 ITR 546 (SC) to contend that the word ‘associate’ means to join in common purpose and in the instant case assessee is an association of person and it is the association alone which has to be taxed.
(iv) CIT v. Chandmal Rajgarhia  213 ITR 789 (Pat.) to point out that the essential requirement to attract the label of ‘association of purpose’ is the unity of income.
19. On the other hand, placing reliance on a ruling of Hon’ble Calcutta High Court in the case of Narayan Prasad Vijaivargiya v. CIT  102 ITR 748, it was argued by Shri Kulkarni, learned Counsel for the assessee that the Bye-laws of the Society have to be read and construed as a whole to know the intention of the members and the purpose of forming the co-operative Society to decide as to whether the amounts paid to the members was taxable in the hands of the Society. We have perused the said Judgment. The relevant portion reads as follows:â
‘â¦â¦â¦â¦â¦. In our view a deed is to be read and construed as a whole and, if possible, effect should be given to all parts thereof. In other words, the general intention is to be collected from the instrument as a whole and that intention should be inferred from the general form of the deed. See Odger’s Construction of Deeds and Statutes, fifth edition, page 55. This would be more so when a deed is to be construed reasonably. The way in which the learned counsel for the revenue wants us to read the deed would amount to deletion or not giving effect to a part of the deed which represents the intention of the parties to the deed. Unless a part of a deed is so inconsistent with the rest of it that no effect can be given to it, that part should be read and given effect to while construing a deed. Further, while construing a deed, one should bear in mind the principle of construction as stated in Odger’s Construction of Deeds and Statutes, fifth edition, at page 54. It is stated thus:
“The law is anxious to save a deed if possible. This is sometimes expressed in the maxim utnes magis valeat quam pareat. If by any reasonable construction the intention of the parties can be arrived at and that intention carried out consistently with the rules of law, the court will take that course.”‘ (Emphasis supplied)
20. We quite see substantial force in the argument advanced by Shri Kulkarni. We have held that the Society has come into existence pursuant to the advice tendered by the Salt Expert Committee, which was appointed by the Government of India. We have noted that the said committee categorically recommended for a merger of salt works under a co-operative society in view of uneconomical size of the land and unfavourable climatic condition. Pursuant thereto, the assessee – Society was formed. The principal object of the Society is to ‘manufacture salt on co-operative basis’. The cumulative income of the Society as enumerated in Chapter XVI cannot be anything more than commission earned on manufacture and sale of salt, interest on loans advanced to members and deposits with the Bank and collection of rents and service charges.
21. The next authority relied upon by the learned Counsel for the assessee is a judgment of the Hon’ble Supreme Court in the case of CIT v. Sitaldas Tirathdas  41 ITR 367, wherein, it is held as follows:â
“These are the cases which have considered the problem from various angles. Some of them appear to have applied the principle correctly and some, not. But we do not propose to examine the correctness of the decisions in the light of the facts in them. In our opinion, the true test is whether the amount sought to be deducted, in truth, never reached the assessee as his income. Obligations, no doubt, there are in every case, but it is the nature of the obligation which is the decisive fact. There is a difference between an amount which a person is obliged to apply out of his income and an amount which by the nature of the obligation cannot be said to be a part of the income of the assessee. Where by the obligation income is diverted before it reaches the assessee, it is deductible; but where the income is required to be applied to discharge an obligation after such income reaches the assessee, the same consequence, in law, does not follow. It is the first kind of payment which can truly be excused and not the second. The second payment is merely an obligation to pay another a portion of one’s own income, which has been received and is since applied. The first is a case in which the income never reaches the assessee, who even if he were to collect it, does so, not as part of his income, but for and on behalf of the person to whom it is payable.” (Emphasis supplied)
22. Learned Counsel has also placed reliance on the Division Bench Judgment of our High Court in the case of CIT v. Pompei Tile Works  175 ITR 1/ 41 Taxman 181 (Kar.) which has also followed the judgment of the Hon’ble Supreme Court in Sitaldas’s case.
23. He has also relied upon Tuticorin Alkali Chemicals & Fertilizers Ltd. (supra) to advance an argument that the accounting practices cannot over-ride the true intent and a case has to be decided on principle of law.
24. The next ruling cited is CIT v. Ramakrishna Nursing Home  313 ITR 290/183 Taxman 267 (Kar.). Learned Counsel for the assessee submitted that in the said case the panel of visiting Doctors collected their fee directly though they were practising in the same Nursing Home. The Division Bench of this Court dismissed the appeal filed by the Revenue.
25. Thus, in the facts and circumstances of the case, we are persuaded to accept the view taken by the Division Bench of the Calcutta High Court in the case of Narayan Prasad Vijaivargiya (supra). Further, in the light of the ratio laid down by the Hon’ble Supreme Court in the case of Sitaldas Tirathdas (supra), which is followed by a Division Bench of this Court in the case of Pompei Tile Works, we hold that income of the Society cannot be anything beyond the scope of Chapter XVI of the Bye – laws. Therefore, logically the amount transferred to the ‘Distribution Pool Fund Account’ cannot be brought within the umbrella of Chapter XVI. Hence, it is not taxable in the hands of the Society.
26. In the premise, the substantial question of law deserves to be answered against the appellant – Revenue. Consequently, this appeal must fail.
27. Before parting with this case, we deem it necessary to place on record that by an earlier order dated 26.2.2016, this appeal was allowed in favour of the Revenue after hearing Counsel on both sides whilst the appeal was listed for admission. Later a Review Petition was filed on the ground that a substantial question of law was not framed prior to hearing. The said Review Petition was allowed by order dated 06.09.2016. Subsequently, the question of law was framed on 2.11.2016 and learned Counsel for the parties were called upon to address their arguments on the said question in this second round. During the course of hearing, learned counsel for the assessee has brought to our notice the judgment of the Hon’ble Supreme Court in the case of Sitaldas Tirathdas (supra) a judgment of Calcutta High Court in the case of Narayan Prasad Vijaivargiya (supra) and a judgment of this Court in the case of Pompei Tile Works, the benefit of which was not available to this Court when the appeal was heard in the first round. Therefore, the earlier view taken is per incuriam. Now following the ratio laid down in the aforementioned judgments cited before us, we are persuaded to hold that the order passed by the ITAT does not require any interference which is fully invariance and obverse to the view taken by this Court earlier in this appeal, which we gracefully do.
28. Resultantly, we answer the question of law against the Revenue. As a consequence, this appeal is dismissed without any order as to costs.
[Citation : 390 ITR 415]