Deduction under Section 80P cannot be denied in full over nominal membership limits.

By | June 26, 2026
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Deduction under Section 80P cannot be denied in full over nominal membership limits.

Issue

  • Whether a co-operative society can be denied its deduction under Section 80P(2)(a)(i) in full on the grounds that it admitted nominal or associate members beyond the statutory 15% limit prescribed under State law, and whether the disallowance of an interest provision leads to an eligible increased profit for the same deduction.

Facts

  • The assessee is a co-operative society registered under the Karnataka Souharda Sahakari Act, 1997, and claimed a tax deduction under Section 80P(2)(a)(i) for the Assessment Years 2017-18 and 2018-19.

  • The Assessing Officer (AO) disallowed the entire deduction, asserting that the society had admitted nominal/associate members (C-Class/D-Class) in excess of the 15% statutory limit prescribed by State co-operative law, thereby violating the principle of mutuality.

  • For AY 2017-18, the society recognized interest income on loans on a cash basis but debited its provision for interest payable on members’ deposits on an accrual basis.

  • The AO disallowed this interest provision, treating the method as an impermissible hybrid system of accounting, which consequently increased the society’s assessed business profits.

Decision

  • On Nominal Membership and Mutuality: Held, yes. A blanket denial of the Section 80P(2)(a)(i) deduction is not justified. Since State law permits nominal or associate members, transactions with them cannot be treated as dealings with the general public simply because they hold restricted rights.

  • On Excess Membership Allocation: Held, yes. The lower authorities failed to record a definitive finding that the 15% limit was actually breached post the amendment to the State Act. Even if a violation occurred, the disallowance must be restricted only to the income earned from the excess nominal members, not the entire business.

  • On Disallowed Interest Provision: Held, yes. Since the disallowance of the interest provision directly relates to the core member-deposit activities of the society, the resultant increase in book profit remains fully eligible for the Section 80P(2)(a)(i) deduction.

Key Takeaways

  • No Total Disallowance for Technical Breaches: A co-operative society cannot be stripped of its entire Section 80P deduction due to a regulatory cap violation regarding nominal or associate members; tax adjustments must be proportionate and restricted to the offending transactions.

  • Status of Nominal Members: Nominal or associate members recognized under a State Co-operative Act are legally distinct from the general public. Business transacted with them satisfies the basic operational criteria of a co-operative society.

  • Enhanced Profits Eligible for Deduction: When a regular business expense or provision is disallowed under scrutiny, the corresponding enhancement of business income automatically qualifies for profit-linked deductions if the underlying activity is eligible.

IN THE ITAT BANGALORE BENCH ‘B’
Panchagangavali Souharda Credit Co-operative Ltd.
v.
Income-tax Officer
Keshav Dubey, Judicial Member
and Waseem Ahmed, Accountant Member
IT Appeal Nos. 2198 & 2199 (Bang) of 2024
[Assessment years 2017-18 and 2018-19]
MAY  13, 2026
Mahesh R. Uppin, Adv. for the Appellant. Subramanian, JCIT (DR) for the Respondent.
ORDER
Waseem Ahmed, Accountant Member.- These two appeals filed at the instance of the assessee for the A.Ys. 2017-18 and 2018-19 are directed against separate orders of the learned Commissioner of Income Tax Appeal (hereafter- learned CIT-A), at National Faceless Appeal Centre-NFAC, under section 250 of the Income Act, 1961 (hereafter- The Act) and were heard together.
First, we take up assessee’s appeal in ITA No. 2198/Bang/2024 for A.Y. 2017-18.
2. The first issue raised by the assessee is that the learned CIT(A) erred in confirming the disallowance of the deduction claimed under section 80P(2)(a)(i) of the Act on allegation of violation of principles of mutuality.
2.1 The facts in brief are that the assessee, a society, registered under The Karnataka Souharda Sahakari Act, 1997, claimed to be carrying on the business of banking or providing credit facilities to its members. In the return of income for the year relevant A.Y. 2017-18, the assessee declared total income at NIL after claiming deduction under section 80P(2)(a)(i) of the Act for a sum of Rs. 56,07,438/- only.
3. During the assessment, the AO observed that during the year, the assessee has 3 class of members i.e. A Class, C Class & D Class members. As per the byelaws of the society, “A” class members are permanent/regular members enjoying all the rights and privileges. On the other hand, “C & D” class members do not have voting rights, share of profit, do not hold share certificates, do not have access to books of accounts and right of participation in administration. They can only make deposits and avail the loan. The numbers of members of each class stand as under:
– A Class – 863
– C Class – 978
– D Class – 230
3.1 Based on these facts the AO alleged that the assessee has nonmembers in the form of “C & D” class members which are 1.5 time more than the regular members (A Class). Hence, the assessee is doing majority of business with the non-members and the profit from such business is being divided among the members (A Class). Therefore, the principle of mutuality in the present case is violated.
3.2 The AO also noted that the provision of cooperative society Act allows such members (C & D class) to the extent of 15% of the regular members. However, in the present case, such members are far more than the allowed limit. Hence, the AO was of the view that the assessee not only violated the principle of mutuality but also violated the provision of state Act under which it is registered. The AO was also of the view that facts of the case are covered by the ratio laid down by the Hon’ble Supreme Court in the case of Citizen Co-operative Society Ltd. v. Asstt. CIT 397 ITR 1 (SC). Accordingly, the AO proposed to disallow the deduction claimed under section 80P(2) of the Act.
3.3 In response, the assessee submitted that that it is engaged in the business of providing credit facilities to the members and its business is confined to the members only. Therefore, the ratio laid down on the case of Citizen Cooperative Society Ltd (supra) cannot be applied in its case. As such, the assessee, i.e. Citizen Cooperative Society Ltd. was dealing with general-public and carved out a sperate class of nominal members which was not allowed in the Act in which it was registered. On the contrary members under the Karnataka Cooperative Society Act includes nominal & associates members. Hence it is dealing only with members as recognized under the state Act and eligible for deduction under section 80P(2)(a)(i) of the Act on the profit and gains derived from the business of providing credit facility to the members. The assessee to support its argument placed reliance on the judgment of Hon’ble Karnataka High Court in the case of CIT v. Sri Biluru Gurubasava Pattina Sahakari Sangha Niyamitha Bagalkot [2015] [2014] 369 ITR 86 (Karnataka) and also placed reliance on the judgment of Hon’ble Madras High Court in the case of CIT v. S-1308 Ammapet Primary Agricultural Co-operative Bank Ltd. 392 ITR 55 (Madras).
3.4 However, the AO rejected the argument advanced by the assessee. The AO held that fact of the case of the assessee are identical to the facts involved in the case of the assessee i.e. Citizen Cooperative Society Ltd. (supra) During the year, the assessee was also catering 3 types of members viz “A, C & D” Class. The C & D class member are only allowed to make deposits and avail loans without participating in the profit and other function of the society like A class members. Hence, the business carried out with those members is like financing business and not the business in the nature of cooperative principle. Therefore, there is clear violation of principle of mutuality. According to the AO, in a cooperative society, there must be complete identity between the contributors and participators. The members who contribute to the common fund must also be entitled to participate in the surplus and affairs of the society. In the present case, the AO found that the assessee accepted deposits from nominal members and advanced loans to them for earning maximum returns, but such nominal members were not given equal rights in the society. Therefore, the AO held that the assessee was not functioning on the principle of mutuality, which is the basic foundation of a co-operative movement.
3.5 The AO held that as per section 18 of the Karnataka Co-operative Societies Act, 1959, as amended w.e.f. 06.09.2014, nominal members should not exceed 15% of the regular members. However, in the assessee’s case, the nominal members were more than 15% of the regular members. The AO further observed that the assessee had not produced any permission allowing it to deal with persons who did not hold shares or who could not participate in the affairs of the society. Therefore, the AO held that the assessee was dealing with people other than regular share-holding members and, hence, was not entitled to deduction u/s 80P(2)(a)(i) of the Act.
3.6 The AO also rejected the assessee’s argument that the judgment of the Hon’ble Supreme Court in Citizen Co-operative Society Ltd (supra) was not applicable because that case related to a multi-state cooperative society registered under the Mutually Aided Co-operative Societies Act, whereas the assessee was registered under the Karnataka Co-operative Societies Act, 1959. According to the AO, the question was not merely under which law the society was registered. The real test was whether the assessee had maintained the principle of mutuality and whether it was carrying on its activity only with its members in true sense. Since the assessee had carried on business with nominal members who did not have equal rights, the AO held that the ratio of the Hon’ble Supreme Court is squarely applied.
3.7 The AO further relied upon the decision in the case of Athmashakthi Multipurpose Co-operative Society Ltd. v. ITO [IT Appeal Nos. 1220 & 1221 (Bang) of 2019, dated 18-10-2019], wherein the Tribunal had upheld similar disallowance.
3.8 In view of the above facts, the AO held that the assessee was not entitled to deduction u/s 80P(2)(a)(i) of the Act. The AO concluded that the assessee was not providing credit facilities only to its regular members but was substantially dealing with associate or nominal members who did not have equal rights and were not members in the real sense. Hence the principle of mutuality was missing, and the assessee’s case was covered by the judgment of the Hon’ble Supreme Court in Citizen Co-operative Society Ltd. (supra) Accordingly, the AO disallowed the entire deduction claimed u/s 80P of the Act.
4. The aggrieved assessee preferred appeal before the learned CIT(A) who confirmed the view taken by the AO by placing reliance on the decision of Tribunal in the case of Atmashakthi Multipurpose Cooperative Society Ltd. (supra)
5. Being aggrieved by the order of the learned CIT(A), the assessee is in appeal before us.
6. The learned AR before us submitted that the assessee is a cooperative society registered under the Karnataka Souharda Sahakari Act, 1997 and engaged in providing credit facilities only to its members. It was contended that A-Class, C-Class and D-Class members are recognized members under the State Act and, therefore, transactions with them cannot be treated as dealings with non-members. The learned AR submitted that the AO wrongly applied the decision in Citizen Cooperative Society Ltd. without appreciating the judgment of the Hon’ble Supreme Court in Mavilayi Service Co-operative Bank Ltd. v. CIT 431 ITR 1 (SC). It was further submitted that associate members were within the permissible limit prescribed under the State law.
7. On the other hand, the learned DR supported the orders of the lower authorities and submitted that the assessee was carrying on substantial business with C-Class and D-Class members who did not enjoy equal rights with regular members. It was contended that such members had no voting rights, no participation in management and no right to share profits and, therefore, could not be treated as members in the real sense. The learned DR further submitted that the assessee violated the provisions of the State Co-operative law by admitting excessive nominal or associate members. Accordingly, the deduction claimed u/s 80P(2)(a)(i) was rightly denied by the AO.
8. We have heard the rival contentions of both the parties and perused the materials available on record. The assessee is a co-operative society registered under the Karnataka Souharda Sahakari Act, 1997 and is engaged in the activity of providing credit facilities to the members. For the year under consideration, the assessee claimed deduction u/s 80P(2)(a)(i) of the Act. The AO disallowed the claim mainly on the ground that the assessee had different classes of members, namely A-Class, C-Class and D-Class members, and that C-Class and D-Class members did not have voting rights, right to share profits, right to participate in administration, right to receive share certificates or right to access the audit report and accounts. The AO, therefore, held that such members were not members in the real sense and that the principle of mutuality was violated. The Ld. CIT(A) confirmed the said view by relying upon the decision of this Tribunal in the case of M/s Atmashakthi Multipurpose Co-operative Society Ltd., Mangalore. The basic facts and the reasoning of the lower authorities are recorded in the appeal file placed before us.
8.1 The limited question for our consideration is whether the deduction u/s 80P(2)(a)(i) of the Act can be denied in full merely because the assessee had nominal or associate members, and whether the ratio of the Hon’ble Supreme Court in the case of Citizen Cooperative Society Ltd. (supra) would automatically apply to the facts of the present case.
8.2 The provision of section 80P(2)(a)(i) of the Act grants deduction to a co-operative society engaged in carrying on the business of banking or providing credit facilities to its members. The expression “members” is not defined under the Income-tax Act. Therefore, for deciding who is a member of a co-operative society, one has to look into the State Act under which the society is registered. This legal position is now settled by the Hon’ble Supreme Court in the case of Mavilayi Service Co-operative Bank Ltd. (supra). In that judgment, the Hon’ble Supreme Court has clearly held that when the Income-tax Act does not define the word “member”, the meaning of the word has to be taken from the concerned co-operative law under which the society is registered. The Hon’ble Supreme Court also explained and distinguished its earlier decision in Citizen Co-operative Society Ltd. and held that the said decision cannot be applied mechanically to every case where the society has nominal members.
8.3 In the present case, the assessee is registered under the Karnataka Souharda Sahakari Act / Karnataka co-operative law. State law recognizes nominal and associate members as members of society. Once the State Act recognizes such people as members, the Income-Tax Authorities cannot treat them as complete strangers or general public only because they do not have all rights equal to regular members. The Act itself does not require that every member must have identical rights in the society. Section 80P(2)(a)(i) of the Act only requires that the business of banking or providing credit facilities should be carried on with members. It does not say that such members must have voting rights, right to participate in management, or right to share profits. Therefore, the reasoning of the AO that absence of equal rights by itself destroys the status of such persons as members cannot be accepted in the light of the judgment of the Hon’ble Supreme Court in Mavilayi Service Co-operative Bank Ltd. (supra)
8.4 We also find that the AO proceeded mainly on the basis that C-Class and D-Class members were not members in the real sense and, therefore, the assessee was carrying on finance business with nonmembers. This approach is not sustainable. If the State Act permits admission of nominal or associate members, and if the assessee has dealt with such persons in their capacity as members recognized under the State Act, then such activity cannot be treated as dealing with general public merely because such members have restricted rights. The question is not whether all categories of members have equal rights. The question is whether such persons are members under the governing cooperative law. Once the answer is in favour of the assessee, the deduction u/s 80P(2)(a)(i) of the Act cannot be denied in full on this ground alone.
8.5 We further note that the lower authorities placed reliance on the decision in the case of M/s Atmashakthi Multipurpose Co-operative Society Ltd., Mangalore. On perusal of the said decision, it is seen that the factual context of that case was different. In that case, the Tribunal found that the assessee had admitted associate members after the amendment brought in section 18 of the Karnataka Co-operative Societies Act, restricting the number of associate members to 15% of regular members. In that factual background, the Tribunal held that the assessee had violated the provisions of the State Act and, therefore, was not eligible for deduction u/s 80P(2) of the Act in the light of the judgment in Citizen Co-operative Society Ltd. (supra)
8.6 In the present case, however, no clear finding has been recorded by the AO or by the Ld. CIT(A) that the assessee admitted associate or nominal members in excess of the prescribed 15% limit after the amendment in section 18 of the Karnataka co-operative law. This distinction is material. If the assessee had existing nominal or associate members prior to the amendment, and if the amendment did not prescribe any clear procedure for removing such existing members, then the assessee cannot be visited with the extreme consequence of denial of the entire deduction u/s 80P of the Act without examining this aspect. The lower authorities have only proceeded on the numerical comparison between regular members and nominal or associate members. They have not examined when such members were admitted, whether they were existing members prior to the amendment, whether there was any fresh admission beyond the prescribed limit after the amendment, and whether the State co-operative authority had treated the assessee as having violated the State Act.
8.7 In our considered view, the decision in Citizen Co-operative Society Ltd. cannot be applied in a mechanical manner. That decision was rendered on its own peculiar facts, where the assessee was found to have carved out a category of nominal members and carried on finance business in violation of the co-operative law applicable to it. The subsequent judgment of the Hon’ble Supreme Court in Mavilayi Service Co-operative Bank Ltd. (supra) has clarified that the word “member” has to be understood with reference to the concerned State Act and that the ratio of Citizen Co-operative Society Ltd. cannot be expanded to deny deduction to every co-operative society having nominal members. Therefore, the blanket denial of deduction made by the AO and confirmed by the Ld. CIT(A) is not justified.
8.8 Without prejudice, even assuming that there is any violation of the prescribed limit of nominal or associate members, the entire deduction u/s 80P(2)(a)(i) of the Act cannot be disallowed. The disallowance, if any, must be restricted only to the income attributable to transactions with associate or nominal members admitted in excess of the permissible limit. The income relatable to regular members, and income relatable to nominal or associate members within the permissible limit, cannot be denied deduction. The deduction u/s 80P(2)(a)(i) of the Act is linked to profits attributable to the activity of providing credit facilities to members. Therefore, only that portion of income, if any, which is found to be attributable to persons not covered by the permissible membership framework can be excluded from deduction.
8.9 Coming to facts of the case on hand the assessee is registered under The Karnataka Souharda Sahakari Act. The Karnataka Souharda Sahakari Act places restrictions on associate members that cannot exceed 15% of total members. As such no restriction placed on number of nominal members. Furthermore, we note that assessee before the lower authorities has contended that total member of the assessee viz A, C & D class members are 2071 out which associate members i.e. D class are 230 which is well within the 15% of total members. Once it is established by the assessee that the associate members are within permissible then proportionate disallowance is also not required to be made. In view of the above detailed discussion, we hereby set aside the findings of the learned CIT(A) and direct the AO to delete the disallowances of deduction claimed under section 80P of the Act on this count. Hence, the ground of appeal of the assessee is allowed.
9. The next and last issue raised by the assessee is that ld. CIT-A wrongly disallowed the provision for interest payable on deposit for Rs. 7,36,805/- only.
10. The AO during the assessment proceedings observed that, during the audit, it was noticed that the assessee was following a hybrid system of accounting. In the profit and loss account, the assessee had made provision for interest payable on members’ deposits on accrual basis. However, the assessee was accounting for interest income on loans and advances only on cash receipt basis.
10.1 The AO noted that such a hybrid system is not permissible under the Income-tax Act, 1961. According to the AO, the assessee can follow either the cash system or the mercantile system of accounting, but it cannot follow both systems selectively for income and expenditure. The AO further observed that the assessee had claimed provision for interest for F.Y. 2016-17 at Rs. 45,27,514 and for F.Y. 2015-16 at Rs. 37,90,709. The excess provision debited came to Rs. 7,36,805 only.
10.2 The assessee explained that it was maintaining books as per the Karnataka Souharda Sahakari Act, 1997, Rules and audit guidelines issued by the Director of Co-operative Audit, Karnataka. It was submitted that as per such system, the assessee was required to provide for outstanding interest payable on members’ deposits, whereas unrealized interest on loans was not accounted for.
10.3 The AO rejected the explanation. He held that if the assessee wanted to claim interest provision on accrual basis, then it should also have accounted for interest receipts on accrual basis. Since the assessee had not done so, the AO held that the excess provision of interest of Rs. 7,36,805/- was not allowable and brought the same to tax.
11. The aggrieved assessee preferred an appeal before the learned CIT(A) without any success. Being aggrieved the assessee in appeal before us.
12. The learned AR submitted that the assessee was consistently following the accounting system prescribed under the Karnataka Souharda Sahakari Act, 1997 and the audit guidelines issued by the Director of Co-operative Audit, Karnataka. It was submitted that interest payable on members’ deposits was required to be provided on accrual basis, whereas unrealized interest on loans could not be recognized until actual receipt. The learned AR further contended that the disallowance made by the AO merely resulted in enhancement of business income derived from providing credit facilities to members and, therefore, deduction u/s 80P(2)(a)(i) of the Act ought to be allowed on such enhanced income.
13. On the other hand, the learned DR supported the orders of the lower authorities. The learned DR submitted that the assessee was admittedly following a hybrid system of accounting, which is not permissible under the provisions of the Act. It was contended that once the assessee claimed expenditure on accrual basis, corresponding income was also required to be recognized on accrual basis. Therefore, the AO was justified in disallowing the excess provision for interest. However, the learned DR relied upon the orders of the authorities below.
14. We have heard the rival contentions of both the parties and perused the materials on record. The limited grievance of the assessee is that profit of the assessee society, increased by such disallowances, whether the deduction under section 80P of the Act shall also be allowed on such increased profit. The AO has disallowed the said provision on the ground that the assessee was following a hybrid system of accounting, namely, claiming interest payable on members’ deposits on accrual basis, while recognizing income on loans on cash basis. According to the AO, such system is not permissible and, therefore, the excess provision debited to the profit and loss account was required to be added back. At the outset, we note that the assessee is a Souharda Credit Co-operative Society engaged in providing credit facilities to its members. The interest expenditure in question relates to deposits accepted from members. Therefore, even as per the reasoning of the AO, the disallowance does not arise from any independent or nonbusiness source. It is only an adjustment made to the business profit of the assessee from its activity of providing credit facilities to its members.
14.1 Once the provision for interest is disallowed, the consequence is that the business income of the assessee gets enhanced to that extent. Such enhanced income continues to retain the same character as income derived from the business of providing credit facilities to members. The disallowance does not change the nature of income. It only increases the taxable profit as computed by the AO. Therefore, if the assessee is otherwise eligible for deduction u/s 80P(2)(a)(i) of the Act in respect of its income from providing credit facilities to its members, then such deduction cannot be denied merely because the income has increased on account of disallowance of expenditure.
14.2 In our considered view, the principle is clear that where an addition or disallowance results in enhancement of eligible business profit, the deduction admissible on such eligible profit has to be allowed on the enhanced figure, unless the addition relates to an income which is outside the eligible activity. In the present case, the disallowance of provision for interest is directly connected with the members’ deposit activity of the assessee. The AO has not brought any material on record to show that the said disallowance represents income from any activity other than the business of providing credit facilities to members.
14.3 We also find that the AO has not disputed the fact that the provision was made in respect of interest payable on members’ deposits. The disallowance has been made only because, according to the AO, the assessee could not adopt one method for interest payable and another method for interest receivable. Therefore, the addition is only a computational adjustment to the profit of the eligible business. Such addition cannot be treated separately so as to deny deduction u/s 80P of the Act. Accordingly, we hold that the assessee shall be eligible for deduction u/s 80P(2)(a)(i) of the Act on the increased profit arising due to disallowance of provision for interest of Rs. 7,36,805, subject to the assessee satisfying the other conditions prescribed under the said provision. The AO is directed to recompute the deduction u/s 80P(2)(a)(i) of the Act by including the enhanced income arising from the said disallowance. This ground of the assessee is allowed.
15. In the result, the appeal of the assessee is allowed.
Coming to assessees appeal in ITA No. 2199/Bang/2024 pertaining to A. Y. 2018-19
16. The only issue raised by the assessee is that the learned CIT(A) erred in confirming the disallowances the deduction under section 80P(2)(a)(i) of the Act on allegation of violation of principle of mutuality.
17. At the outset, we note that the issue raised by the assessee in its grounds of appeal for the AY 2018-19 is identical to the issue raised by the assessee in ITA No. 2198/Bang/2024 for the assessment year 201718. Therefore, the findings given in ITA No. 2198/Bang/2024 shall also be applicable for the assessment year 2018-19. The appeal of the assessee for the A.Y. 2017-18 has been decided by us vide paragraph No. 8 of this order in favour of the assessee. The learned AR and the DR also agreed that whatever the findings are for the assessment year 2017-18 shall also be applied for the assessment year 2018-19. Hence, the ground of appeal filed by the assessee is hereby allowed.
18. In the result, the appeal of the assessee is allowed.
19. In the combined result, both the appeals of the assessee are allowed.