Whether benefit conferred on assessee by way of conversion of loan into grant by Govt for maintaining SLR so as to enable assessee to carry out banking would constitute capital receipt and hence not liable to tax - YES: ITAT

THE issue before the Bench is - Whether the benefit conferred on the assessee by way of conversion of loan into grant by the Government for maintaining Statutory Liquidity Ratio (SLR) in compliance with the requirements of RBI so as to enable the assessee bank to carry out its banking activities would constitute capital receipt and hence not liable to tax. And the verdict favours the assessee.

Facts of the case

Assessee is a Non-scheduled Cooperative Bank engaged in the business of banking. For the assessment year under consideration, assessee bank filed a return of income on 16.10.2010 declaring total income at ‘Nil’. The return was selected for scrutiny assessment whereby after making certain disallowances the total income has been determined at Rs.181,85,34,355/-. Various additions/disallowances made by the AO were carried in appeal before the CIT(A), who has allowed partial reliefs. The assessee is in appeal on the aforestated Grounds of Appeal challenging the additions sustained by the CIT(A) whereas the Revenue is in appeal challenging the reliefs allowed by the CIT(A). In this background, now we may proceed to adjudicate the captioned cross-appeals.

Assessee received a loan of Rs.110 from the Government of Maharashtra in the past years which has been converted into a non-refundablegrant during the year under consideration. The assessee treated the same as a capital receipt not chargeable to tax whereas the AO and thereafter the CIT(A) has held the same to be a revenue receipt chargeable to tax. The AO noticed that the grant was given by the Government of Maharashtra to enable the assessee-bank to recoup its negative net worth so that the assessee bank could come out of the restrictions imposed by RBI u/s 35A of the Banking Regulation Act, 1949. The stand of the AO of treating such receipt as a revenue receipt chargeable to tax has also been upheld by the CIT(A), against which assessee is in before the Tribunal.

Assessee submitted that the benefit conferred on the assessee by way of conversion of loan into grant by the Government of Maharashtra during the year was used for maintaining Statutory Liquidity Ratio (SLR) in compliance with the requirements of RBI so as to enable the assessee bank to carry out its banking activities. According to the counsel, assessee is a non-scheduled District Co-operative Bank whose services are majorly used by the farmers and small depositors in smaller towns of Maharashtra. The counsel submitted that the action of the Government of Maharashtra is a welfare step to help the farmers and small the depositors of the assessee bank and the grant has been specifically given to maintain the SLR ratio with the RBI. In sum and substance, the stand of the assessee is that the objective of the Government was to help the farmers and small depositors of Nanded, and the grant enabled assessee-bank to maintain the SLR ratio with the RBI so that assessee bank could carry out its business of banking activity. It is sought to be made out on the basis of the material furnished that the grant by Government of Maharashtra is an encumbered receipt inasmuch as the same is to be utilized only to be put in as SLR security with RBI. It was therefore contended that the aforesaid receipt was a capital receipt not chargeable to tax.

After hearing the party, the Tribunal held that,

++ in order to determine the taxability of the grant received, it is essential to appreciate the object and purpose for which the grant has been given to the assessee-bank. As a consequence of the tripartite agreement dated 28.02.2008 was also entered into between the assessee bank, Government of Maharashtra (through Principal Secretary, Co-operation and Marketing Department) and the Maharashtra State Co-operative Bank Ltd., a loan of Rs.100 crores was sanctioned by the Government of Maharashtra and the loan proceeds so received were deposited by the assessee-bank in an Escrow account maintained with Maharashtra State Co-operative Bank Ltd.. The amount was kept in fixed deposits for the purpose of maintaining SLR investments, as is evident by a communication dated 28.03.2008 addressed to the Maharashtra State Co-operative Bank Ltd. At this stage, we may also make a mention of the earlier amount of Rs.20 crores infused by the Government of Maharashtra on 28.03.2007 as share capital in the assessee bank. In this connection, on 26.09.2008, NABARD informed the Government of Maharashtra that the share capital held by the Government in the assessee bank exceeded 25% and that the same should be restricted to 25%. As a result, the Government of Maharashtra vide letter dated 01.12.2008 informed the bank that out of Rs.20 crores invested in the share capital, only Rs.10 crores should be treated as part of share capital and the balance of Rs.10 crores be taken as an interest-free deposit lying with the assessee bank;

++ by way of a decision of the Government of Maharashtra dated 10.08.2009, the sum of Rs.10 crores kept with the assessee bank as interest-free deposit and the loan of Rs.100 crores granted @ 6% per annum was converted into a grant as a measure of financial assistance. The receipt of such grant by the assessee bank from the State Government is the subject-matter of controversy here. The aforesaid decision of the Government of Maharashtra clearly brings out that the assessee bank was facing financial hardships and it was put under restrictions by the RBI in terms of section 35A of the Banking Regulation Act, 1949 whereby assessee bank was restricted from accepting deposits or making payment of deposits from the customers. The net worth of the assessee-bank was eroded and therefore the restrictions u/s 35A of the Banking Regulation Act, 1949 were imposed by the RBI. The Government of Maharashtra considered the aforesaid background and decided to provide financial assistance to the assessee bank. The financial assistance was formulated in the form of (i) converting the interest-free deposit of Rs.10 crores as Government grant of Rs.10 crores w.e.f. 26.03.2007; and, (ii) converting the Government loan of Rs.100 crores carrying interest @ 6% into a Government grant w.e.f. 14.03.2008. It is pertinent to note that the interest free deposit and the Government loan were converted into a grant with effect from respective dates of their original sanctions. Factually speaking, the financial assistance rendered by the State Government was with the object of safeguarding the interest of farmers and depositors from the district. The aforesaid object was sought to be achieved by providing financial grant to the assessee-bank, and thereby enabling the assessee-bank to comply with the RBI mandate and getting the restrictions placed by the RBI u/s 35A of the Banking Regulation Act, 1949 removed and regularizing its normal banking functions;

++ it quite clear that the objective of the Government of Maharashtra to give grant to the assessee was to protect the interests of farmers and depositors from the Nanded district. The English translation of Government decision No.DCB-1206/P.K.5666/2-S dated 10.08.2009, gives an insight to the object of the Government. In the said Government decision, it is stated that "Keeping in mind the interest of farmers and depositors from District, it is utmost important that the transactions of bank are regularized in normal manner". The aforesaid clearly shows that the object of the Government was to protect the interest of farmers and depositors from the Nanded district and for the said purpose the Government deemed it fit to provide financial assistance to the assessee-bank to enable it to regularize its functioning. Pertinently, the functioning of the bank was restrained by the RBI in the face of the restrictions imposed u/s 35A of the Banking Regulation Act, 1949. The objective and purpose of the Government was sought to be achieved by providing Rs.110 crores as a grant. The case made out by the Revenue is that the financial assistance given to the assessee-bank is for smooth running of its business and therefore it is to be regarded as a trading receipt. No doubt, the aforesaid sum has been used by the assessee for the purpose of maintain the Statutory Liquidity Ratio (SLR) as per the requirements of RBI, which enabled the assessee-bank to regularize its banking operations. So, however, the form or mechanism of subsidy is not important, as held by the Supreme Court in the case of Ponni Sugars and Chemicals Ltd. The nature of subsidy has to be determined by the object for which the subsidy is given. The underlying object of the Government was to safeguard the interest of farmers and small depositors, and this object was sought to be achieved by the mechanism of providing financial grant to the assessee-bank and regularizing its normal banking activity. In this manner, it has to be deduced that the subsidy/grant in question has not been received by the assessee-bank is the course of a trade but it is of capital nature;

++ in-fact, in a somewhat similar situation, the decision of the House of Lords in the case of Seaham Harbour Dock Co. vs. Crook (1931) 16 Tax Cases 333 (HL) is relevant. The import of the said judgement and its significance in the present fact-situation becomes aptly clear from the discussion in the judgement of the Supreme Court in the case of Ponni Sugars and Chemicals Ltd;

++ even if the grant received by the assessee bank has been used for meeting SLR requirements of RBI, which is relatable to its banking activity, yet the purpose of the payment made by the Government was to safeguard the interest of farmers and small depositors in the district Nanded. The strategy of providing financial assistance by way of the impugned grant was a mechanism devised by the Government of Maharashtra with the purpose of safeguarding the interest of farmers and depositors from the Nanded district, and the same clearly emerges from the Government decision dated 10.08.2009. Therefore, following the legal position explained by the Supreme Court in the case of Ponni Sugars and Chemicals Ltd. and having regard to the facts of the present case and keeping in mind the object and purpose of providing the impugned financial assistance to the assessee, the plea of the assessee needs to be upheld that the impugned grants received are not in the course of any trade but is of capital nature, which is not chargeable to tax. Thus, on this aspect, assessee has to succeed.