Kerala High Court Upholds Proviso to Section 194A(3) of Income Tax Act in Challenge by Cooperative Societies

Introduction

The Kerala High Court, in a consolidated judgment delivered by Justice N. Nagaresh, dismissed multiple writ petitions filed by various Primary Agricultural Credit Societies challenging the constitutional validity of the proviso to Section 194A(3) of the Income Tax Act, 1961 . The proviso, introduced via the Finance Act, 2020, mandates Tax Deducted at Source (TDS) on interest payments if a cooperative society's total sales, gross receipts, or turnover exceeds Rs 50 crores in the preceding financial year. The court ruled that this provision does not violate Article 14 of the Constitution, as it creates a reasonable classification and aligns with the structure of tax legislation. The petitioners, including Vellangallur Peoples Welfare Co-operative Society Ltd and others, argued it imposed undue burdens on their operations, while the Union of India defended it as a measure to prevent tax evasion.

Case Background

The petitioners are numerous Primary Agricultural Credit Societies registered under the Kerala Co-operative Societies Act, 1969 , primarily engaged in providing financial assistance to members for agricultural purposes. These societies, totaling over 100 in the consolidated cases (WP(C) Nos. 7053/2023 and others from 2021-2024), historically enjoyed exemptions from TDS on interest income or payments under clauses (v) and (viia) of Section 194A(3) of the Income Tax Act. This exempted interest credited or paid by a cooperative society (other than a bank) to its members or another society, and interest on deposits with primary credit societies.

The dispute arose from the 2020 amendment adding a proviso that withdraws this exemption for societies with turnover exceeding Rs 50 crores, subjecting such interest payments to TDS if they surpass specified thresholds (Rs 50,000 generally, Rs 1 lakh for senior citizens). The societies contended this disrupted their operations, as they are required under Section 57 of the Kerala Co-operative Societies Act to deposit surplus funds with the Kerala State Co-operative Bank (an apex body with turnover far exceeding Rs 50 crores), leading to TDS on incoming interest despite exemptions under Section 80P(2)(d) for such income. Additionally, it deterred member deposits, as interest payments to members would attract TDS for larger societies.

The writ petitions, filed between 2021 and 2024, sought to declare the proviso ultra vires the Constitution, primarily under Article 14 for unreasonable classification. Interim orders stayed TDS deductions during pendency, and the court addressed practical issues post-judgment.

Arguments Presented

The petitioners, represented by senior counsel including Sri. A. Kumar and others, argued that the proviso violated Article 14 by creating an arbitrary classification among similarly situated cooperative societies based on turnover, without intelligible differentia or rational nexus to the object of TDS. They highlighted that Section 80P(2)(d) fully exempts interest income from investments in other cooperatives, rendering TDS on non-taxable income illogical and burdensome. For instance, mandatory deposits with the Kerala Bank (turnover > Rs 50 crores) would trigger TDS on all incoming interest, nullifying the exemption. They also claimed it harmed business by pushing members to smaller societies, affecting rural economies, and exceeded the proviso's scope by altering the main provision's intent.

The respondents, including the Union of India via Standing Counsel Sri. Christopher Abraham, countered that the proviso was within legislative competence to curb tax evasion by ensuring advance collection via TDS, with refunds available upon filing returns under Section 80AC . They clarified Section 80P offers deductions, not absolute exemptions, contingent on compliance like timely returns, so TDS applies to income chargeable under Section 4. The classification was reasonable, mirroring the Income Tax Act's income-based slabs, and not manifestly arbitrary. The Kerala government, through Special Government Pleader Sri. Mohammed Rafiq, partially supported petitioners by arguing the proviso overreached the main section's exemption for payees.

Legal Analysis

Justice N. Nagaresh analyzed the challenge under established principles from precedents like Union of India v. Elphinstone Spinning and Weaving Co. ( AIR 2001 SC 724 ), emphasizing judicial restraint in economic legislation and a presumption of constitutionality unless violation is clear beyond doubt. The court distinguished Commissioner of Income Tax v. Eli Lilly and Company (India) Pvt. Ltd. ( (2009) 15 SCC 1 ), noting Section 80P provides deductions, not exemptions from chargeability under Section 4, as benefits require return filing under Section 80AC —thus, TDS ensures collection without creating new liability.

On Article 14, the court upheld the turnover threshold as reasonable, aligning with the Act's progressive taxation structure where higher income incurs higher burdens ( K.T. Moopil Nair v. State of Kerala , AIR 1961 SC 552 ). It rejected claims of unreasonableness, citing R.K. Garg v. Union of India ((1981) 4 SCC 675) for latitude in economic laws, and Murthy Match Works v. CCE ((1974) 4 SCC 428) affirming classifications with nexus to objectives like revenue collection.

Regarding the proviso's scope, drawing from S. Sundaram Pillai v. V.R. Pattabhiraman ((1985) 1 SCC 591), the court held provisos can be substantive provisions altering main enactments if legislatively intended, as here via the 2020 amendment to restrict exemptions for larger entities prone to higher transactions. Hardships from state laws (e.g., deposit mandates) were irrelevant to federal tax validity ( Ajmera Housing Corporation v. CIT , (2010) 326 ITR 642 (SC)). The societies did not qualify under Section 194A(3)(iii)(a) as they were not engaged in banking per the Banking Regulation Act, 1949.

Precedents like Shayara Bano v. Union of India ((2017) 9 SCC 1) on manifest arbitrariness were distinguished, as no such vice was found; Mavilayi Service Co-operative Bank Ltd. v. CIT ( 2021 (1) KHC 303 ) affirmed Section 80P but did not bar TDS mechanisms.

Key Observations

• "As far as the tax liability on income from interest is concerned, for a Co-operative society, it is not an absolute exemption, but it is a deduction permissible for such a Society, on submitting the returns." (Para 17, distinguishing exemptions from deductions under Section 80P.)
• "The classification based on the total income or the taxable income, forms the basic structure of the Income Tax Act. Since the very concept involved is, 'the liability is higher when the income is higher', fixing a criterion in similar lines, in the matter of TDS, cannot be found fault with." (Para 18, on reasonableness under Article 14.)
• "A proviso may serve four different purposes: (1) qualifying or excepting certain provisions from the main enactment; (2) it may entirely change the very concept of the intendment of the enactment...; (3) it may be so embedded... as to become an integral part...; and (4) it may be used merely to act as an optional addenda." (Para 25, quoting S. Sundaram Pillai v. V.R. Pattabhiraman .)
• "Even if a statutory provision causes hardship to some people, it is not for the court to amend the law." (Para 33, on judicial non-interference despite practical difficulties.)
• "The proviso... was subsequently introduced... bringing in, some conditions restricting the operation of the main provision. Thus, it is evident that it was intended to alter the scope of the main provision." (Para 28, validating the proviso's substantive effect.)

Court's Decision

The Kerala High Court dismissed all writ petitions on October 25, 2024 (judgment dated as such in text), holding the proviso to Section 194A(3) constitutionally valid and not violative of Article 14 or other fundamental rights. No interference was warranted due to lack of unreasonableness, arbitrariness, or overreach in the proviso's form.

However, recognizing practical difficulties from interim stays on TDS (operative since filing), the court made these orders absolute for transactions up to the judgment date, shielding petitioners from retrospective adverse actions like penalties or reassessments for non-deduction during pendency. This protects past compliance but mandates future TDS for qualifying societies.

The decision reinforces legislative flexibility in tax administration, potentially increasing compliance burdens for larger cooperatives while enabling refunds for exempt income. It may influence similar challenges to turnover-based thresholds in tax laws, emphasizing that economic policies warrant deference unless fundamentally flawed, and could prompt larger societies to streamline return filings for deductions under Section 80P.