PRINCIPLES OF MUTUALITY

A JUDICIAL ANALYSIS

 

Pravin Saraswat,  FCA, CS, DISA

 

Can a man trade with himself and earn profits ? If he can, are such profits liable to tax under the Income-tax Act ? The answer is, apparently, in the negative though the Income-tax Act does not contain any specific exemption for the profits and gains of a mutual concern. However, profits and gains of a trading association earning income by rendering specific services to its members, or of  a mutual insurance society, or of a co-operative society are liable to tax under the Act. What, then, what are the ingredients of the concept of mutuality? In this article, the author goes through the basic case law and underlines those principles which serve, at the same time, as a charter of rights as well as a warning for the various types of mutual organization.

 

No man  can trade with himself; he cannot  make, in what is its true sense or meaning, taxable profit by dealing with himself" – (As per Palles, C.B. in Dublin Corpn. v. M. Adam 2 T.C. 387 at p. 397;) 

 

The Principle of  Mutuality which has its genesis from the  above statement,  is beneficially utilised by mutual concerns like members' clubs, co-operative societies, mutual benefit funds or chit funds, etc., where the persons form the concern or the association for the benefit or advancement of certain mutual activities. Such  organizations where the objectives are not of `General Public Utility’ and therefore their incomes are not eligible for exemption u/s 11  of the Income Tax Act, 1961 as the benefits are available to only a `Class of Public’ instead of `General Public’ take the shelter of  ‘Principle of  Mutuality’.  Thus, in case the receipts of such a mutual association exceed the expenses, then, on the footing of the 'principle of mutuality',  such  surplus  is to be regarded as devoid of revenue quality, hence, not taxable under the Act.  

 

The `Principle of Mutuality’  which  was borrowed from  the   `English Decisions’ has further been refined  over the years with the various decisions  pronounced by  Supreme Court and High Courts.  Still  the application of this principle in a fact-situation should be very cautious and as per the  ratios emanating from the various decision.

 

So far as the recognition of the 'Principle of  Mutuality' under the Income Tax Act, 1961  is concerned,  the `Act’ has following indirect references to this principle:

 

a)       Section 2(24)(vii)  states:

 

               “income” includes “the profits and gains of any business of insurance carried on

               by a mutual insurance company”

 

b)      Section 28(iii)  states:

 

    The following income shall be chargeable to income-tax under the head    

     `Profits   and gains of business or profession’:

 

     “ income derived by a trade, professional or similar association from specific

                  services  performed for its members”

 

      c)     Circular no. 11/2008, dated 19-12-2008  states:

 

“Therefore, where industry or trade associations claim both to be charitable institutions as well as mutual organizations and their activities are restricted to contributions from and participation of only their members, these would not fall under the purview of the proviso to section 2(15) owing to the principle of mutuality.”

 

The whole  structure of  the  `Principle of Mutuality’   rests upon  three pillars which have been discussed  in the light of   judicial interpretation from time to time:

 

a)         Is there any commerciality involved ?

 

Commissioner of Income-tax v. Royal Western India Turf Club Ltd. [1953] 24 ITR 551 (SC):

 

In the earliest case of Royal Western India Turf Club, the Supreme Court adopted a very strict approach in applying the principle of mutuality. In that case, the assessee, which was an incorporated company, carried on the business of race course and dealt with non-members as well in the ordinary course of business carried on with a view to earning profit as in any other concern. It gave to its members the same or similar amenities as it gave to non-members. On these facts, the Supreme Court held that the facilities were given to members and non-members alike for a price   and therefore items of receipts from the members also, were to be taken into account in computing the total income of the company.

 

Commissioner of Income-tax v. Bankipur Club Ltd. [1997] 092 TAXMAN 278 (SC):

 

SC  while upholding  the judgments in  Royal Western and  Kumbakonam further elaborated the `Principle of Mutuality’  in more clear words.  

 

It necessarily follows that the receipts for the various facilities extended by the clubs to its members, as stated hereinabove, as part of the usual privileges, advantages and conveniences, attached to the membership of the club, cannot be said to be 'a trading activity'. The surplus - excess of receipts over the expenditure - as a result of mutual arrangement cannot be said to be 'income' for the purpose of the Act. Supreme Court also favoured  the  exemption to the assessee mutual clubs  for the receipts or surplus arising from the sales of drinks, refreshments, etc., or amounts received by way of rent for letting out the buildings or amounts received by way of admission fees, periodical subscriptions and receipts of similar nature, from its members.

 

Chelmsford Club v. Commissioner of Income-tax [2000] 109 TAXMAN 215 (SC) 

 

A perusal of section 2(24) shows that the Act recognises the principle of mutuality and has excluded all businesses involving such principle from the purview of the Act, except those mentioned in clause (vii) of that  section. It is also an admitted fact that the business of the appellant does not come within the scope of the business referred to in section 2(24)(vii). This Court in the case of Royal Western India Turf Club Ltd. (supra), on facts, came to the conclusion that the club in that case had kept open its business not only to its members but also to outsiders who would participate in the  club’s  business on payment of which income from the outsiders would go to the same kitty as that of the members, consequently, the identity between the contributors and the recipients was lost. Therefore, this Court held that the doctrine of mutuality did not apply in the case of Royal Western India Turf Club Ltd. (supra), otherwise this Court in that judgment had accepted that, in regard to the businesses governed by the doctrine of mutuality, the levy of tax under the Act did not arise.”

 

For the reasons stated above,  this court is  of the view that the business of the appellant is governed by the principle of mutuality, even the deemed income from its property is governed by the said principle of mutuality. Therefore, these appeals have to succeed

 

 

CIT v. Standing Conference of Public Enterprises (DELHI-2009) ITA No. 1409 of 2008

Simply because some incidental activity of the assessee is revenue generating, does not provide any justification to hold that it is tainted with “commercially” and reaches a point where relationship of mutuality ends and that of trading begins.

 

b)    What would constitute complete identity between the contributor and the  

        participator  ?

 

The cardinal requirement is that all the contributors to the common fund must be entitled to participate in the surplus and that all the participators in the surplus must be contributors to the common fund; in other words, there must be complete identity between the contributors and the participators' observed Lord Macmillan in the case of Municipal Mutual Insurance Ltd. v. Hills [1932] 16 TC 430 at p. 448 (HL).

 

CIT v. Kumbakonam Mutual Benefit Fund Ltd. [1964] 53 ITR 241(SC)

 

A company limited by shares carried on banking business which was restricted to its shareholders. However, a shareholder, who had neither contributed by way of recurring deposit nor had taken any  loan from the company, was entitled to participate in the profits as and when the dividend was declared.   The Supreme Court laid down that in the absence of complete identity between the contributors and the participators,  the benefit of mutuality was not available.

 

Commissioner of Income-tax v. Nataraj Finance Corporation [1987] 35 TAXMAN 280 (AP)

 

The question still remained whether the association satisfied its mutuality in the sense that all the participators to the common fund were also contributors and their identity was established. There was nothing on record to show that the assessee had been carrying on the business activity of lending moneys to any persons other than its 19 members(partners). The two other persons referred to, from whom interest was received, were not really persons to whom moneys were advanced. One person was a former partner who was paying interest on the moneys owed by him at the time of his retirement, and the other person was a bank with whom moneys were kept in safe deposit. It was not possible to say that any business transactions were carried on by the assessee with the former partner and the bank. Therefore, the assessee's claim that it confined its money-lending activity only to its members and to no outsiders, had to be accepted. If that be so, it followed automatically that the interest received by the assessee was distributed amongst the members forming the association and, thus, the principle of mutuality governed the case. Accordingly, the order of the Tribunal was to be upheld.

 

 

 

Commissioner of Income-tax v. I.T.I. Employees Death & Superannuation Relief und [1998] 101 TAXMAN 315 (KAR.) 

 

 

In this case,  relying on the SC  judgment in  Kumbakonam Mutual Benefit Fund Ltd., held: 

 

“Apart from the contributions made by the members, there are other sources of funding of the trust fund. The trust fund can be augmented by contribution made by the I.T.I. Management; donations; interest or other income accrued or earned from the said funds or any investment thereof and investment made from out of the funds.  In the case on hand, the tax sought to be levied is not on the surplus from out of the contribution made by the members or from the interest earned on the money advanced to its members. The deposits in the banks were made for earning interest by way of income. The principle that no person can trade with himself does not arise in this case as the monies had been invested by the assessee with the bank to earn income to enable the assessee to discharge its obligations created under the trust. It is clear that income earned from outside agency on interest or securities from the bank would not be covered on the principles of mutuality for claiming exemption from tax and, therefore, it could not be excluded from the arena of taxation.”

 

 

Yum! Restaurants (Marketing) (P.) Ltd. v. Commissioner of Income-tax  [2009] 180 TAXMAN 27 (DELHI)

 

Assessee-company was a wholly owned subsidiary company of  YRIPL   which was engaged in developing and managing franchisees for running restaurants. It was set up to carry out and economise cost of advertising and promotion by catering to specific needs of franchisees of YRIPL in order to enable them to concentrate on restaurant operations and management. Assessee-company filed its return declaring nil income on ground that it was a non-profit organization governed by principles of mutuality

 

HC upheld decision of  Tribunal and Commissioner (Appeals) noting fact that assessee-company had not only received contributions from various franchisees but also from  `P’   Ltd. and YRIPL who were neither franchisees nor beneficiaries, and, therefore, essential requirements of a mutual concern were missing

 

Commissioner of Income-tax v. J.K. Organisation  [2005] 144 TAXMAN 560 (ALL.)

 

Applying the principle laid down by the Apex Court in the case of Royal Western India Turf Club Ltd. (supra) and followed in the case of Chelmsford Club (supra) to the facts of the present case, we find that the Organisation has been formed to promote and protect the interest of its members and it also provided that upon dissolution the surplus shall be distributed amongst the members of the organisation on the basis of their contribution. There is no finding that the respondent-organisation was catering to the need of any outsider. The principle laid down by the Apex Court in the aforementioned cases are fully applicable in the present case.

 

 

c)   Whether the benefit is available to the non-mutual income  ?

 

Director of Income-tax v. All India Oriental Bank of Commerce Welfare Society [2003] 130 TAXMAN 575 (DELHI):

 

 

While completing assessment of the respondent-assessee, a co-operative society comprising  of the employees of the Bank, the Assessing Officer had held that the interest income earned by the society on the contributions received from the members was not exempt on the principle of mutuality. It has been observed that what is required to be seen is whether there is a complete identity between the contributors and participators. Once the identity of the contributor to the fund of the recipients of the funds; the treatment of the company, though incorporated as a mere entity for the convenience of the members, in other words as an instruments obtained to their mandate; and the impossibility that the contributors should derive profits from contributions made by themselves to a fund which could only be expended or returned to themselves is established, the doctrine of mutuality is established.

 

 

Madras Gymkhana Club v. Deputy Commissioner of Income-tax [2009] 183 TAXMAN 333 (MAD.)

 

 

The question arose for the decision of the court was: 

 

Whether the interest income of the assessee received from its corporate members on the investments of surplus funds as Fixed Deposits or Debentures etc., is exempted from tax on the concept of Mutuality”?

 

It is held that investment of surplus fund with some of the member banks and other institutions in the form of Fixed Deposits and securities which in turn result in earning of huge surplus amounts by way of interest cannot be held to satisfy the mutuality concept. As held in the decision of the Karnataka High Court reported in (1998) 234 ITR 308 (CIT Vs. I.T.I. Employees Death and Superannuation Relief Fund) the principle of Mutuality could be confined in respect of the income earned by the club out of the contributions received by the club from its members but it will have no application in respect of the interest earned from the deposits of surplus funds in the banks by way of income.

 

 

Canara Bank Golden Jubilee Staff Welfare Fund v. Deputy Commissioner of Income-tax [2009] 308 ITR 202 (KAR.)

 

 

The Court  held that the Tribunal was not right in stating that the principle of mutuality did not apply to income of the appellants derived from interest on investments and dividend on shares and is, therefore, non-taxable income and that the decision in I. T. I. Employees Death and Superannuation Relief Fund [1998] 234 ITR 308 (Karn) is not applicable to the facts and circumstances of this case as far as the two relevant assessment years are concerned. The judgment, however, makes it clear that  the  conclusion is based on the source of funds of the assessee during the two relevant assessment years.”

 

The Karnatka High Court while delivering the “Canara Bank Golden Jubilee Staff Welfare Fund’  judgment elaborately distinguished the judgment of  . I.T.I. Employees delivered by the same court.  The principal reason of two diametrically opposite judgments was `Source of  Funds’.  While in the case of   I.T.I. Employees, the management contributed funds which were invested in bank deposits and therefore lost the  benefit of mutuality, however the in the case of `Canara Bank’,  sources of funds were from members only in last two relevant assessment years and therefore were granted the benefit of  `Principle of Mutuality’.