DOCTRINE OF MUTUALITY

[Mr. M. GOVINDARAJAN]

              The principle of mutuality postulates that all the contributors to the common fund must be entitled to participate in the surplus and that all the participators in the surplus are contributors to the common fund.   It is in this sense that the law postulates that there must be a complete identity between the contributors and the participators.   The essence of the doctrine of mutuality lies in the principle that what is return is what is contributed by a member.   A person cannot trade with himself.   It is on the hypothesis that the income which falls within the purview of the doctrine of mutuality is exempt from taxation.

              In 'Sports Club of Gujarat Limited V. Commissioner of Income Tax' - 2009 -TMI - 77939 - (GUJRAT HIGH COURT) the High Court held that one of the essential requirements of mutuality is that the contributors to the common fund are entitled to participate in the surplus thereby creating an identity between participators and the contributors.   Once such identity is established the surplus income would not be exigible to the tax on the principle that no man can make a profit out of himself.

 In 'Wholesale Society Limited V. Commissioner of Agricultural I.T.' (1948) 16 ITR 270 (PC) the Supreme Court adopted the following principles as establishing mutuality:

 The identity of the contributors to the fund and the recipients from the fund;

 The treatment of the company, though incorporated as a mere entity for the convenience of the members and policyholders, in other words, as an instrument obedient to their mandate; and

 The impossibility that contributors should derive profits from contributions made by them to a fund which could only be expended or returned to themselves.

          In 'Commissioner of Income Tax V. Bankipur Club Limited' - 1997 -TMI - 5595 - (SUPREME Court) the Supreme Court considered as to whether a surplus of receipts over expenditure generated from the facilities extended by a club to its members were exempt on the ground of mutuality.   The Supreme Court reiterated the principle that in the case of a mutual society, there must be a complete identity between the class of contributors and of participators.

         In 'Commissioner of Income Tax V. I.T.I. Employees Death and Superannuation Relief Fund' - (1998 -TMI - 16675 - KARNATAKA High Court) a fund was created by the employees of the Indian Telephone Industries and interest was generated by making deposits by investment in a bank.   The Court noted that the ingredients of mutuality were missing since apart from the contributions made by the members, there were other sources of funding for the trust fund.  The Court is of the view that income was earned by making deposits by way of investment in the bank and that was a case where the assessee had invested surplus funds and earned interest on these deposits.   The High Court further held that the principle of mutuality could be confined to the surplus which has accrued to the club out of the contributions received from the members but this principle would have no application to the surplus received from non members.   The tax was sought tobe levied not on the surplus arising from the contributions made by the members or from interest earned on the moneys contributed by the members.   On the other hand, the deposits in banks were made for earning interest by way of income.   The principle that no person could trade with himself would not arise as moneys were invested by the assessee with the bank to earn income, to enable the assessee to discharge its obligations.   Consequently, the income earned from an outside agency by way of interest would not be covered by the principle of mutuality.

          In 'Commissioner of Income Tax V. Bangalore Club' - 2006 -TMI - 9974 - (KARNATAKA High Court) the assessee was a club which was registered under the Societies Registration Act and its members included four scheduled banks.  The surplus which was generated during the course of assessment year1989-90 was held in fixed deposits with the four banks and the interest that was generated thereon was claimed not to be exigible to tax on the principle of mutuality.   The Court held that what had been done by the club is similar to what could have been done by a customer of a bank.   The principle that no man trade with himself would not be applicable where the deposit was held by a nationalized bank with its customers since the prevailing relationship was that of a banker with its customer.

           In 'Canara bank Golden Jubilee Staff Welfare Fund V. Deputy Commissioner of Income Tax' - (2008 -TMI - 32175 - KARNATAKA HIGH COURT) the assessee was a registered society comprising of the employees of the Canara Bank, and was established with the object of promoting welfare amongst the members who contributed towards the corpus fund.   The Assessing Officer taxed the interest income on investments and dividend income on shares.   The appeals of the assessee were dismissed by the Commissioner and by the Tribunal.   The question before the High Court was whether the principle of mutuality would apply.   The Karnataka High Court noted that during the assessment years in question the source of funds was exclusively the members and no outsiders had contributed.   The High Court was of the view that it was the contribution of the members which had formed the corpus of the fund.   A portion of the fund which was not advanced to the members was invested.   The High Court noted that the investment was 'as a precaution for the purpose of keeping it in safe custody and not with an intention to drive a profit by way of interest".

           In 'Amar Singh Club V. Union of India' - (2008 -TMI - 78713 - Jammu and Kashmir High court) the High Court of Jammu and Kashmir held that interest received on fixed deposits and bank deposits would not be covered by the principle of mutuality.   The High Court observed that there was no statutory obligation on the part of the assessee to make such deposits.  The principle of mutuality could be applied only if interest was earned for advances/facilities of loan given to the members of the club.

           In 'Commissioner of Income Tax V. Standing Conference of Public Enterprises (Scope)' - 2009 -TMI - 34946 - (DELHI HIGH COURT) the parties agreed before the High Court that the issue as to whether receipts on account of interest earned from surplus funds deposited with the banks would be taxable would follow by the application of the principle of mutuality.   The Delhi High Court was of the view that simply because some incidental activity of the assessee is revenue generating that does not give any justification to hold that it is tainted with commerciality and reaches the point where a relationship of mutually ends and that of trading begins.

          In 'Commissioner of Income Tax V. Madras Race Club' - 1975 -TMI - 39239 - (MADRAS High Court) the Court noted that the application of the principle of mutuality is not destroyed by the presence of the transactions which are non mutuality in character.   However in such a case, the principle of mutuality has to be confined to transactions with members possessing the essential character of mutuality.   The two activities can in appropriate cases be separated and the profits derived from transactions which do not fulfill the requirements of mutuality can be brought to tax.