DECODING ‘THE DOCTRINE OF MUTUALITY’ CODE FOR ALTERNATIVE INVESTMENT FUNDS (‘AIF’)

[Saket Agarwal]

A. DOCTRINE OF MUTUALITY

1. MEANING AND HISTORY:

“Doctrine of Mutuality” means no person can transact with himself. There can be no sale or supply to self, i.e., to say that a man cannot trade with himself or no one can make profit out of himself.  Doctrine of mutuality has evolved as early as 18^th century by way of jurisprudence advanced in the English laws. It has constantly been a trial for the revenue in proving contrary to the doctrine and supporting the leviability of tax, whether under the income tax laws where the subject of tax is profits or under the VAT laws where the existence of supply is cross-examined.

It is significant to dwell into few of the landmark judgments of the English Courts to comprehend the basis and development of doctrine of mutuality.

In Graff v Evans (28 Feb 1882 8 QBD 373, DC), Field J and Huddleston in Queen's Bench Division held that the members of the club are the joint owners of the general property in all the goods and the trustees were agents of the members with respect to the general property in goods. Thus, the liquor supplied to the members at cost or at a profit margin of 33% did not amount to sale as the members are the owners of the property. Sale involves an element of bargain and existence of a contract except the contract of association. There was no contract between two persons as the members are the purchaser as well as the buyer the buyer.

In Trebanog Working Men’s Club and Institute Ltd v Macdonald (09 Feb 1940 [1940] 1 KB 576, DC), it was held that the club holds the liquor purchased as agent or trustee for the members of the club and the supply of the liquor to the members cannot be constituted as sale. The incorporated entities are legal entities distinct from its members, and thus they can act as the agents or trustees of the members. In the words of Lord HEWART C.J.;

“In our opinion, the decision in Graff v. Evans[13] applies to and governs the present case. Once it is conceded that a members' club does not necessarily require a licence to serve its members with intoxicating liquor, because the legal property in the liquor is not in the members themselves, it is difficult to draw any legal distinction between the various legal entities that may be entrusted with the duty of holding the property on behalf of the members, be it an individual, or a body of trustees, or a company formed for the purpose, so long as the real interest in the liquors remains, as in this case it clearly does, in the members of the club. There is no magic in this connection in the expressions “trustee” or “agent.” What is essential is that the holding of the property by the agent or trustee must be a holding for and on behalf of, and not a holding antagonistic to, the members of the club. We are dealing here with a quasi-criminal case, where the Court seeks to deal with the substance of a transaction rather than the legal form in which it may be clothed.”

In The New York Life Insurance Co v Styles (Surveyor Of Taxes) (01 Jul 1889 14 App Cas 381, HL), the members of a mutual insurance company made contributions in the form of premium towards the expected expenses which includes liabilities of insuring each other i.e. the members. The surplus, if any, arising out of difference between the contributions made by the members and the expenses or liabilities, are returned to the members in the form bonuses or by way of reduction in the future premiums or credited to the members’ account. Also, remainder if any, is carried forward as funds in the hands of the general body of the members of the company.

It was held by Lord Watson that the surplus funds returned or credited to the members of the company do not constitute trade between the company and the members, and neither such surplus can be regarded as profits. In the words of Lord Watson;

“When a number of individuals agree to contribute funds for a common purpose, such as the payment of annuities, or of capital sums, to some or all of them, on the occurrence of events certain or uncertain, and stipulate that their contributions, so far as not required for that purpose, shall be repaid to them, I cannot conceive why they should be regarded as traders, or why contributions returned to them should be regarded as profits. That consideration appears to me to dispose of the present case. In my opinion, a member of the appellant company, when he pays a premium, makes a rateable contribution to a common fund, in which he and his co-partners are jointly interested, and which is divisible among them, at the times and under the conditions specified in their policies. He pays according to an estimate of the amount which will be required for the common benefit; if his contribution proves to be insufficient he must make good the deficiency; if it exceeds what is ultimately found to be requisite, the excess is returned to him. For these reasons I have come to the conclusion that the transactions of the appellant company, in so far as these relate to participating policies, do not constitute the carrying on of a trade, within the meaning of the Income Tax Acts, and that the surplus funds returned or credited to its members are not profits.”

Jurisprudence evolved under the English law may lead us to the following conclusions:

1. Members of an association are the joint owners of the general property in the goods.

2. Associations may hold the purchased goods as agents or trustees of the members.

3. Transaction amongst the association and the members may not constitute trade or sale.

2. 46 ^TH AMENDMENT TO THE CONSTITUTION OF INDIA:

The Constitution (Forty-sixth Amendment) Act, 1982 introduced a new clause (29A) in article 366 of the Constitution of India. The new clause expanded the concept of ‘sale’ or ‘purchase’ of goods with the objective of providing legislative power to the States for the levy of tax on the transactions entailed in the said clause. Such objective would have only been achieved by way of amending the Constitution of India.

Article 366(29A) of the Constitution of India reads as follows (emphasis applied):

`(29A) "tax on the sale or purchase of goods" includes-

(a) a tax on the transfer, otherwise than in pursuance of a contract, of property in any goods for cash, deferred payment or other valuable consideration;

(b) a tax on the transfer of property in goods (whether as goods or in some other form) involved in the execution of a works contract;

(c) a tax on the delivery of goods on hire-purchase or any system of payment by instalments;

(d) a tax on the transfer of the right to use any goods for any purpose (whether or not for a specified period) for cash, deferred payment or other valuable consideration;

(e) a tax on the supply of goods by any unincorporated association or body of persons to a member thereof for cash, deferred payment or other valuable consideration;

(f) a tax on the supply, by way of or as part of any service or in any other manner whatsoever, of goods, being food or any other article for human consumption or any drink (whether or not intoxicating), where such supply or service is for cash, deferred payment or other valuable consideration,

and such transfer, delivery or supply of any goods shall be deemed to be a sale of those goods by the person making the transfer, delivery or supply and a purchase of those goods by the person to whom such transfer, delivery or supply is made;'

Sub clause (e) mobs the street for levying of tax on the supply of goods by unincorporated association or body of persons to its members for consideration. The intent behind insertion of sub clause (e) was to overcome the hurdles of doctrine of mutuality and make the way for levying of tax even if the supply of goods is with self. The question whether sub clause (e) affords power to levy tax on the supply of goods by incorporated associations also, is dealt later in this article referring to the judgment of the Honorable Supreme Court in the case of Calcutta Club Ltd.

It is imperative to advert to the Statement of Objects and Reasons appended to the Constitution (Forty-Six Amendment) Bill, 1981. In para 3, it has been asserted that the rationale behind sub clause (e) of Article 366(29A) is to avoid the scope of avoidance of tax. Further, the assertions are made in the statement of objects that the sale by registered associations having corporate status to its members is taxable in itself without any thought of doubt. Although, the tax has been escaped in case of sales by an unincorporated club or association of persons to its members as unincorporated club or association of persons has no separate existence from that of the members. Thus, it can be inferred from the reading of the Statement of Objects that, the language of sub clause (e) brings in the legislative power to levy tax on sale of goods only by an unincorporated clubs or associations to its members as it is supposed that the sale of goods by incorporated clubs or associations is leviable to tax even if there was no amendment to the Constitution or without the occurrence of Article 366(29A)(e).

Relevant portion of para 3 of the Statement of Objects and Reasons reads as follows:

“Similarly, while sale by a registered club or other association of persons (the club or association of persons having corporate status) to its members is taxable, sales by an unincorporated club or association of persons to its members is not taxable as such club or association, in law, has no separate existence from that of the members.”

The substance of article 366(29A)(e) was contemplated in the 61^st Law Commission Report which delt with certain problems connected with the powers of the States to levy tax on the sale of goods. The Law Commission report referred to the judgment of the Honorable Supreme Court in the case Young Men’s Indian Association where it was held that the members are joint owners of all the property belonging to the club and the supply of articles cannot regarded as sale. The report inter alia, conceptualized that there is absence of transfer of property and thus, there is no sale as the member takes his own goods. In conclusion, the report suggested that it would not be appropriate to amend the Constitution for the purpose of expanding the concept of sale for the purpose of granting the legislative power to the States to tax supply of goods by unincorporated clubs or associations to the members.

3. JURISPRUDENCE IN INDIA:

One of the early origins and traceability of the doctrine of mutuality under Indian Jurisprudence can be found in the case of COMMISSIONER OF INCOME-TAX, BOMBAY CITY VERSUS THE ROYAL WESTERN INDIA TURF CLUB LIMITED - 1953 (10) TMI 9 - SUPREME COURT, where the reference was made to the English case of The New York Life Insurance Co v Styles supra. The Styles case was examined and explained by the Judicial committee in ENGLISH AND SCOTTISH JOINT CO-OPERATIVE WHOLESALE SOCIETY LTD. VERSUS COMMISSIONER OF AGRICULTURAL INCOME-TAX, ASSAM - 1945 (4) TMI 16 - CALCUTTA HIGH COURT

The summary of the grounds of the decision in the Styles case is as follows, as also envisaged in the Royal Western India Turf Club Ltd supra is as follows:

1. There must be complete identity between the contributors and the participators.
2. The association must be obedient to the complete mandate of the contributors.
3. The contributors should not derive profits from the contributions made by themselves to a fund which can only be used or returned to the contributors.

The above three conditions may be considered as the base for forming a view whether the doctrine of mutuality shall stand good qua transactions between association and its members or contributors.

The three conditions were profoundly analyzed in the case of M/S. BANGALORE CLUB VERSUS COMMISSIONER OF INCOME TAX & ANR. - 2013 (1) TMI 343 - SUPREME COURT. In this case, the club was earning interest income from the fixed deposits kept with certain banks which were the corporate members of the club. The club sought an exemption from the payment of tax on the interest income earned on such fixed deposits kept with the member banks. However, the club paid tax on the interest income earned on fixed deposits kept with the non-member banks. The Hon’ble Supreme Court discussed the applicability of the three conditions as derived from the decision of Styles case to establish the mutuality qua interest income earned from the fixed deposit kept with the member banks.

The Court disconnected this transaction with all the three conditions, emphatically the third condition citing that even though the interest earned from the member bank is returned to the members, however, actually the funds are expended to the clients of the member bank who are non members of the club. In the words of the Court:

“The facts at hand also fail to satisfy the third condition of the mutuality principle i.e. the impossibility that contributors should derive profits from contributions made by themselves to a fund which could only be expended or returned to themselves. This principle requires that the funds must be returned to the contributors as well as expended solely on the contributors. True, that in the present case, the funds do return to the club. However, before that, they are expended on non members i.e. the clients of the bank. Banks generate revenue by paying a lower rate of interest to club-assessee, that makes deposits with them, and then loan out the deposited amounts at a higher rate of interest to third parties. This loaning out of funds of the club by banks to outsiders for commercial reasons, in our opinion, snaps the link of mutuality and thus, breaches the third condition.”

Another case where the three conditions to establish the existence of doctrine of mutuality was analyzed, which is YUM! RESTAURANTS (MARKETING) PRIVATE LIMITED VERSUS COMMISSIONER OF INCOME TAX, DELHI - 2020 (4) TMI 827 - SUPREME COURT.

In this case, Yum! Restaurants (Marketing) Private Limited (‘YRMPL’) was formed as a fully owned subsidiary of Yum! Restaurants (India) Private Limited (‘YRIPL’) as non profit entity under section 25 of the Companies Act, 1956 with a condition that no dividends would be repatriated to the shareholders. The sole objective of YRMPL was to conduct Advertising, Marketing and Promotion (‘AMP’) for and on behalf of YRIPL and the franchisees. For this purpose, YRMPL entered into a tripartite agreement with the franchisees and YRIPL who would make a fixed percentage of contribution to the extent of 5% of gross sales to YRMPL to conduct AMP activities related to the brand. In case of any surplus amounts arising with YRMPL, the same would be carried forwarded or refunded to the franchisees in the same proportion as the actual contribution made by each franchisee. However, the refund to be made to the franchisees shall be subject to the approval of the Board of Directors of YRMPL. In case of any deficit, the same would be carried forward to the next accounting period and would be met out of the contribution made by the franchisee during that accounting period. It was agreed between the parties that YRIPL will not be under direct obligation to fund the deficit. Further, it was also agreed between the parties that YRIPL would contribute any amount as it deems fit or contribute nothing if it decides to do so. Apart from the contributions received from the franchisees, YRMPL also received contribution from M/S Pepsi Foods Ltd. (‘Pepsi’) for the purpose of AMP.

The question before the Court was the taxability of excess of income over expenditure in the books of YRMPL. The Court based its conclusion on the pillars of three conditions or tests to establish whether the doctrine of mutuality exists between the franchisees, YRIPL and YRMPL, and thus the surplus would be taxable or not.

Deciding on the first condition of being common and completeness of identity, it was held that the first condition was not met owing to the arrangement of YRMPL with the Pepsi Foods Ltd. The Court observed that Pepsi is contributor to the fund, but it does not participate in the surplus of the fund as the surplus is meant to be for the franchisees.

Deciding on the second and third condition of obedience to mandate and non-profitability, the Court held that both the tests were not fulfilled. On the second test of obedience to mandate, the Court observed that the mandate of YRMPL was within the framework of the approval that it had obtained from the Government and the receipt of money form Pepsi clearly dissatisfies the mandate.

On the third test of non-profitability, the Court observed that YRIPL had discretion whether to contribute to the funds of YRMPL or not, and still be able to derive profits in the form of royalty from the franchisees as the direct result of the AMP activities carried out by YRMPL through the contributions received from the franchisees.

Another important ruling of the Hon’ble Supreme Court which must be understood is the case of THE JOINT COMMERCIAL TAX OFFICER, HARBOUR DIVISION II, MADRAS VERSUS YOUNG MEN´S INDIAN ASSOCIATION, MADRAS AND OTHERS   - 1970 (2) TMI 87 - SUPREME COURT which was pronounced before the 46^th amendment to the Constitution of India. In this case, the Court held that even if the clubs are distinct legal entities, they still act as agents for the members in relation to the supply of various preparations to them. No sale would be involved as the element of transferring of property is completely absent and thus, the transaction could not be subject to sales tax under the Act. Reliance was placed on the English jurisprudence in the case of Graff v. Evans supra and Trebanog Working Men’s Club and Institute Ltd supra since the principle laid down in these cases have throughout been followed. In the words of the Court:

“The final conclusion of the High Court in the judgment under appeal was that the case of each club was analogous to that of an agent or mandatory investing his own monies for preparing things for consumption of the principal, and later recouping himself for the expenses incurred. Once this conclusion on the facts relating to each club was reached, it was unnecessary for the High Court to have expressed any view with regard to the vires of the Explanations to S. 2(g) and 2(n) of the Act. As no transaction of sale was involved there could be no levy of tax under the provisions of the Act on the supply of refreshments and preparations by each one of the clubs to its members.”

Although, a significant observation was made by Justice Shah J in this case. Even if the club or association act as an agent of the members and there was no transfer of property in goods to the members, it can be said that the clubs or associations are rendering services to their members. In the words of Justice Shah J:

“It appears on the findings recorded by the High Court that the clubs or associations sought to be rendered liable in these appeals were not transferring property belonging to them but were merely acting as agents for and on behalf of the members. They were not selling goods but were rendering a service to their members.”

At this stage, before understanding one of the most significant jurisprudence under the Indian laws, it is imperious to get acquainted with the term ‘Consideration’ as defined under the Indian Contract Act, 1872 and the term ‘Person’ as defined under the General Clauses Act, 1897. Under section 2(d) of the Contract Act, the term consideration deliberates the existence of two persons who are characterized as ‘promisor’ and the ‘promisee’. The term ‘Consideration’ as defined under section 2(d) which reads as follows:

“(d) When, at the desire of the promisor, the promisee or any other person has done or abstained

from doing, or does or abstains from doing, or promises to do or to abstain from doing, something, such act or abstinence or promise is called a consideration for the promise;”

As per the definition, it is essential that the consideration must flow from promisee to the promisor which indicates the presence of two person. Naturally, the consideration can flow by one person to another as no man can transact with oneself, thus, no consideration can flow from one man to his own self.

The term ‘Person’ is defined under section 3(42) of the General Clauses Act, which reads as follows:

“(42) “person” shall include any company or association or body of individuals, whether

incorporated or not;”

Using of the word “includes” specifies the inclusive nature of the definition, which shall not only include unincorporated person such as association or body of individuals, but shall also include incorporated person such as company.

Now, having understood the definition of ‘Consideration’ under the Indian Contract Act and definition of ‘Person’ under the General Clauses Act, let us now discuss the judgment of State of STATE OF WEST BENGAL & ORS. VERSUS CALCUTTA CLUB LIMITED AND CHIEF COMMISSIONER OF CENTRAL EXCISE AND SERVICE & ORS. VERSUS M/S. RANCHI CLUB LTD. - 2019 (10) TMI 160 - SUPREME COURT, where in the moot question of whether the 46^th Amendment to the Constitution of India had done away with the doctrine of mutuality and the ruling pronounced by Hon’ble Supreme Court in Young Men’s Association supra was answered. The Court had the job of dealing with the language of article 366(29A)(e) which uses the words “any unincorporated associations or body of persons”, whether this would also cover incorporated associations.

The argument which came forward was while applying the concept of ejusdem generis, ‘unincorporated associations’ must be read with ‘body of persons’. While the revenue contended that it is important to construct the provision of the Constitution in consonance with its Statement of object which sought to achieve disabling of the doctrine of mutuality, and thus, ‘body of persons’ must include incorporated associations as well. However, the Court beautifully reached to the construction of the conclusion that the 46^th Amendment to the Constitution has not done away with the doctrine of mutuality and the case of Young Men’s Indian Association supra.

The observation of the Court which supports the conclusion is enlightened below:

1. The Statement of objects and reasons appended to the 46^th Constitution Amendment Act did not read the case of Young Men’s Indian Association supra correctly. The Statement of objects and reasons mentioning that the sale of goods by incorporated club to its members is taxable as it stood on the date of the 46^th Amendment is completely wrong. And on this incorrect basis, the 46^th Amendment sought to bring the transaction of sale of goods by unincorporated clubs to its members within the tax. 61^st Law Commission report clearly mentioned that there cannot be any evasion of tax as the member of the club really takes its own goods.
2. Clause (e) of Article 366(29A) uses the term, ‘body of persons’ which would not refer to the incorporated form unless it had used the word ‘person’ accompanied by the phrase ‘whether incorporated or not’.
3. Clause (e) of Article 366(29A) uses the term ‘valuable consideration’. Consideration, as defined above evidently insists the presence of two person. The term ‘valuable consideration’ has been deliberated in Pollock and Mulla, taken from an English case Currie v. Misa which requires reciprocity between the two person.

In the above case, the Court also dealt with the appeal filed by revenue challenging the Writ Petitions allowed by Gujarat and Jharkhand High Court pertaining to the leviability of services tax in relation to clubs or associations. The contention of the revenue was that services tax was also levied on services provided by member clubs in the incorporated form to its members during the period starting from the year 2005, when for the first time, services provided by clubs or associations were introduced, till the year 2012 when the service tax regime was changed towards negative list approach.

Both the High Courts followed the judgment of Young Men’s Indian Association supra, and held that whether it is sale or services, the existence of two parties is must. In case of services by club or associations to its members, the foundation of existence of two legal entities is missing. Gujarat High Court also held that the sections 65(25a) and 65(105)(zze) are ultra vires to the extent these provisions purports to levy services tax in respect of services provided by club to its members.

The definition of club or association was defined under section 65(25a) of the Finance Act, 1994 w.e.f. 16^th June, 2005, which reads as follows:

“club or association means any person or body of persons providing services, facilities or advantages, (primarily to its members*) for a subscription or any other amount, to its members, but does not include –

1. anybody established or constituted by or under any law for the time being in force, or

-----------------------

*added w.e.f. 1^st May, 2011"

Taxable services by clubs or associations was defined under section 65(105)(zze) of the Finance Act, 1994, which reads as follows:

“Taxable service means any service provided –

(zze) to its members (or any other person*) by any club or association in relation to provision of services, facilities or advantages for a subscription or any other amount.

*added w.e.f. 1^st May, 2011”

B. RETROSPECTIVE AMENDMENT IN SECTION 7 OF THE CENTRAL GOODS AND SERVICES TAX ACT, 2017 (‘CGST ACT’):

The Government of India vide section 108 of the Finance Act, 2021 inserted a new clause (aa) along with an explanation to sub-section 1 of section 7 of the CGST Act which came into force from 1^st day of January 2022.

Section 7(1)(aa) of the CGST Act reads as follows:

“(aa) the activities or transactions, by a person, other than an individual, to its members or constituents or vice-versa, for cash, deferred payment or other valuable consideration.

Explanation.––For the purposes of this clause, it is hereby clarified that, notwithstanding anything contained in any other law for the time being in force or any judgment, decree or order of any Court, tribunal or authority, the person and its members or constituents shall be deemed to be two separate persons and the supply of activities or transactions inter se shall be deemed to take place from one such person to another;”

The term ‘person’ is defined under section 2(84) of the CGST Act, which reads as follows:

“(84) "person" includes,-

(a) an individual;

(b) a Hindu Undivided Family;

(c) a company;

(d) a firm;

(e) a Limited Liability Partnership;

(f) an association of persons or a body of individuals, whether incorporated or not, in India or outside India;

(g) any corporation established by or under any Central Act, State Act or Provincial Act or a Government company as defined in clause (45) of section 2 of the Companies Act, 2013 (18 of 2013.);

(h) any body corporate incorporated by or under the laws of a country outside India;

(i) a co-operative society registered under any law relating to co-operative societies;

(j) a local authority;

(k) Central Government or a State Government;

(l) society as defined under the Societies Registration Act, 1860 (21 of 1860.);

(m) trust; and

(n) every artificial juridical person, not falling within any of the above;”

Clause (f) of the definition includes an association of persons or body of individuals to be considered as a person capable of provision of supply of goods or services of both. Further, the incorporation status of the association of persons or body of individuals is immaterial as it has been the specific deliberation of the legislature to include both, incorporated as well as unincorporated.

Section 7(1)(aa) excludes activities or transactions by individual, as it seems evident that except for an individual, all other person as defined in section 2(84) of the CGST Act, are capable of having members or constituents.

C. JUDGMENT OF ICICI ECONET IN TERMS OF DOCTINE OF MUTUALITY:

The Honorable Bangalore Tribunal in the year 2021, pronounced one of the notable judgment in the case of M/S. ICICI ECONET INTERNET AND TECHNOLOGY FUND AND OTHERS VERSUS COMMISSIONER OF CENTRAL TAX, BANGALORE NORTH - 2021 (7) TMI 216 - CESTAT BANGALORE (‘ICICI Fund’). The Tribunal decided on the appeal filed by ICICI Fund against the order passed by the department. The Tribunal affirmed the order of the department which alleged the leviability of services tax on the supposed services provided by the ICICI Fund to its beneficiaries / contributories. The Tribunal further held that ICICI Fund and the subscribers/ contributors/ investors are separate person in the eyes of law as the doctrine of mutuality of interest is not applicable.

ICICI Fund, an Alternative Investment Fund (‘AIF’), was established as a trust under the Indian Trusts Act, 1882 for carrying out Venture Capital Fund (‘VCF’) activities. ICICI Fund was registered with Securities Exchange Board of India (‘SEBI’) as per the SEBI (Venture Capital Fund) Regulations, 1996, as well as it had obtained other registrations under the Income Tax Act and Service Tax (Finance Act, 1994).

Basic framework of the VCF’s in the form of Trust is as follows:

1. The ‘Author/Settlor’ declares or reposes confidence,
2. The ‘Trustee’ accepts the confidence declared by the author/settlor for the benefit of the beneficiaries,
3. Terms and conditions of the trust are contained in the ‘Trust Deed’ or the ‘Indenture of Trust’ (‘IOT’),
4. The ‘Beneficiaries/ Contributors’ are invited by way of a ‘Private Placement Memorandum’ (‘PPM’),
5. Contribution received by the Trust from the beneficiaries/ contributors are held as asset with the Trust,
6. To ensure professionalism, ‘Investment Manager/ Asset Manager’ is appointed for which an ‘Investment Management Agreement’ is executed between the Trust and the Investment Manager.

The Hon’ble Tribunal concluded that there is breach or violation of the doctrine of mutuality between ICICI Fund and its subscribers/ contributors/ investors due to the explanations cited below:

1. The fund had concerned and involved itself in commercial activities. There is usage of discretionary powers by the fund which are beneficial to a certain class of investors or nominees, or employees or subsidiaries.
2. Distribution of huge amounts to AMC’s in the form of performance fee and carry interest resulted in actions which is beyond the interest of the subscribers/ contributors/ investors.
3. The fund has reserved certain powers to utilize the dividends or profits which would benefit ultimately the entities which are not subscribers/ contributors/ investors.
4. The fund has failed to pass the test laid down by the Hon’ble Supreme Court in the case of Bangalore Club supra.
5. The cases such as Calcutta Club ltd supra, Young Mens Indian Association supra etc. relied upon by the appellants drawing analogy of the clubs to the funds are not acceptable as there is basic difference between clubs and funds. Common man does not consider VCF’s as clubs and thus, such common understanding cannot be washed away.
6. The fund which is in the nature of trust was initiated with the profit motive and the activities are similar to those of a bank or a financial institution.

D. CONCLUSION:

Three conditions for establishing doctrine of mutuality:

Whether the three conditions laid down and analyzed in Royal Western India Turf Club Ltd supra and Bangalore Club supra respectively, to determine the presence of doctrine of mutuality can be established for the relationship between AIF’s and its beneficiaries / contributors.

The first condition lays down completeness of identity between contributors of the fund and the participators in the surplus. All contributors of the fund must be entitled to participate in the surplus and all the participants in the surplus must be the contributors to the common fund. Although, it is not necessary that the contributors of the fund should distribute the surplus amongst themselves. Having the right of disposal over the surplus would also be enough.

The second conditions lays down that the association must be obedient to the complete mandate of the contributors. The principles, objects, memorandum or the actions of the association must be solely for appraising the benefits of the contributors or the members. The surplus receipts must be utilized for furtherance of the mandate of the contributors.

In the arrangement of an AIF, all the contributions and the surplus earned out of such contributions is distributed amongst the contributors or the beneficiaries of the fund after deduction of certain expenses which are necessary to carry out the day to functions or operations and to achieve the common goal and motive. The only goal and motive for formation and establishment of all the AIF’s is ultimately earning surplus or profit. To achieve such goal and motive, investment managers are appointed whose sole responsibility is to advise the fund on certain investments which leads to achieving profitability out of the funds contributed by the contributors. For rendering of such services, the investment managers charge certain consideration in the nature of performance fee or carry interest for their professional expertise. Such an expense incurred by the Fund ultimately results in generation of profits and surplus to the contributors. The existence of investment managers does not hamper the completeness of the identity of contributors and the beneficiaries. It is imperative to understand the motive and intention for which the AIF’s are established. The motive of AIF’s is not to provide consideration to the investment managers. Rather, the only motive is to earn the profit or surplus for the contributors.

Further, as discussed above, the only motive of AIF’s is to earn profit or surplus. Such profits or surplus is earned by AIF’s by investment in various vehicles such as startups, other funds or companies and ventures. By this, the fund enters the shoes of investor, though investing on behalf of the contributors. Such investment transaction undertaken by the fund as investor is all together an independent transaction. Investments made by the fund is to earn profits or surplus on behalf of the contributors and at the end, distribute such profits amongst them. The existence of investee entities does not negate completeness of the identity amongst contributors and beneficiaries. There always exists a completeness of identity even if the funds are invested. Further, the activity of undertaking investment is naturally abiding with the complete mandate of the contributors which is to earn surplus and profits.

The third condition lays down that there should not be any profit derived out of the contributions which can only be used or returned to the contributors. This condition essentially says that the contributors should not make any profit out of the contributions made by them. Such profits should not be at the cost of their collective contribution from the fund. Contributors come together and contribute to a common pool by way of creation of a vehicle. Such vehicle is established to achieve a common goal or motive. Such common pool should not be exposed to expense which result in profits to the contributors. However, this condition should not create a bar for the fund to earn profit for and on behalf of the contributors out of the contributions pooled together. This condition does not stop the fund to earn profits.

There are two separate and distinct transactions in case of AIF’s. First is the contribution pooled together by the contributors into the AIF, and second is the investment of such contributions by the AIF. The third condition restricts the profit earning capacity from the first transaction i.e. the profits if paid by the fund to the contributors which shall be recorded as expense in the books of the AIF. There is no restriction on the profits to be earned by the AIF from its investments. It is held by the Madras High Court in the case of COMMISSIONER OF INCOME-TAX VERSUS MADRAS RACE CLUB - 1995 (7) TMI 15 - MADRAS HIGH COURT that principle of mutuality cannot be violated due to profits derived from non members / contributors. Doctrine of mutuality should be analyzed qua each transaction in isolation and not on the entity as a whole. The transaction of collection of funds by the AIF from the contributors is mere flow of money from the contributors to the fund and cannot be treated as consideration in the hands of AIF. Thus, this transaction wholly and reasonably satisfies all the three conditions laid down by the Honorable Supreme Court of India.

Further, it is significant to know that under the Income Tax Act, 1961, the funds are liable to pay income tax on the profits and capital gains earned out of their investments. However, such profits to the funds are exempted under section 10 of the Income Tax Act and by way of pass through status, the contributors are liable to pay tax on the profits earned by the fund. This clearly shows that, even under the Income Tax Act, the contribution and then distribution of funds along with profits by the AIF’s to the contributors is nothing but mere flow of money in terms of doctrine of mutuality.

Amendment to CGST Act by inserting section 7(1)(aa):

The purpose of inserting a new sub section can be observed as a step to overcome the ruling pronounced by the Honorable Supreme Court in the case of Calcutta Club Ltd. supra. Although, the definition of ‘person’ had covered the association of persons or body of individuals into its gambit, there was a specific need to include such transactions into the definition of supply.

This section outplays the concept of doctrine of mutuality by way of a deeming fiction by announcing that the persons, capable of having members or constituents, shall be deemed to be two different persons and any supply between or amongst such persons shall be deemed to be supply by the person to its members or constituents or vice a versa. Thus, the sub section is based on the three pillars of notwithstanding clause, and two deeming fictions.

The explanation to the section itself acknowledges the existence of mutuality by way of using the words “inter se”. Also, the deeming fictions created in the definition can be directed towards the conclusion of existence of mutuality in the first place. The constitutional validity of such deeming fictions and disbanding of universal concepts by legislature is not yet tested in the Courts, but it may be interesting to observe how the Courts interpret the existence of such deeming fictions and disbanding of universal concepts. The doctrine of mutuality is naturally a universal concept, and it is difficult to deconstruct such universal concepts for the purpose of taxation statute.

The following are the debatable questions with respect to section 7(1)(aa) of the CGST Act, that may arise before us are:

1. Vires of section 7(1)(aa) of the CGST Act, i.e. whether, the section has been inserted within the four corners of the Constitution of India with sufficient power to legislate tax on such transactions?
2. Whether the section has done away with the ratio laid down in Calcutta Club Ltd supra and Young Mens Indian Association supra?
3. Whether the doctrine of mutuality still exists after notably creating a deeming fiction disbanding the universal doctrine within the legislature itself?