2020 (4) TMI 827 - SC - Income Tax

Doctrine of mutuality - Exemption from taxability - excess of income over expenditure - Common Identity - Oneness with the members / contributors - Completeness of Identity - Non-profiteering and Obedience to Mandate - assessee incorporated by YRIPL as its fully owned subsidiary after having obtained approval from the Secretariat for Industrial Assistance (for short SIA ) for the purpose of economisation of the cost of advertising and promotion of the franchisees as per their needs - HELD THAT - What is prohibited is the infusion of a participant in the transaction who does not become a member of the common fund, at par with other members, and yet participates either in the contribution or surplus without subjecting itself to mutual rights and obligations. The principle of common identity prohibits any one dimensional alteration in the nature of participation in the mutual fund as the transaction fructifies. Any such alteration would lead to the non-uniform participation of an external element or entity in the transaction, thereby opening the scope for a manifest or latent profitbased dealing in the transaction with parties outside the closed circuit of members. It would be amenable to income tax as per Section 2(24) of the 1961 Act. In the present case, it is indisputable that Pepsi Foods Ltd. is a contributor to the common pool of funds. However, it does not participate in the surplus as a beneficiary for at least two reasons first, Pepsi is not a member of the purported mutual concern as the Tripartite Agreement as well as the terms of SIA approval permit only franchisees to become members of the mutual concern. Notably, Pepsi Foods Ltd. is not a franchisee and thus, it cannot participate in the surplus. Second, Pepsi does not enjoy any right of participation in the surplus or any right to receive back the surplus which are mandatory ingredients to sustain the principle of mutuality. The contention of the assessee company that Pepsi Foods Ltd., in fact, does benefit from the mutual operations by virtue of its exclusive contracts with the franchisees is tenuous, as the very basis of mutuality is missing as far as Pepsi Foods Ltd. is concerned, as discussed hitherto. Even if any remote or indirect benefit is being reaped by Pepsi Foods Ltd., the same cannot be said to be in lieu of it being a member of the purported mutual concern and therefore, cannot be used to fill the missing links in the chain of mutuality Surplus of a mutual operation is meant to be utilised by the members of the mutual concern as members enjoy a proximate connection with the mutual operation. Non-members, including Pepsi Foods Ltd., stand on a different footing and have no proximate connection with the affairs of the mutual concern. The exclusive contract between the franchisees and Pepsi Foods Ltd. stands on an independent footing and YRIPL as well as the assessee company are not responsible for implementation of this contract. Resultantly, the first limb of the three pronged test stands severed. In the present case, even if any surplus is remaining in a given assessment year, it is unlikely to reduce the liability of the franchisees in the following year as their liability to the extent of 5 per cent is fixed and non-negotiable, irrespective of whether any funds are surplus in the previous year. The only entity that could derive any benefit from the surplus funds is YRIPL, i.e. the parent company. This is antithetical to the third test of mutuality. Exemption granted to a mutual concern is premised on the assumption that the concern is being run for the mutual benefit of the contributors and the contributions made by the members ought to be directed in that direction. Contrary to this fundamental tenet, clause 8.1 of the Tripartite Agreement relieves the assessee company from any specific obligation of spending the amounts received by way of contributions for the benefit of the contributors. It explicates that the assessee company does not hold such amount under any implied trust for the franchisees The doctrine of mutuality bestows a special status to qualify for exemption from tax liability. It is a settled proposition of law that exemptions are to be put to strict interpretation. The appellant having failed to fulfil the stipulations and to prove the existence of mutuality, the question of extending exemption from tax liability to the appellant, that too at the cost of public exchequer, does not arise. Difference between purported mutual concern (assessee company) and clubs - Held that - In the case of clubs, the operations are exempted from taxability because of the underlying notion that they operate for the common benefit of the members wishing to enter into a social exchange with no commercial intent. Further, all the members of the club not only have a common identity in the concern but also stand on an equal footing in terms of their rights and liabilities towards the club or the mutual undertaking. Such clubs are a means of social intercourse, as rightly observed by CIT (A) in the present case, and are not formed for the facilitation of any commercial activity. On the contrary, the purported mutual concern in the present case undertakes a commercial venture wherein contributions are accepted both from the members as well as non-members, as discussed earlier. Moreover, one member is vested with a myriad set of powers to control the functioning and interests of other members (franchisees), even to their detriment. Such an assimilation cannot be termed as a case of ordinary social intercourse devoid of commerciality. Once it is conclusively determined that the assessee company had not operated as a mutual concern, there would be no question of extending exemption from tax liability. Application of income by overriding title - It is urged that once the incoming amount is earmarked for an obligation, it does not become income in the hands of the assessee as no occasion for the application of such income arises. - Held that - the question of diversion by overriding title was neither framed nor agitated in the appeal memo before the High Court or before this Court (except a brief mention in the written submissions), coupled with the fact that neither the Tribunal nor the High Court has dealt with that plea and that the rectification application raising that ground is still undecided and stated to be pending before the Tribunal - Argument rejected. Decided against the assessee.

Summary

Issues Involved:
1. Applicability of the doctrine of mutuality to the assessee company.
2. Taxability of the excess of income over expenditure in the hands of the assessee company.

Detailed Analysis:

1. Applicability of the Doctrine of Mutuality to the Assessee Company:
The primary issue revolves around whether the assessee company qualifies as a mutual concern, thereby exempting it from tax liability. The doctrine of mutuality is based on the principle that a person cannot trade with themselves, and thus, any surplus generated from mutual activities is not considered taxable income.

Common Identity:
The court examined if there was a common identity between the contributors and beneficiaries. It was found that Pepsi Foods Ltd., a contributor, was not a member of the mutual concern as it was neither a franchisee nor entitled to participate in the surplus. This breached the principle of common identity, as the doctrine requires that all contributors must also be beneficiaries.

Completeness of Identity:
The court noted that the contributions from Pepsi Foods Ltd. and the discretionary contributions from YRIPL (the parent company) violated the requirement for a complete identity between contributors and beneficiaries. The Tripartite Agreement allowed YRIPL to contribute at its discretion, which was contrary to the mutuality principle that mandates equal contribution obligations.

Non-profiteering and Obedience to Mandate:
The court found that the assessee company’s operations were tainted with commerciality due to contributions from non-members and the discretionary nature of YRIPL’s contributions. The management structure, which placed YRIPL in a controlling position over the franchisees, further contradicted the mutuality principle, which requires reciprocal rights and obligations among members.

Conclusion on Mutuality:
The court concluded that the assessee company did not operate as a mutual concern due to the inclusion of non-members in the contribution pool, the discretionary nature of contributions from YRIPL, and the overall commercial nature of its operations. Therefore, the doctrine of mutuality did not apply.

2. Taxability of the Excess of Income Over Expenditure:
Given that the assessee company did not qualify as a mutual concern, the court addressed the taxability of the surplus income.

Trust Argument:
The assessee contended that it acted as a trustee for the contributors and was under an overriding obligation to spend the contributions on advertising, marketing, and promotional activities. The court referred to established legal principles distinguishing between diversion of income before accrual and application of income post-accrual. It was noted that the contributions received by the assessee were not diverted at source but were instead applied to discharge obligations after reaching the assessee.

Pending Rectification Application:
The court acknowledged that the assessee had filed a rectification application under section 254(2) of the Income Tax Act, which was still pending. The court left it open for the assessee to pursue this rectification application, without expressing any opinion on its tenability.

Conclusion on Taxability:
The court upheld the findings of the lower authorities, confirming that the surplus income in the hands of the assessee was taxable. The appeal was disposed of, with the court affirming the High Court's judgment and granting the assessee the liberty to pursue the pending rectification application.

Final Judgment:
The Supreme Court dismissed the appeal, holding that the assessee company did not qualify as a mutual concern and that the surplus income was taxable. The court allowed the assessee to pursue the pending rectification application regarding the issue of diversion by overriding title.