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TMI Blog2013 (1) TMI 343X X X X Extracts X X X X X X X X Extracts X X X X ..... 95- 96, 1996-97, 1997-98, 1998-99 and 1999-2000, the assessee sought an exemption from payment of income tax on the interest earned on the fixed deposits kept with certain banks, which were corporate members of the assessee, on the basis of doctrine of mutuality. However, tax was paid on the interest earned on fixed deposits kept with non-member banks. The assessing officer rejected the assessee's claim, holding that there was a lack of identity between the contributors and the participators to the fund, and hence treated the amount received by it as interest as taxable business income. On appeal by the assessee, the Commissioner of Income Tax (Appeals)-II, Bangalore ("CIT (A)" for short) reversed the view taken by the assessing officer, and held that the doctrine of mutuality clearly applied to the assessee's case. On appeal by the revenue the Income- Tax Appellate Tribunal (for short "the Tribunal"), affirmed the view taken by the CIT (A), observing thus (ITA No. 2440/Ban/1991): "7. In the instant case, the funds of the club are given in the form of deposits for earning income from the corporate members, namely, the banks here and, therefore, the earning of intere ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... aring for the assessee strenuously urged that the assessee meets all the requirements, as laid down in The English & Scottish Joint Co-operative Wholesale Society Ltd. Vs. The Commissioner of Agricultural Income Tax, Assam[AIR 1948 PC 142 (E)], as affirmed by this Court in Chelmsford Club Vs. Commissioner of Income Tax, Delhi[(2000) 3 SCC 214] in order to fall within the ambit of the principle of mutuality. According to the learned counsel, there is a complete identity between the contributors to the fund and the assessee and the recipients from the funds, in as much as the interest earned by the assessee from the surplus fund invested in fixed deposits with member banks are always available and are used for the benefit of members alike. It was asserted that there is no commercial motive involved in the dealings of the assessee with its members, including the banks concerned. It was also argued that the interest earned on such deposits with the member banks was always available for use and benefit of the members of the assessee, in as much as the said interest merged with the common fund of the club. 6. Mr. A.S. Chandhiok, learned Additional Solicitor General of India, on ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... receiving a financial benefit from the surrender of their membership. A further feature of licensed clubs is that there are both membership fees and, where prices charged for club services are greater than their cost, additional contributions. It is these kinds of prices and/or additional contributions which constitute mutual income. 8. The doctrine of mutuality finds its origin in common law. One of the earliest modern judicial statements of the mutuality principle is by Lord Watson in the House of Lords, in 1889, in Styles (Surveyor of Taxes) Vs. New York Life Insurance Co.[[1889] 2 TC 460 ] (hereinafter referred to as the "Styles case"). The appellant in that case was an incorporated company. The company issued life policies of two kinds, namely, participating and non- participating. The members of the mutual life insurance company were confined to the holders of the participating policies, and each year, the surplus of receipts over expenses and estimated liabilities was divided among them, either in the form of a reduction of future premiums or of a reversionary addition to the policies. There were no shares or shareholders in the ordinary sense of the term but each a ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... tribute funds for a common purpose ... 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." 9. Lord Watson's statement was explained by the House of Lords in The Commissioners Of Inland Revenue Vs. The Cornish Mutual Assurance Co. Ltd.[[1926] 12 T.C. 841 (H.L.)] wherein it was held that a mutual concern may be held to carry on a business or trade with its members, though the surplus arising from such trade is not taxable income or profit. 10. The High Court of Australia first considered the mutuality principle in The Bohemians Club Vs. The Acting Federal Commissioner of Taxation[(1918) 24 CLR 334] in 1918: "A man is not the source of his own income ... A man's income consists of moneys derived from sources outside of himself. Contributions made by a person for expenditure in his business or otherwise for his own benefit cannot be regarded as his income ... The contributions are, in substance, advances of capital for a common purpose, which are expected to be exhausted during the ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... s certain activities, certain members only of the association take advantage of the facilities which it offers does not affect the mutuality of the enterprise. * * * Members' clubs are an example of a mutual undertaking; but, where a club extends facilities to non-members, to that extent the element of mutuality is wanting...." 14. Simon's Taxes, Vol. B, 3rd Edn., paras B1.218 and B1. 222 (pp. 159 and 167) formulate the law on the point, thus: "..it is settled law that if the persons carrying on a trade do so in such a way that they and the customers are the same persons, no profits or gains are yielded by the trade for tax purposes and therefore no assessment in respect of the trade can be made. Any surplus resulting from this form of trading represents only the extent to which the contributions of the participators have proved to be in excess of requirements. Such a surplus is regarded as their own money and returnable to them. In order that this exempting element of mutuality should exist it is essential that the profits should be capable of coming back at some time and in some form to the persons to whom the goods were sold or the services rendered.... ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ty as a class, so that at any given moment of time the persons who are contributing are identical with the persons entitled to participate; it does not matter that the class may be diminished by persons going out of the scheme or increased by others coming in...." (Emphasis supplied) 17. In Jones Vs. South-West Lancashire Coal Owners' Association Ltd.[1927 AC 827], Viscount Cave LC held that "sooner or later, in meal or in malt, the whole of the associations" receipts must go back to the policy holders as a class, though not precisely in the proportions in which they have contributed to them and the association does not in any true sense make any profit out of their contributions. 18. Therefore, in the case of Royal Western India Turf Club Ltd. (supra), since the club realized money from both members and non- members, in lieu of the same services rendered in the course of the same business, the exemption of mutuality could not be granted. This Court held thus: "As already stated, in the instant case there is no mutual dealing between the members inter se and no putting up of a common fund for discharging the common obligations to each other undertake ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... lves. The locus classicus pronouncement comes from Rowlatt, J's observations in Thomas Vs. Richard Evans & Co. Ltd.[(1927) 11 TC 790] wherein, while interpreting Styles case (supra), he held that if profits are distributed to shareholders as shareholders, the principle of mutuality is not satisfied. He observed thus: "But a company can make a profit out of its members as customers, although its range of customers is limited to its shareholders. If a railway company makes a profit by carrying its shareholders, or if a trading company, by trading with the shareholders - even if it limited to trading with them - makes a profit, that profit belongs to the shareholders, in a sense, but it belongs to them qua shareholders. It does not come back to them as purchasers or customers. It comes back to them as shareholders, upon their shares. Where all that a company does is to collect money from a certain number of people - it does not matter whether they are called members of the company, or participating policy holders - and apply it for the benefit of those same people, not as shareholders in the company, but as the people who subscribed it, then, as I understand the New York case, ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... enture in the nature of trade and the transactions entered into with the members or non-members alike is a trade/business/transaction and the resultant surplus is certainly profit - income liable to tax. We should also state, that "at what point, does the relationship of mutuality end and that of trading begin" is a difficult and vexed question. A host of factors may have to be considered to arrive at a conclusion. "Whether or not the persons dealing with each other, is a 'mutual club' or carrying on a trading activity or an adventure in the nature of trade", is largely a question of fact [Wilcock's case - 9 Tax Cases 111, (p.132); C.A. (1925) (1) KB 30 at p. 44 and 45]." 24. In Royal Western India Turf Club Ltd. (supra), this Court made similar observations, holding that it is not always the case that a legal entity cannot make profits out of its members. It held as follows : "14...The principle that no one can make a profit out of himself is true enough but may in its application easily lead to confusion. There is nothing 'per se' to prevent a company from making a profit out of its own members. Thus a railway company which earns profits by carrying passengers may ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ird parties outside of the mutuality, rupturing the 'privity of mutuality', and consequently, violating the one to one identity between the contributors and participators as mandated by the first condition. Thus, in the case before us the first condition for a claim of mutuality is not satisfied. 27. As aforesaid, the second condition demands that to claim an exemption from tax on the principle of mutuality, treatment of the excess funds must be in furtherance of the object of the club, which is not the case here. In the instant case, the surplus funds were not used for any specific service, infrastructure, maintenance or for any other direct benefit for the member of the club. These were taken out of mutuality when the member banks placed the same at the disposal of third parties, thus, initiating an independent contract between the bank and the clients of the bank, a third party, not privy to the mutuality. This contract lacked the degree of proximity between the club and its member, which may in a distant and indirect way benefit the club, nonetheless, it cannot be categorized as an activity of the club in pursuit of its objectives. It needs little emphasis that the seco ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... comes back to them as shareholders, upon their shares. Where all that a company does is to collect money from a certain number of people - it does not matter whether they are called members of the company, or participating policy holders - and apply it for the benefit of those same people, not as shareholders in the company, but as the people who subscribed it, then, as I understand the New York case, there is no profit. If the people were to do the thing for themselves, there would be no profit, and the fact that they incorporate a legal entity to do it for them makes no difference, there is still no profit. This is not because the entity of the company is to be disregarded, it is because there is no profit, the money being simply collected from those people and handed back to them, not in the character of shareholders, but in the character of those who have paid it. That, as I understand it, is the effect of the decision in the New York case." (Emphasis supplied) In the present case, the interest accrues on the surplus deposited by the club like in the case of any other deposit made by an account holder with the bank. 30. An almost similar issue arose in Kumbako ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... availed by its members, before it is deposited with the bank. This surplus amount was not treated as income; since it was the residue of the collections left behind with the club. A façade of a club cannot be constructed over commercial transactions to avoid liability to tax. Such setups cannot be permitted to claim double benefit of mutuality. We feel that the present case is a clear instance of what this Court had cautioned against in Bankipur Club (supra), when it said: "... if the object of the assessee company claiming to be a "mutual concern" or "club", is to carry on a particular business and money is realised both from the members and from non- members, for the same consideration by giving the same or similar facilities to all alike in respect of the one and the same business carried on by it, the dealings as a whole disclose the same profit earning motive and are alike tainted with commerciality. In other words, the activity carried on by the assessee in such cases, claiming to be a "mutual concern" or Members' club" is a trade or an adventure in the nature of trade and the transactions entered into with the members or non- members alike is a trade/business ..... X X X X Extracts X X X X X X X X Extracts X X X X
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